The nightmare war scenario is becoming reality in energy markets

ENERGY ANALYSTS modelling a war involving Iran have long feared two developments: the Islamic Republic lashing out at its oil-rich neighbours and a blockade of the Strait of Hormuz, through which a third of global seaborne crude and a fifth of liquefied natural gas (LNG) transit daily. Until February 28th both eventualities seemed remote. Iran had too much to lose: it would push Gulf states even closer to America, its sworn enemy; anger China, the main buyer of its oil; and invite strikes on its own petroleum infrastructure.

After America and Israel struck at the heart of the mullahs’ regime on February 28th, killing its supreme leader, what remains of it is desperate. And both aspects of the nightmare scenario are unfolding at once. Iranian missiles and drones have hit Saudi Arabia’s largest refinery, the world’s biggest LNG-export facility in Qatar, another refinery in Kuwait, fuel tanks in Oman and the Fujairah oil terminal in the United Arab Emirates (UAE), a major bunkering hub. The first two are offline, as are gasfields in Israel and Kurdistan.

Meanwhile, traffic through the Strait of Hormuz has largely stopped after drones struck several vessels and insurers suspended coverage for many others (see chart 1). On March 2nd the Islamic Revolutionary Guard Corps, the regime’s praetorian guard, declared the strait closed, warning that any ship attempting passage would be set ablaze. Energy prices are already burning up. Assurances on March 3rd by Donald Trump that America would provide insurance and guarantees for shipping lines, and, if necessary, a naval escort for tankers in the Gulf, have not cooled things down. Brent crude, the global benchmark, has jumped by 15% since February 27th, to $84 a barrel. In Europe a megawatt-hour (MWh) of natural gas costs €50 ($58), an increase of over 55% on the week (see chart 2). Prices in Asia have risen even faster.

The initial reaction to the American-Israeli campaign was contained. On March 2nd Brent finished the day at $78, just $5 above its pre-war close. European gas spiked but closed at €43 per MWh, well below the peak of over €310 in 2022, after Russia invaded Ukraine. Traders expected disruptions to last days, not weeks.

They are revising that view. Start with oil. The main problem is impeded traffic through the Gulf. Freight prices are hitting records (see chart 3). Only five oil tankers crossed the Strait of Hormuz on March 2nd, compared with a daily average of 51 in February, according to Vortexa, a ship-tracker. Some 14m barrels per day (b/d) of crude and 4m b/d of refined products usually pass through it. Only around a quarter of the crude can be rerouted via Saudi and UAE pipelines that bypass the strait. JPMorgan Chase, a bank, estimated on March 3rd that Iraq and Kuwait had about three and 14 days, respectively, before hitting storage limits and shutting in the crude supply they export via Hormuz—amounting to nearly 5m b/d, or 5% of global production. Iraq has already cut output by 1.6m b/d.

Gulf exporters have yet to declare force majeure on scheduled shipments. But traders expect some will, and soon. A measure of the premium Brent commands over oil traded in Dubai, which reflects the cost of hedging Atlantic crude sales to Asia, has rocketed (see chart 4). Asian buyers are turning to west Africa, America, Brazil, Guyana and Norway to plug shortfalls. On March 2nd Brazilian barrels for May delivery to China were offered at a $10 premium to Brent, up from $3.40 on February 27th.

Asian buyers will be the first to feel the pain. Although China, Japan and South Korea have stockpiled enough oil to last a few months, they rely on Gulf imports. These account for a third of China’s total demand. Trading in the most popular Chinese crude futures was halted on March 2nd after they tripped the 9% daily-increase limit. The authorities in China and other Asian countries have told refiners to halt diesel and petrol exports.

Asia’s scramble for alternatives will push up prices for everyone else. If oil does not start flowing again soon, Brent could hit $100 a barrel. Four weeks of disruption could push prices towards $150, reckons Kpler, a data firm. New supply from elsewhere could be unlocked, but even pulling every lever would yield only 1m-2m b/d—and take at least six months to materialise. Europe buys little Gulf crude but a fifth of its diesel transits Hormuz. Diesel “crack” spreads—the margins refiners earn when turning crude into finished fuel—have exploded in recent days.

A halt to gas supplies may hit harder and sooner. More than 80m tonnes of LNG sailed through Hormuz in 2025. Qatar’s Ras Laffan complex, shut on March 2nd, accounted for 75m tonnes, equivalent to 17% of global exports. Nearly 30 vessels due to load there in March are circling the Indian Ocean and Arabian Sea; another eight, already laden, are idling on the wrong side of the strait. None has crossed since March 1st. QatarEnergy, which operates Ras Laffan, has issued force majeure notices to some long-term buyers. The facility will stay shut for at least two weeks, according to Reuters, and will need another two once it restarts to reach capacity.

As with crude, gas is worrying Asian buyers. Last year Qatar supplied 30% of China’s LNG imports, 45% of India’s and 99% of Pakistan’s; Japan and South Korea buy lots, too. On March 3rd the measure of the profit earned from loading gas on America’s Gulf coast and sending it to Asia rather than elsewhere next month surged to its highest since 2022. Asian gas prices were so far above European ones that it would in theory have made sense to load tankers with LNG stored in Europe and ship it east, says Natasha Fielding of Argus Media. Importers from Bangladesh and India went into the spot market to seek new cargoes—but found nobody willing to sell to them. LNG freight costs from the Atlantic have never risen so fast in a day.

European prices will soon have to catch up with Asia’s, because buyers are starting to compete for the same spot cargoes. Gas storage in Europe, already below seasonal norms and 10% lower than a year ago, is running low with winter not yet over. Every week Hormuz stays shut, global supply shrinks by 1.5m tonnes, reckons Wood Mackenzie, a consultancy. As Asia and Europe drain storage faster and restock more aggressively over the summer, markets could stay tight long after the strait reopens. Anne-Sophie Corbeau of Columbia University expects panic to set in if Qatari exports do not resume by March 9th. Prices could soar beyond €100 per MWh.

The energy shock has already rocked some stockmarkets, especially in Asia. Its economic impact will be far-reaching. A rule of thumb from the IMF is that a 10% rise in the price of a barrel of oil cuts global GDP growth by 0.15 percentage points and raises inflation by 0.4 points the following year. If prices get to $100 a barrel, this would subtract some 0.4 points from GDP growth and raise inflation by 1.2 points.

Big energy importers will, naturally, suffer the most—and poor ones especially. Energy costs tend to make up a greater share of spending in less well-off places. India spends about 3% of GDP on foreign oil a year (and has barely 20-25 days of usable stocks); Thailand splurges nearly 5%. In both cases, though, costlier imports will be reflected not in higher consumer prices but in wider fiscal deficits, as governments force state-owned refineries to operate at a loss or hand out subsidies to consumers. Asia’s low inflation gives central banks more room to ignore a period of dearer energy—so long as it is brief and currencies, which could plunge as investors rush for safe havens, do not force their hand.

Europe is not so lucky. The European Central Bank reckons that a 10% increase in oil prices adds 0.4 percentage points to inflation directly plus another 0.2 points indirectly, over three years, as businesses pass higher costs on to consumers. A tenth of the increase in natural-gas prices also passes through to inflation in a year. Higher energy costs will feed through to power prices and sap industrial margins. If both oil and gas become dearer, substitution will become harder. This may revive coal demand and force consumers to cut back.

Despite causing the price shock, America will face less pain. Its domestic gas market has only a loose connection to global prices, owing to limited export capacity. Prices of gas piped to Henry Hub, the American benchmark, have jumped by only 4%. A study by the Dallas branch of the Federal Reserve suggests that a 10% increase in the price of crude raises those at the pump by 5%. But if they get uncomfortably high, America can always tap 415m barrels in its Strategic Petroleum Reserve. Energy makes up only a small part of the consumption basket. And since America produces lots of oil and gas, a price shock pushes up output rather than cutting it, as it does for net importers.

Mr Trump and his Republican Party may nevertheless suffer political consequences in the midterm elections. Voters are already furious over the rising cost of living. Higher energy prices may boost economic aggregates, but they also redistribute income from America’s many energy consumers to its small number of energy producers. They may also make it harder for the Fed to cut interest rates. Traders have trimmed bets that the central bank will do so at least twice this year.

No wonder Mr Trump wants to soothe energy markets with naval escorts and insurance plans. “No matter what”, he said on social media, America “will ensure the FREE FLOW of ENERGY to the WORLD”. He is up against an adversary that is setting out to make America feel its pain. ■