When the war with Iran began, I wrote that the market was treating it as a short conflict. My concern was that Iran had a different end game: create another 1979. An energy shock would spread through the economy until the pressure to end the war not only became impossible to ignore, but it would also serve as a warning for the future.
Nearly seven months on, we are approaching the pointy end.
The Strait of Hormuz has been severely disrupted for months. Saudi Arabia’s east–west pipeline helped keep oil moving around it, carrying roughly four million barrels a day to the Red Sea. Then that pipeline was attacked, just as the Houthis intensified their activity around the Red Sea. Saudi Arabia has since restarted the pipeline, but that event shows how exposed the alternative route really is. Iran and its allies have shown how much of the world’s energy supply they can disrupt. It leaves the world with little room for further setbacks.
Countries around the world continue to draw down on their strategic reserves. The International Energy Agency estimates that observed global oil inventories fell by 507 million barrels between the start of the war and August. Meanwhile, Europe is heading towards winter, when heating demand puts more pressure on supply. In the United States, the midterm elections are just over five weeks away. The price of fuel at the pump will influence the election. That could give Iran an incentive to escalate if they want to apply real pressure. This makes the next three months critical.
Oil recently climbed back above US$100 a barrel, although it has since eased as hopes of diplomacy and the pipeline restart brought some relief. The number I am watching even more closely is diesel. US diesel and gasoil prices passed US$200 a barrel in early September; European diesel futures reached US$210 a barrel. That is the wholesale price, not the pump price, but the pain is already reaching businesses and households.
Diesel powers the trucks that move goods, the machinery that plants and harvests crops, and much of the work done in mines and on construction sites. A farmer cannot just stop harvesting because fuel costs have risen. A freight company still has to deliver food. Those costs move through supply chains, often with a delay, until they appear in the prices everyone pays. At the same time, businesses facing higher bills may postpone investment or cut back elsewhere.
To me, we are still in the first of three distinct stages. First an energy shock, then growth shock, and ultimately economic shock. Higher prices squeeze consumers, while higher operating costs squeeze businesses. If both last long enough, recession becomes a real possibility. It is the same danger I have been writing about since the beginning. We are seven months in, and the energy shock phase is still playing out.
There is now talk in the US of restricting diesel exports to ease domestic prices. I understand the political appeal, particularly before an election. It might provide temporary relief at home. But an export ban does not create more diesel, and countries that rely on American supply would be left competing harder for what remains. The pressure would move elsewhere rather than disappear.
Markets still broadly seem to expect that somehow everything will return to normal soon enough. I think the opposite is likely true. I think Iran has been strategic and deliberate from the day they were first attacked. I still hope diplomacy provides an exit. But I do not expect it.
The risks I outlined at the start of this war are now coming into focus. Ultimately, the timing rests on how long the world can absorb an energy shock before the economic damage becomes the force that determines the wars end game.
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