Oil and gas have been the defining commodities of modern civilisation.
Oil enabled rapid industrialisation in the 1800s – utterly transforming societies. It has dictated how human beings live, go to war and are governed ever since.
Gas has, at the same time, become central to the mass production of food.
But the extent to which we all rely on these raw materials in one way or another is rarely fully appreciated. The past five weeks have proven to be a steep learning curve for many.
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The impact of choking global supply, like that seen during March, has been to first drive up the cost of petrol and diesel, but the longer-term effects will spread throughout modern industrial economies.
When it published its latest economic commentary last week, the Economic and Social Research Institute (ESRI) was scrambling to assess the impact on the Republic.
It used a rough rule of thumb to figure out what the “pass through” of higher energy costs would be in terms of consumer prices, stating that an overall 1 per cent rise in Irish inflation would result from a 30 per cent increase in oil and gas prices.
It was on this basis that the ESRI revised its inflation forecast for the year from 2.1 per cent to 3.2 per cent.
Oil has risen about 45 per cent since the United States and Israel launched their war on Iran. Natural gas futures were 56 per cent higher than at the end of February.
The respected think tank, with the hindsight of another two weeks of war, is now poised to increase that headline inflation number again.
“We took our forward trajectory around the 16th of March,” says one of the ESRI report’s authors, associate research professor Conor O’Toole.
“It does look like the effects will be longer lasting than we anticipated and we were probably on the low side in our inflation forecast.
“We based our technical assumptions on the futures markets, but it is very clear in the couple of weeks since that the damage to the infrastructure in the region is more lasting than the markets had anticipated. We are looking at higher inflation rates than we expected.”
O’Toole says the ESRI would carry this revision in its June commentary.
He says it is difficult to forecast how exactly prices will be affected, and the ESRI doesn’t model on a product-by-product basis. A lot depends, he says, on how individual industries have insulated themselves or hedged against rising energy prices.
Second round effects
The main component of this fresh inflation shock will obviously be accounted for by fuel prices for motorists, but it is likely to be much deeper than that. Economists refer to these as second-round effects.
“We will be expecting these [higher prices] to come through within this year, as you are moving from now to the summer months into the winter,” says O’Toole.
Hauliers are hugely dependent on diesel, which has been rising in price. Nearly all of them have been passing on surcharges to customers, and those businesses are passing them down the line to consumers.
The Strait of Hormuz is described by the UN trade and development body as a “critical artery” for global fertiliser supplies. The surge in gas prices – a key component in the production of urea and ammonia – has driven up the cost for farmers worldwide.
“It could be the back end of the year before we see this feeding through to food prices, even if the strait opens in the next three weeks,” says Tadgh Buckley, an economist with the Irish Farmers’ Association.
This “inevitable” increase in food prices has yet to be seen on the shelves, says Buckley, and predicting exactly when it will happen is difficult.
“There is no movement yet, nothing of significance, but a substantial increase in input prices will take time to feed through,” he adds.
“What normally would happen is that when the price of cereals starts going up, the first thing that will be hit is your bread and pastas. Internationally, cereals form a big part of animal feed.
“When the feed price starts to go up, it will impact dairy, beef and pork – they use a huge amount of feed – not so much in Ireland. As soon as feed prices start moving, they will start moving.”
Buckley says it is also hard to be certain about the impact an economic downturn would have on prices. “If that were to dampen demand, would that be a counterbalance on the other side?”
The immediate concern for Irish farmers is the cost of fertiliser, as opposed to any worries about availability. Most fertiliser here is sourced from Europe and North Africa, whereas Asia and Oceania are very reliant on whatever comes out of the Gulf region.
Thia Hennessy is an agri-food economist at University College Cork. She says “anecdotal” evidence suggests Irish farmers have a good store of fertiliser for the growing season, but beyond that, problems will come.
She says there was not only a lag between increased fertiliser costs and higher food prices, but one when fuel and fertiliser started to fall. Prices did not fall as rapidly as perhaps consumers would have liked.
“More generally, food prices have never fallen back to levels they were before the Ukraine war,” she says.
“That is largely down to increased geopolitical risk, like we saw with the Red Sea and the inability of some shipping routes to go through there. We also had a number of extreme weather events and that is something we are going to have to live with.”
She says Government policies on agriculture had also moved away from profitability towards sustainability and this, too, was having an impact on higher food prices. “Those factors are really contributing to a long-term trend in food prices”.
Air fares
A more immediate impact on consumers is likely to be seen in air fares. Summer holiday plans for tens of thousands of people could still end up in jeopardy.
A highly refined product, jet fuel costs significantly more than a barrel of crude. Last week, the International Air Transport Association said it stood at about $195, more than double the prices of late February.
Airlines like Ryanair have bought the bulk of their fuel in advance. Chief executive Michael O’Leary said this week that about 80 per cent of its fuel is bought forward until March 2027.
The remaining 20 per cent is vulnerable to this current spike, and the longer the crisis persists, the higher the chances of significant fare increases. That is presuming, of course, there are no big disruptions to jet fuel supplies and planes grounded as a result.
The industry, says O’Leary, was reasonably placed in terms of supply until late April, early May. Should things in the Gulf remain as they are beyond the end of this month, however, then cancellations could become a big issue.
O’Leary said that if the war continued, there was a “reasonable risk at some low level – maybe 10 [per cent], 20 [per cent], 25 per cent of our supplies might be at risk through May and June”.
And then there is the lesser-noted impact that a reduction in oil will have on those industries that need it to make consumer products.
Not only does it fuel industry, transport and heat homes, but oil is also used in all manner of production processes.
Plastics, pharmaceuticals, synthetic textiles, rubber and fertilisers are among scores of categories where crude plays a critical role.
Should the conflict persist, the cost of many consumer goods will rise.
According to the US energy information administration, from a typical 42-gallon barrel of crude oil, about 6 per cent is used for purposes other than fuel.
The Australian oil producers organisation claims that nearly all pesticides and fertilisers are made from oil or oil byproducts.
Iran’s cyber-attacks on Irish-based companies and the ongoing impact of conflict in the Middle East
The industry is not slow in highlighting the wide and varied uses of oil. Lobbyists claim that thousands of everyday items are dependent on its easy availability.
Things like mobile phones, contact lenses, credit cards, computer monitors – even dentures – are listed by these organisations as having required oil for their production.
In the United States, the industry plays up the use of oil in the manufacture of medical devices and says it is critical to the functioning of the health industry.
Pacemakers, MRI machines, IV bags and tubes, monitors, and stethoscopes are all claimed as oil products.
A more prolonged closure of the critical waterway now appears probable.
Dismissed
US president Donald Trump’s speech to the American public on Wednesday night dismissed market hopes of a quick ending to hostilities and a rapid return to the normal transit of oil and gas.
In response, the price of Brent Crude, which had fallen on conciliatory noises from the US president earlier in the week, moved higher. At the same time, stock markets declined. Stocks in Asia and Europe were also lower.
The Irish economy has proven remarkably resilient to shocks over the past decade. It has weathered Brexit, Covid-19, Ukraine and Trump’s Liberation Day tariffs without sustaining lasting damage to jobs or investment.
At the same time, the public finances have been swollen by taxes from American multinationals.
Unprecedented amounts of corporation tax gave the Government plenty of leeway to ramp up emergency measures, first to protect jobs during coronavirus lockdowns and then to soften the blow from the subsequent cost-of-living crisis.
But the prospect of a global recession – sparked by the US-Israel attack on Iran might finally puncture this armour.
In terms of its economic impact, is this crisis likely to be bigger or smaller than that caused by the Russian invasion of Ukraine? After all, that shock was one right on Europe’s doorstep.
“It is a little bit too early to say,” says Conor O’Toole. “When we did our commentary, we parameterised it as being initially quite sharp but then declining into next year.
“With Ukraine, there was a big second-round gas effect about seven or eight quarters after the start of the conflict. It is a very different pathway than what we would expect from the Strait of Hormuz – when you think of how Europe was linked in with Russian gas.”
Economists like O’Toole have had to take guidance from futures markets that are themselves floundering. Reading Trump’s intentions is proving next to impossible and oil prices have whipsawed back and forth in response to his public pronouncements.
Wednesday proved a perfect example of investors getting ahead of themselves.
With oil trading around the $100 mark in advance of Trump’s speech, there was a growing hope that he would outline some sort of credible exit strategy. But he did not, again claiming a war that was already won would continue for several more weeks.
A barrel of oil rapidly climbed back towards $110.
Advocates for clean and renewable energy believe the world’s addiction to oil and gas makes crises like this one inevitable.
The climate-change think tank E3G says “chokepoints” like Hormuz exist in several locations around the globe and hang over the global economy like swords of Damocles.
“What we’re seeing in Hormuz isn’t a freak, one-off event. It’s an inherent and unavoidable part of the global oil and gas system,” says senior policy adviser Richard Smith.
“Renewables aren’t without risk; there are also solar panels stuck in Hormuz right now. But for every solar panel that makes it through, that’s secure energy every day for a generation. Renewables and energy efficiency are the only realistic way to escape this crisis loop.”
The Government has spoken about the need to accelerate our transition to renewable energy, but short-term problems are looming on the horizon.
Should a US escalation occur in the Gulf, the price of oil is likely to surge again, putting pressure on policymakers to revisit measures that would lessen prices at the pumps.
Likewise, widely anticipated increases to the cost of food, electricity and gas will start to bite just as the budget for 2027 is being prepared.
