International Monetary Fund produces gloomy scenarios
International Monetary Fund I created some scenarios About what might happen once the war against Iran and its impact on global energy supplies and prices ends. What it fails to do is reveal the long-term consequences of one of the largest disruptions in energy markets in history.
The IMF’s “reference” forecast, which assumes that the war will end soon and its impact will fade by mid-year, is that global growth will slow to 3.1 percent, from the pre-war forecast of 3.3 percent (which it plans to raise to 3.4 percent). Global inflation is expected to rise to 4.4 percent, compared to the IMF’s January forecast of 3.8 percent.
In the “negative” scenario, which envisages large and longer-term increases in oil and gas prices, global growth is expected to slow down to 2.5 percent and inflation to reach 5.4 percent.
Under the “severe” scenario, which includes further damage to regional energy infrastructure, global growth would fall to just 2 percent this year and inflation would rise above 6 percent by 2027.
Thus, the impact of the war initiated by the US and Israel, even if it ends soon, will range from very damaging to seriously damaging; Poorer countries, those dependent on imported energy, and those unintentionally involved in the conflict (Iran’s neighbors) will be hardest hit.
Even energy exporting countries such as Australia or the USA are not immune from the rise in global energy prices and supply shortages, with the IMF reducing expected growth rates and increasing expected inflation rates.
The world, now knowing that Iran can close the strait whenever it wants, will not allow itself to become so dependent on such a volatile region again.
While Donald Trump and his advisors appear to believe that oil and gas supplies and prices will return to “normal” with the forced or negotiated reopening of the Strait of Hormuz, this is unlikely, and in fact the history of previous oil shocks suggests that this will not happen.
The memories and scars of the closure of the strait and the near-total halt of nearly 20 percent of the world’s flow of oil and oil-derived products will not be easily erased from the consciousness of energy-dependent economies and businesses.
The damage to the region’s infrastructure, the hub of more than 30 percent of the world’s oil and natural gas and a vital global producer of fertilizers and their precursors, petrochemicals and aluminium, will not be recovered for months or, in some cases (such as Qatar’s LNG facilities), years.
The world will not allow itself to become so dependent on such a volatile region again, knowing that Iran can close the strait at will and target the region’s energy infrastructure regardless of whatever deal the Americans can ultimately negotiate.
The developed world, which is overly dependent on the United States for security, will also not rely on the United States to resolve any future conflicts.
The rest of the world had already lost confidence in the Trump administration. Its military may have demonstrated its might, but its political leadership has shown a shameful lack of strategic foresight, given that Iran has flagged how it will respond to any attack.
Previous oil shocks changed the world.
Following the 1973 Arab oil embargo, the world was plunged into stagflation (low economic growth, high inflation) and recession. There was global economic turmoil.
By the end of the decade in the United States (and after another oil crisis in 1979), interest rates approached 20 percent as the Federal Reserve and its peers struggled to control inflation.
These shocks in the 1970s changed the world’s use of oil; The oil intensity of economic growth then fell consistently and dramatically.
Industries invested in energy efficiency, consumers (even in the US) turned to smaller vehicles (leading to a boom in the Japanese auto industry), a number of new nuclear power plants were built in Japan and Europe, the fledgling LNG industry was given a massive and lasting boost, and the seeds were planted for the future growth of renewables.
Control of the oil industry passed to OPEC, a cartel that provided geopolitical influence in the Middle East, cemented by the Nixon administration’s agreement to maintain American dominance of the world financial system after the collapse of the Bretton Woods agreement in 1971.
The United States signed a deal with the Saudis promising to denominate future oil sales in U.S. dollars and use dollar reserves to purchase U.S. assets in exchange for security guarantees. “Petrodollars” have since strengthened the dollar’s dominance.
The demand side of the energy sector’s supply-demand equation will change as the United States shows the rest of the world how vulnerable it is to supply disruptions from the Middle East and how vulnerable the Middle East is to disruptions.
Further efforts will be made to reduce dependence on oil-derived products such as gasoline and diesel in transportation, energy and energy-intensive industries such as steel, aluminum and cement. Renewable energy and electrification of transportation (electric cars and trucks) will see greater momentum.
Attempts will be made to diversify the supply.
The US is already benefiting from its war, with a queue of tankers normally heading towards its shores with their cargo from the Middle East.
But that will lead to higher US gasoline and diesel prices (gasoline is $1 per gallon and diesel is $2 per gallon higher than a year ago) and growing discontent among households and those who will vote in this year’s midterm elections – and it’s already flowing.
This greatly increased international demand will also put pressure on U.S. refineries, which are now struggling to secure oil and paying higher prices for their raw materials.
Others that could benefit are non-Middle Eastern oil producers such as Brazil, Guyana and Australia; Our extensive gas reserves here put us in a good position to capitalize on the inevitable demand for more LNG in our region.
Regardless of when the conflict ends, it is likely to create a structural change in oil and gas prices (a risk premium) relative to if the conflict had never occurred. Insurance and transportation risk premiums will also increase; The cost of shipping oil and gas from the Middle East will increase.
This will also have an impact on geopolitics. The United States has damaged its reputation and global authority with the war, pressure and threats against former allies, and before that, Trump’s trade wars.
China, which built oil reserves of more than a billion barrels before the crisis, has access to Russian oil and gas, and has the most electrified advanced economy (while also commanding many of the critical inputs for electrification), is emerging stronger.
The drive to internationalize the yuan would be aided by the increased use of the currency in trade through the strait, which could be a more permanent feature of the post-war environment if Iran retains control of the passage.
There will also be lasting macroeconomic impacts. In response to increases in energy prices, countries are capping and subsidizing gasoline and diesel prices, lowering taxes, and financing other measures to secure supply and mitigate price impacts.
The world was already struggling with debt before the war, with most developed economies running debt and deficits at record levels.
War will increase both, leading to greater calls on debt markets, higher interest rates, and higher debt servicing costs for governments, especially in the United States, which are shifting their maturing debts to increasingly shorter maturities to take advantage of the lower interest rates offered.
Higher debt loads, in addition to current overleveraged starting points, mean further reductions in fiscal flexibility not just for this year but in the future.
Trump’s little “trip” to the Middle East will leave a costly legacy for the rest of the world, and the United States will not be immune from that legacy.
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Stephen Bartholomeusz is one of Australia’s most respected business journalists. He was most recently co-founder and deputy editor of the Business Spectator website and associate editor and senior columnist at The Australian.Connect via email.
