While Trump and Netanyahu started the war in the Middle East, it needs Iranian agreement to end the conflict. And even though weakened militarily, Iran could continue to fire a drone a day to scare tankers away and keep the Strait of Hormuz closed indefinitely.
If hostilities ceased tomorrow, it would take some time before the oil and gas markets return to normal. A prolonged war continuing into the autumn and beyond would create a world energy shock similar to that of the 1970s, and cause huge economic dislocation.
While the Irish Government has taken short-term action, it must assess the implications of a possible prolonged energy shock.
Our world still relies to a huge extent on oil and gas for its energy needs. If world supply falls by 20 per cent because of the war, prices would have to rise very high to balance supply and demand. If most countries try to subsidise domestic consumption to counteract dearer energy costs, that would drive the market-clearing price even higher. More expensive energy and transport also feeds into the price of other goods and services, fuelling general inflation.
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Higher energy prices transfer wealth from energy consumers to producers. The reduced resources of consuming nations would lead to a big drop in world GDP. That would choke off some energy demand, and slow inflation, as happened in the Covid recession in 2020, when world oil consumption fell by 7 per cent and gas consumption by 2 per cent.
In the upward march of prices, poorer countries in Africa and Asia will eventually have to cut back dramatically, while richer regions, like the EU, could pay the higher energy prices to secure a bigger share of the remaining supplies.
The oil crises of the 1970s show what could happen if there is long-lasting energy disruption. Ireland’s energy imports in 1973 cost about 2 per cent of national income, but this trebled to 6 per cent in 1974 as the supply squeeze hit energy costs.
Paying more for imported oil effectively cut our standard of living by about 5 per cent. Other EU countries and the US (then a net oil importer) experienced similar hits.
The then Irish government failed to recognise that, collectively, we were poorer, resulting in policy mistakes that worsened things. The government initially tried to protect the population from the impact of this loss of income by dramatically increasing public expenditure in 1974 and 1975. This proved financially unsustainable.
In trying to recover the situation, the government panicked and introduced the toughest budget in history in 1976, just when the economy was beginning to recover.
Plan for the long haul
A big lesson from that crisis is that when the State suffers a really big loss of income that is likely to persist, the government should not try temporary fixes to insulate all of the population from the full costs of energy. Instead, government needs to plan for the long haul.
By acknowledging that paying more for imported energy makes Ireland poorer, the best strategy is to work harder to wean our economy off reliance on oil and gas supplies that are so exposed to political risk in the Middle East and other volatile regions.
After the 1970s oil price shocks, countries like France, Germany, Sweden and the US undertook big investment in nuclear energy that made them more independent of the Middle East as these plants came on stream in the late 1980s and the 1990s. In the current crisis, France will reap the benefit of this past investment.
Other big efforts were made to diversify sources of energy. Higher oil prices also encouraged exploration for fossil fuels, which resulted in a substantial drop in energy prices from the mid-1980s as new production began to flow.
Wisely, the measures the Government has just introduced are temporary and limited in scope. If the war ends, and energy flows return over the coming months, the supports will have helped tide people over a temporary shock. However, if the supply crisis persists, it’s not a real option to insulate us all from the full costs of this crisis. Prioritisation will be essential: tax cuts benefiting all motorists are not sensible. As the ESRI has suggested, scarce resources should be targeted at low income households.
The lesson for the long-term is that we need to become energy-independent. In particular, we need to accelerate the investment in renewable energy, and reduce our fossil fuel dependency. Higher energy costs will help drive this.
At higher fuel prices, insulating our homes and installing solar panels mean bigger savings for households. Motorists upset at high petrol prices should ensure their next car is electric.
