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The global oil crisis is even worse than it looks

Even if the Iran war ends tomorrow, high energy prices will persist.

The oil market’s worst nightmare just came true.

For decades, energy traders have feared that a war might one day close the Strait of Hormuz — the narrow waterway that links the Persian Gulf’s oil reserves to global markets. Before today’s war in Iran, about one-third of the world’s seaborne oil exports and a fifth of global natural gas shipments flow through the strait each day.

Iran has long had the power to block that artery. And it threatened to do so, repeatedly. But it could not follow through on that threat without gravely damaging its own economy. Thus, investors always viewed that scenario as a “tail risk” — a grim but wildly improbable hypothetical.

Now, it is our reality.

As a result, oil prices have soared and Gulf state producers have throttled production, as they have no way to get all their crude to market – and no place to put their unsold stocks.

Today’s oil shock is largest in history.

The United States probably can’t clear the Strait of Hormuz without ending its war with Iran.

Rising oil prices will slow industrial activity and raise food costs.

Markets may be too optimistic about how quickly the war’s impacts can be reversed.

The scale of today’s crisis is unprecedented. And its trajectory is hard to discern. Investors appear profoundly uncertain about where we’re heading: During the past week, oil prices have repeatedly risen or fallen by more than 20 percent in a single day.

If anyone knows what the Iran war will mean for the global economy, however, it might be Gregory Brew.

Brew is a historian of both the Iranian regime and world oil markets. As a senior analyst at the Eurasia Group, he has spent years advising investors on the risks posed by the conflict between Iran, the US, and Israel.

We spoke on Tuesday about how today’s oil shock will impact the economy, the obstacles to a quick ceasefire — and why it may already be too late to avoid a prolonged energy crisis. Our conversation has been edited for clarity and concision.

How big is today’s oil shock, in historical context? Does this resemble any past crisis or is it unprecedented?

In terms of barrels taken off the market, this is the largest supply shock in history by at least a factor of two. The only one that comes close is the 1979 shock, which also involved Iran, and which caused oil prices to more than double. But the current disruption — 20 million barrels a day unable to flow for over a week — is twice that size in real terms.

So, we’re very much in an unprecedented situation. Which is part of why markets have struggled to interpret it. For years, Iran has threatened to close the Strait of Hormuz and it never happened. On some level, I think traders came to believe that Iran would never really do it. Now, many believe that it’s a situation that won’t last much longer despite the fact that we’re in the second week and it doesn’t show any signs of ending.

The immediate consequences of an oil shock are obvious: higher gasoline and energy prices. But what are the downstream effects of a historic drop in the global fossil fuel supply? What are the biggest second-order impacts?

The increase in domestic gasoline prices is the most immediate and politically salient effect, but it’s not really the most important one. I would say the most important effect is higher prices for middle distillates — particularly diesel. Higher diesel prices make construction and industrial activity more expensive, not only in the United States but worldwide. That broadly depresses economic activity.

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