When war breaks out in the Middle East, its impact does not stop at the battlefields; its shockwaves are felt across the world in no time, especially in oil markets, financial systems, and national economies. The renewed conflict between the United States (US), Israel, and Iran has once again reminded the world of the vulnerability of the world’s oil supplies. Oil prices are soaring in the wake of rising tensions in the region, and economists are beginning to draw parallels to crises that reshaped the world’s economic order.
Though oil is at the core of geopolitics, nowhere is its importance felt more than in the Middle East, where nearly half of the world’s proven oil reserves are located, and the region is the focal point of global petroleum exports. Instability in the Middle East means instability in oil supplies, which will have a ripple effect on national and international economies, from the industrial nations of Europe and East Asia to oil-dependent developing nations.
But here is a disconcerting thought: are we in fact witnessing the beginning of a new oil shock, reminiscent of those that shook the world in the 1970s?
A War that Shakes the Energy Arteries of the World: The strategic importance of the US–Iran conflict centres on geographical considerations. Iran is a geopolitically critical country located on the northern coast of the Persian Gulf. It is also a neighbour to the Strait of Hormuz, which is a key shipping channel for oil tankers. Each day, 20 million barrels of oil pass through the Strait. This equates to one-fifth of the world’s oil consumption and a third of all oil traded by sea.
The free flow of oil from the Strait of Hormuz is critical to the economic prosperity of major oil-importing countries such as China, India, Japan, and South Korea. Any interruption in oil flow through the Strait of Hormuz will result in immediate shortages in these countries. This will also send oil prices skyrocketing.
Iran has threatened on several occasions that if the security of the Strait of Hormuz is threatened, it will be closed. This will affect not only the countries that import oil from the Strait of Hormuz but also Iran’s own economy. Nevertheless, the threat by itself has already started to unsettle oil traders and investors. This is because they know that any attacks on oil tankers or oil installations will send oil prices skyrocketing.
The instability of the region’s oil infrastructure has been experienced before. In 2019, drone and missile attacks on Saudi Arabia’s Abqaiq oil processing facilities took out nearly five percent of the world’s oil supply overnight. Oil prices rose sharply in response to these attacks.
The threat of war in the Strait of Hormuz has already driven up shipping insurance costs and oil tanker freight rates in the current conflict.
Echoes of 1973 - The First Great Oil Shock: To appreciate the potential impact of the current crisis, let’s examine the 1973 Oil Crisis. The 1973 Oil Crisis was one of the greatest turning points in modern economic history. The crisis started during the Yom Kippur War when Egypt and Syria unexpectedly attacked Israel in October 1973. In retaliation for the West’s support for Israel, the Arab countries in the Organization of Petroleum Exporting Countries (OPEC) imposed an oil embargo against the US and several European countries.
The industrial world was highly dependent on Middle Eastern oil at that time and lacked strategic reserves. The impact of the oil embargo was dramatic. Within a year or so, the price of oil quadrupled from about $3 per barrel to nearly $12 per barrel. The economic impact was severe. There were fuel shortages in the US and Europe. There were long lines at gas stations. There were fuel rationing and fuel conservation measures. The rate of economic growth slowed down. Inflation rates rose across all industrial countries. The Oil Crisis also created a phenomenon known as stagflation, a rare combination of high inflation and low growth. At the same time, the Oil-Importing Countries faced a significant economic disadvantage. The high prices increased the revenue for Oil-Exporting Countries. The geopolitical impact was also dramatic. Energy security has become a key component of national security strategies worldwide.
The Second Shock- The Iranian Revolution of 1979: Just six years after the first oil crisis, oil prices rose sharply following the Iranian revolution. The Iranian Revolution replaced the government of Shah Mohammad Reza Pahlavi with the Islamic Republic of Iran under the leadership of Ayatollah Ruhollah Khomeini. The Iranian Revolution disrupted the Iranian oil industry, leading to a decline in Iranian oil exports.
Though the actual cut in oil supply was not very large, its psychological impact was huge, given that energy traders were apprehensive that this unrest could spread to other parts of the Persian Gulf, leading to a loss of other crude oil supplies.
After just one year of this unrest in Iran, oil prices almost doubled, increasing from $15 per barrel to almost $39 per barrel. This resulted in an economic shock that once again led to inflation and a global economic slowdown. The Iranian Revolution of 1979 also taught an important lesson: that even minor changes in oil supply can lead to a major increase in oil prices if markets are apprehensive about future supply shortages.
How Today’s Crisis Is Different: Though this is not the first time an oil supply crunch has occurred, this time around the world is very different from what it was during the 1970s oil crunch. This is because over the last five decades, governments and industries alike have taken several major steps to reduce their dependence on oil supplies.
The first major step was the establishment of strategic petroleum reserves, in which some countries that are part of the International Energy Agency established emergency crude oil reserves following the 1973 oil crisis. Emergency reserves enable countries to inject millions of barrels of crude oil into the market to stabilize prices.
Another major change is the diversification of energy resources. Gas, nuclear, and even wind and solar energy contribute to the energy mix. Although oil is the main source of energy for transportation and industrial production, the modern economy is less dependent on petroleum than it was a few decades ago.
Technological innovation is the third major change to affect the global energy landscape. The shale revolution in the US has driven a dramatic increase in global energy supply. The US is now one of the world’s largest energy producers, reducing its energy dependence on the Middle East.
However, the lifeblood of the modern global economy is still oil. Aviation, shipping, transportation, and many industrial processes still rely on petroleum as their primary energy source. This means that any sharp increase in oil prices can still cause a ripple effect throughout the modern economy.
The Inflation Threat: One immediate effect of the rise in oil prices is inflation. The price of energy affects every sector of the economy. An increase in fuel prices means transportation costs rise, production becomes more expensive, and the cost of producing agricultural products increases due to higher fuel costs used to produce fertilisers.
Businesses usually pass on the higher production costs to the end consumer, making the end product more expensive. However, the modern economy may face stagflation if oil prices continue to rise. Stagflation is a situation characterised by both high inflation and stagnating economic growth.
The modern economy is facing a major crisis, which is a cause for concern. The current economic crisis is occurring as the modern economy is still recovering from the shocks of the COVID-19 pandemic.
For developing economies, rising oil prices can be devastating. Developing economies heavily dependent on imported oil face increasing trade deficits and a depreciating local currency. Governments face increasing difficulties in maintaining the fiscal balance.
Historical Oil Price Surges: Over the past several decades, geopolitical crises have repeatedly driven oil prices higher. The 1973 oil embargo led to a surge in crude oil prices. Oil prices rose from $ 3 to $ 12 a barrel over a few months. The Iranian Revolution of 1979 sent crude oil prices to almost $39 a barrel. The Gulf War of 1990 resulted in a surge in oil prices when Iraq attacked Kuwait. Oil prices almost doubled.
In 2008, oil prices reached a historic high of $147 a barrel. This escalation occurred over a period of rapid global economic growth. Over the past year or so, geopolitical tensions have escalated to levels not seen since the Gulf War. Russia’s invasion of Ukraine and the escalation of the Middle East conflict have escalated oil prices to over $100 a barrel. The common factor in all the above instances is the rapid escalation of global economic conditions due to geopolitical crises.
Implications for Bangladesh: For Bangladesh, the escalating oil prices pose a significant challenge to the national economy. Bangladesh heavily depends on imported oil to meet the domestic demand for oil products. Oil is used to power vehicles, generate electricity, and fuel industries. Bangladesh faces a significant challenge in maintaining the balance of trade. The rise in oil prices increases the trade deficit. Bangladesh heavily depends on imported fuel oil to generate electricity. These increased costs will eventually have a cascading effect on the overall economy. Transport and production costs will rise, and consumer goods will become costlier. The oil price increase may also prompt Bangladesh and other developing countries to invest more in alternative energy sources, such as renewable energy and solar power.
A Critical Moment for the Global Economy: The world is at a critical juncture where geopolitics and oil prices are interlinked, potentially altering the global economic order. If the tension between the US and Iran remains under control over the next few days, oil prices are likely to remain stable. However, if these tensions increase, especially if the Strait of Hormuz is closed, their consequences on the world economy could be immense.
History shows that oil price shocks often mark a turning point in the global economy. The oil price shocks of 1973 and 1979 marked a paradigm shift in the world economic order.
The present scenario has perhaps not yet reached those levels. Nevertheless, the warning signs are ominous. Oil price hikes, geopolitical tensions, and economic instability are a potent mix that economic policymakers cannot ignore. In a globalised world, one of the important factors contributing to economic stability is energy security. The conflict between the United States and Iran is a prime example of how oil prices, politics, and the economy are interconnected. A disruption in any of these factors will create a ripple effect on the global economy.
Dr Serajul I Bhuiyan is a professor and former chair of the department of Journalism and Mass Communications at Savanah State University, Savannah, Georgia, USA.
sibhuiyan@yahoo.com