Transcription
This is the Persian Gulf, where roughly 20% of the world's oil and natural gas comes from. Iraq, Kuwait, Bahrain, Qatar, Saudi Arabia, and the United Arab Emirates. Almost all of their oil has to pass through this narrow strait, the Strait of Hormuz, which is currently almost completely closed due to the threat of Iranian missiles and especially drone strikes.
This is already causing major energy price spikes in the US, Europe, and especially in Asia. But experts are telling us that it's likely to get much, much worse if the conflict continues much longer, which it probably will. So, what can you expect? How bad will the energy crisis get?
Hey, I'm Yuri. I have a PhD in economics. And in this briefing, I will summarize and visualize for you the latest research by geopolitical experts and energy economists on the upcoming energy crisis. Specifically, I've constructed three scenarios for you and will tell you how likely I think that they are.
Scenario number one, the strait is open soon, but damage to crucial infrastructure means that it will take time to go back to normal. Scenario number two, the conflict will continue for a while because Trump may want to back out, but the Iranians and Israelis won't let him. And scenario number three, a wild card, but apparently seriously considered by the Trump government. The conflict continues and Trump moves to ban US energy exports to keep voters happy for the upcoming midterm elections. This scenario would be a disaster for Europe and Latin America.
But before digging into these three scenarios with price predictions and how likely each of these scenarios is, we have to start our briefing with three crucial pieces of context. The first is that this energy crisis is essentially about three different products which have quite different dynamics. First, there is oil, crude oil, which still has to be refined locally, and so-called oil products like gasoline, diesel, cooking oil, and jet fuel, which have already been refined in the Gulf. Finally, there is liquefied natural gas, LNG, which is mostly used to generate electricity and for heating buildings.
Now, LNG mostly comes from Qatar, and about 90% of it goes to Asia and about 10% goes to Europe. These numbers really only matter in the short term because ships take, for example, more than a week to travel from the Gulf to Japan. However, after that, ships can go wherever they please. So, in the long term, everyone that uses LNG will suffer from this. After all, if there is no LNG in Asia, then Asian buyers will just start bidding up the price, which will attract ships from, for example, Europe, which will raise the price of LNG all around the world, even in places that export LNG like the US.
However, for crude oil, the dynamic is quite different. Again, about 90% of crude oil goes to Asia. But luckily, in this case, if the strait remains closed longer, there may be some relief because there are actually two pipelines, one in Saudi Arabia and one in Dubai, through which, after a while, about 10 to 15% of crude oil could bypass the Strait of Hormuz.
And for Europeans like me, there may be some more good news. Not all oil is the same. There is sweet and then there's sour crude oil. There's light and then there's heavy crude oil. This is important because our European refineries are optimized for sweet light oil from Africa and from the United States. On the other hand, Asian refineries are optimized for Middle Eastern crude, medium sour oil. And crucially, because this will become important later, US refineries are not optimized for light US shale oil, of which there is a lot, but rather for heavy and sour crude oil from Alaska, from Canada, and from Mexico. This is why European and American crude oil prices, measured by Brent crude and the West Texas Intermediate, respectively, did go up, but not by as much as crude oil prices in Asia.
The West Texas Intermediate (WTI) crude oil. President Trump has used this benchmark to try to convince the American public that things have not gotten so bad yet. But this is misleading. What matters for most Americans is, of course, not crude oil, but rather the price of refined oil products such as gasoline, diesel, and jet fuel. And actually, a lot of crude oil was already refined in the Gulf countries. But now, ships carrying fuel, diesel, and jet fuel are also stuck in the Gulf. Therefore, as you can see here, even in the US, consumers are already suffering more than the West Texas Intermediate benchmark would have you believe, which is the blue line. While it went up by about 60% since the start of the year, diesel in the US is up by almost 100%, and gasoline and jet fuel by 80%. And this makes sense, right? Given that we've seen that for crude oil, the global market is not completely global due to refineries in the US, Europe, and Asia being optimized for different types of crude oil. But on the other hand, jet fuel, diesel, gasoline, this can be shipped all over the world. So, ordinary Americans are less protected than some may think.
But sadly, today's already sky-high prices might get quite a bit worse if the conflict drags on because of our second piece of crucial context, which is reserves matter. This is about the role of strategic reserves. Rich countries like Japan, China, the US, and the European Union, they all have strategic reserves. China has the most, about 1.3 billion barrels, and then the EU has about 570 million. The US has about 415 million, and finally, Japan has about 470 million barrels. And together, that is about 75% of global reserves. But because, for example, China imports more than the US, the picture for how many days that these reserves will last for these countries is actually different. Here, Japan is the big winner. It has about 224 days of reserves left. China, about 110 days, even though it has a giant reserve. And then the US, 120 days. And finally, European countries, only 90 days of reserves are left.
Now, so far, countries together have released about 400 million of these reserves, and this has kept prices lower than they would have otherwise been. But if the conflict lasts much longer, these reserves will run out, and then oil prices can go quite a bit higher.
Luckily, there is also some good news in the form of crucial context. Number three, people can change. For example, when the 2022 gas crisis hit Europe, a massive price spike, then Europeans collectively reduced the price by quite a lot simply by lowering the temperature in their homes, for example, improving the efficiency of factories, and wearing sweaters more. Similarly, countries without significant reserves, like, for example, Bangladesh and the Philippines, have already contributed to lower demand for oil because they rationed fuel. For example, by reducing the work week from five to four days.
Now, if prices really spike due to a longer war, a lot of Asian countries will probably turn from gas back to coal energy, and Europeans may actually start buying a lot of EVs from China again. Meanwhile, on the supply side, there's good news for gas and bad news for oil. The good news for gas is that there's actually a lot of capacity scheduled to come online in the United States, export capacity for LNG. And that is about as much in the next three years as the entire production of Qatar, which was 20% of the global supply. This means that while gas prices are projected to go up, it probably will not be as dramatic as it was during the 2022 gas crisis in Europe.
On the other hand, when it comes to oil, most excess capacity was actually in the Gulf countries. So, if the price went up by a lot historically, the Gulf countries would bring it back down by pumping more oil. And now, they will not be able to do that, given that the Strait of Hormuz is closed.
These three are, I think, the main dynamics that you'll need to be aware of if you want to know what to expect from the upcoming energy crisis. Asian countries will hurt the most because their refineries need Middle Eastern crude. But when it comes to natural gas and diesel, gasoline, jet fuel, we are actually all in the same boat because markets are global. Reserve releases will help. Keep an eye out for them, but also keep an eye on total reserves because if they run out, oil prices could really spike. Luckily though, over time, economies will adapt somewhat as they learn to live without oil.
But okay, what can we expect concretely? Here are my three scenarios.
In scenario number one, the US, Israel, and Iran reach a quick deal which fully opens the Strait of Hormuz. This could either happen because overwhelming US military force cripples the Iranian regime or because a country like China is able to negotiate a truce. In this scenario, oil and gas prices will slowly come down from the level that they are now. But prices will remain higher than they were before the war due to a lingering threat of Iran closing the strait again. Most professional economic reports that I've read, like those from Goldman Sachs, the International Energy Agency, and Deutsche Bank, use this as their baseline. But honestly, I think this scenario is very unlikely and give it a 10% probability.
Now, scenario number two. The war continues for six months or longer. The Strait of Hormuz remains largely closed. This means the world will run out of reserves sooner or later. But at the same time, the world will adapt somewhat, meaning that gas and oil prices will stabilize at around 200 to 300% of where they were. That's a lot higher. Europe will face the highest gas prices, whereas Asia will face the highest oil prices. The US gets off relatively easy, but still faces around double the energy prices than it had before the war. Just for reference, this means Brent crude oil prices will go to around $150 to perhaps even $200 per barrel. I give this scenario an 80% likelihood.
Finally, scenario number three, the energy nationalism scenario where Trump becomes extremely unpopular due to high energy prices. And to somewhat save the midterm elections, he bans many US exports of energy. And since we've seen that especially Europe heavily relies on US gas and oil, this would be a massive disaster for Europe. And while it would probably be very effective at lowering US natural gas prices, it would not fully lower gasoline, diesel, and jet fuel prices because US refineries are optimized for heavy crude oil, which they do not produce enough of themselves. Finally, not being able to export would of course cost US producers a lot of money and therefore the US government a lot of tax income, which it will probably need to fight the war. So I only give this scenario a 10% probability.
But why did I pick these probabilities for these three scenarios? Because the reports that I use for the oil price estimates, Goldman Sachs, Deutsche Bank, International Energy Agency, they all use the short conflict as their go-to scenario, their baseline. So why do I think that a long war is now way more likely? Well, there are two reasons.
The first reason has to do with the geography of the Strait of Hormuz, which favors Iran. You see, there are mountains here everywhere on the Iranian side. So, it will be super easy for small Iranian strike teams with, for example, cheap drones to keep harassing ships in the Strait of Hormuz, even if there are American troops here somewhere. And even if American troops take out the regime in Tehran, for example, then it will still be possible for Iranian resistance fighters to hide in these mountains again with very cheap drones. Or they can even lay mines in the Strait of Hormuz. Or they can come in with these new naval drones that we've seen all over the Black Sea in Ukraine and that have dominated the Russian Navy there.
And this brings us to reason number two why the Strait of Hormuz will likely remain closed. A short war seems increasingly unlikely. You see, so far whenever Trump did something wild and it spooked financial markets, like threatening to annex Greenland, he always made a deal. Financial market traders actually called this the "taco trade," standing for "Trump always chickens out." And one potential reason why oil prices are not higher right now is exactly this. Oil traders expect Trump to back out when oil prices get too high. However, according to many of the geopolitical experts that I follow, the real problem right now is that Trump is no longer in full control for two reasons.
First, he started this war with Israel. Even if Trump can convince the Iranians that he will truly retreat or stop attacking them, he also needs to convince the Israelis that they will retreat. And so far, he has not been able to fully do that. However, the second reason is now perhaps even more important. Many experts agree that neither the US or Israel are now fully in control of the war, and that is because they essentially hurt the Iranians too much. Therefore, they don't have much more to lose. And importantly, given that Trump struck them in the middle of negotiations, killed their leader, how can the Iranians trust that he won't just hit them again in a few months? This is why they demanded that the US retreat from all major bases in the region. Which do you think Trump will just leave the entire Middle East like that? Humiliated? Who knows? I don't think so. I mean, he's very unpredictable, but I don't think so.
And this is why sadly I think scenario number two is currently the most likely. Meaning that European natural gas prices are likely to go up by almost double to 100%, which is still, of course, far, far below the 2022 Ukraine crisis. And given that reserves are limited, oil will likely also get far more expensive, perhaps even $150 to $200 USD per barrel, which would be unprecedented, although corrected for inflation, which is what you see in this graph. It would be slightly below still what happened in 2008, just before the global financial crisis.
So there you have it. This will be a massive hit to all economies across the globe, especially in Europe and Asia, who are the biggest oil importers. It will lead to inflation. It may cause another food crisis because natural gas is a big input in fertilizers. And it may cause a massive currency crisis or multiple massive currency crises in South Asia because they rely a lot on remittances from the Gulf countries. It would mean airline tickets get much more expensive, and of course, it would be like a great depression for the Gulf countries themselves.
But that was not what this video was about. It was purely about the effects on oil and gas. If you'd like to see a follow-up analysis about these other subjects, then let me know in the comments below. And if you want to dig deeper, I highly recommend you check out the excellent analysis by our advertising sponsor, The Economist, who, as you probably noticed, I heavily relied on for this analysis. Specifically, I got the idea for the third scenario from their article, "What if Donald Trump decided to ban oil exports?" And for scenario number one, I heavily relied on the article, "Even the best-case scenario for energy markets is disastrous." I highly recommend you go read these articles right after this video. And then to determine which energy scenario is most likely, I think The Economist's "Donald Trump has bad options for the war" is essential reading. As these articles show, The Economist delivers insights to let you see the bigger picture and think for yourself. This is why I almost always rely on their analysis for my research. And it's why I highly recommend that you subscribe to The Economist, which I'm excited to say has agreed to give a special 35%—that's quite a lot of money—discount for Money and Macro viewers. Whether you want your daily journalism in The Economist's app or you are like me and prefer to catch up on the global economy during the weekend with a nice cup of coffee and the paper edition, you will always stay on top of the latest global developments and signal to others that you care about factual information and the values of integrity and responsibility. So don't miss out. Click the link in the description or top comment below, or head over to economist.com/moneymacro to claim your exclusive 35% discount today.