The energy crisis, three months in

The closure of the Strait of Hormuz – a critical transit route for global oil and gas – has long been considered a worst-case scenario for energy markets. Yet, ten weeks into a crisis that has seen the effective closure of the Strait, the global economy appears surprisingly resilient. The global economy is expected to grow by around 3.0% this year, only modestly below 3.4% in 2025 and close to trend. Equity markets, meanwhile, remain near record highs. The experience so far contrasts with the deep recessions triggered by energy shocks in the 1970s and early 1980s.

This resilience has a number of sources. Investment into AI and optimism about the sector have helped bolster US growth and buoy equity markets. The structure of the global economy has changed: advanced economies are now less energy-intensive, and the energy mix has diversified, with renewable energy and US fossil fuel production helping reduce reliance on Middle Eastern supply. Crucially, oil-importing countries now maintain strategic petroleum reserves, providing a buffer that was absent in earlier crises.

This buffer has, so far, done what it was designed to do and has absorbed much of the shock from the disruption to Middle Eastern energy supply. The Economist estimates oil supply has fallen by around 12 million barrels per day (bpd) – just over 10% of pre-conflict levels. Roughly eight million bpd of this shortfall is being offset by drawing down existing inventories. The remaining adjustment – around four million bpd – has come through so-called demand destruction, with higher energy prices suppressing activity and reducing energy consumption.

The fragmented nature of energy storage, with different refined products held across a large number of public and private facilities, makes it impossible to assess the precise level of remaining stocks. What is clear is that the current pace of depletion is not sustainable. As inventories are depleted, and assuming no resumption of supply, a larger share of the adjustment will have to come through weaker demand.

Demand destruction is most visible in Asia, which accounts for roughly 80% of Gulf energy exports. Economies including India, Japan, South Korea and Taiwan are heavily reliant on Middle Eastern energy supplies. Some governments in the region have responded with a mix of administrative and behavioural measures, including promoting working from home, restricting air conditioning use, and encouraging public transport. Signs of some oil product shortages are also emerging in parts of East Africa and Eastern Europe.

Most oil consumed in Europe is sourced from outside the Middle East, meaning the region has been less exposed to the initial disruption, though higher prices are hitting firms and households. Rich European economies will tolerate higher fuel bills for longer than less-developed nations can, so there is less demand destruction. Still, high energy prices are squeezing corporate margins and hitting discretionary spending in Europe. Governments are trying to mitigate the pain – The Economist notes that 16 of the EU’s 27 member states have cut fuel duty or are subsidising energy bills.

The GDP numbers do not tell the whole story of how higher energy prices are affecting the economy. Shortages for certain refined petroleum products, due to bottlenecks and reliance on particular refineries, are having significant sector-level impacts.

The price of jet fuel has doubled since April, sharply increasing costs for airlines and feeding through to the wider travel sector. Tui, Europe’s largest travel firm, has reported summer bookings down 7% year-on-year and suspended its revenue guidance amid heightened uncertainty.

US automakers including Ford, General Motors and Stellantis estimate that the crisis has added a combined $5bn to costs, as supply chains for energy-intensive inputs such as aluminium and plastics are disrupted. Firms in Asia are warning of a plastic crisis, with shortages of naphtha, the petroleum product used to make plastic, hard to come by.

Meanwhile, higher energy prices are driving inflation up, eroding real incomes and tightening financial conditions as markets price in future interest rate rises. Growth forecasts are falling. In the UK, consensus expectations for GDP growth this year have fallen from 1.0% to 0.6% since the conflict.

A de-escalation – involving a US-Iran agreement and the reopening of the Strait – would lower energy prices, but it would take time for the system to get back to normal. Insurers and shipping companies would require assurances, and a persistent risk premium is likely to remain embedded in prices, reflecting the risk of future disruption.

The sustained loss of 10% of the world’s oil supply is bound to cause significant economic pain. As the stagflationary shock feeds through, oil inventories dwindle and demand destruction broadens, the risks to growth will mount. The buffers in the system have so far cushioned the impact of the shock. Without a resolution to the conflict, and a resumption of Middle Eastern supply, those buffers will become exhausted.