Germany’s Friedrich Merz warns the economic fallout from the war in Iran is on track to rival that of the Covid pandemic or the Russian invasion of Ukraine.
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BRUSSELS — With the war in Iran threatening to choke off energy flows for the foreseeable future, Europe is facing a supply shock that promises to cripple manufacturing, ground airlines, hike up the price of food, spike borrowing costs and send inflation spiraling back to crisis levels.
As the last tankers carrying fossil fuels from the Persian Gulf pull into European ports, the scale of what is about to hit seems to be dawning on the continent’s leaders.
If the war drags on, it will place a burden on the European economy “as heavy as we recently experienced during the Covid pandemic or at the start of the Ukraine war,” German Chancellor Friedrich Merz told reporters Monday.
“I’m living with the reality of this war and its consequences 24 hours a day,” Italian Defense Minister Guido Crosetto told the La Repubblica newspaper. “I’m forced to know things that don’t let me sleep.” The conflict could last “years,” Christine Lagarde, the president of the European Central Bank, warned in an interview with the Economist last week. The long-term effects, she added, are “probably beyond what we can imagine at the moment.”
Some 20 percent of the oil and natural gas that powers the global economy runs through the Strait of Hormuz, which Iran has closed by threatening to attack any vessel that passes through without Tehran’s permission. On Tuesday, U.S. President Donald Trump posted a message to countries suffering from fuel shortages from Iran’s closure of the strait. “You’ll have to start learning how to fight for yourself,” he wrote on Truth Social. “The hard part is done. Go get your own oil!”
Oil and gas are vital for transport and heating, but also underpin the entire industrial supply chain, affecting food production, plastics, chemicals and agriculture. And that doesn’t include shortfalls in other resources caused by the closing of the strait, including fertilizer and helium, which is used in the manufacturing of microchips.
So far, the damage to European consumers has been confined primarily to the price at the pump (and a hike in the cost of new PlayStations that Sony has attributed to “pressures in the global economic landscape”).
POLITICO outlines the risks facing the European economy should what Fatih Birol — the executive director of the International Energy Agency — has described as “the greatest threat to global energy security in history” persist.
Unlike previous crises — chiefly the oil shock that followed the OPEC oil embargo in 1973 and the gas shock that followed Russia’s invasion of Ukraine in 2022 — the current panic affects all energy supplies equally, ranging from crude oil and natural gas to refined products like jet fuel and diesel.
“Markets are now grappling with a scenario long discussed in theory but rarely thought of as a legitimate possibility — the effective shutdown of the world’s most critical energy chokepoint,” said Ana Maria Jaller-Makarewicz, lead energy analyst for the Europe team at the Institute for Energy Economics and Financial Analysis. While the 1970s crises knocked out 7 percent of global supplies, she said, the closure of the Strait of Hormuz affects 20 percent.
When the war first broke out, EU officials hoped the bloc would be spared from serious shortages thanks to its relatively low exposure to the Persian Gulf, which it relied on for just 6 percent of its crude oil and under 10 percent of its natural gas. The biggest risk articulated in countless ministerial and technical meetings was higher prices.
Europe’s security of supply was rarely questioned, with officials pointing to the continent’s diversified sources beyond the Persian Gulf: the U.S., Norway, Azerbaijan and Algeria. The biggest risk, they said, was that the conflict would go on a long time — only then would supply seriously become a concern.
As the war enters its fifth week, those fears are being borne out. One immediate worry is that Asian countries, which before the war relied on the Gulf for some 80 percent of their gas and oil, are beginning to bid up the price of those products as they fight over dwindling supplies. That has diverted merchants with more flexible contracts toward Asia to exploit the higher profit margins, turning them away from Europe.
According to Charles Costerousse, a senior energy analyst at maritime consultancy Kpler, 11 U.S.- and Nigerian-flagged LNG tankers have been redirected from Europe to further east in the past few days. Within the next few days, the last tanker bearing Qatari LNG will arrive in Europe, he said.
With almost all global suppliers at maximum capacity, European leaders are beginning to “realize that the LNG supplies they were counting on were not coming here as expected,” said Jaller-Makarewicz. “It’s not like we have a buffer. It’s not like we have some security there.” Europe, she said, will start to feel the pain “this coming month” — perhaps within a few weeks.
“The very worst case is that the Strait of Hormuz remains closed for at least another month,” combined with further attacks on energy infrastructure, agreed an executive at a key LNG importer, speaking on condition of anonymity. The executive cautioned that the higher prices may in the long run support efforts to increase production, eventually rebalancing global supplies.
But even then, the executive warned, prices could remain structurally higher — perhaps forever.
The same holds true for oil products. While the EU buys very little crude oil from the Gulf, it relies on the region for more than 40 percent of its refined products — including diesel and aviation fuel. “If the strait remains closed there’s basically no alternative options,” said Homayoun Falakshahi, an oil analyst at market research firm ICIS. Financial markets are betting the strait will be closed for only two or three weeks, he added. But if it “remains closed longer, we will see higher prices — and that will translate into a worse economic crisis.”
The benchmark oil price briefly dropped after rich countries agreed to a historic release of 400 million barrels of oil in early March. Since then, however, prices have only climbed back up.
The most immediate effect of constrained supply is already visible: higher prices at the pump. Rising crude oil prices translate directly to higher fuel costs. The Euro Super 95, a key benchmark for EU fuel prices, increased by around 15 percent between Feb. 23 and March 23, according to EU data.
European governments have tried to keep down prices, slashing fuel duties and warning against gouging. But unless new flows arrive, they’ll likely have to reach for an unpopular tool: demand destruction.
Already, EU energy chief Dan Jørgensen has advised EU governments, in a letter first seen by POLITICO, to curb the use of transport to offset the loss of critical diesel and aviation fuel supplies from the Gulf. The missive, with its hints of drive-free Sundays and gasoline rationing, harks back to the oil crises of the 1970s. Some are also warning that Covid-style “energy lockdowns” are approaching.
With fuel the largest expense of flying a plane, air travel is particularly vulnerable to an energy shock. Since the first bombs fell on Iran, the price of jet fuel in Europe has more than doubled to record highs above $1,700 per metric ton. Though it has dropped slightly in the last week, European airlines have been forced to jack up prices.
“It’s been a double hit from the blow to refining capacity as well as crude production,” said Willie Walsh, director general of airline lobby IATA. “There’s no way the industry can absorb that increase, so prices will rise.”
Draconian measures, such as cutting routes, have been taken by some Asian airlines. In Europe, meanwhile, Lufthansa Group has discussed temporarily grounding between 20 and 40 of its planes due to the jet fuel crisis, according to German media reports, a move that would reduce the group’s seating capacity by 2.5 percent to 5 percent. If the war continues, some holidaymakers will have to stay home and some expats will miss family birthdays.
“What’s happening in Eastern markets is sort of a preview of what’s potentially going to happen in European markets,” said George Shaw, senior oil analyst at Kpler.
The pain has already started to ripple through European manufacturing. It’s already visible in what European Commission President Ursula von der Leyen has called the “industry of industries” — the energy-intensive chemicals sector that underpins much of the continent’s manufacturing.
“The cost increases we are experiencing — from rerouted logistics, raw material price spikes, and sustained energy price elevation — are substantial and need to be reflected in our pricing,” said a spokesperson for German chemicals giant Covestro.
Adolfo Aiello, deputy director general of Eurofer, the lobby for European steelmakers, said it was too early to forecast the overall impact of the war in Iran. But, he said, “the risk is clear.”
“Energy price volatility is now one of the biggest risks for industrial investment in Europe,” he said. “Without stable and competitive electricity prices, investment decisions — including in low-carbon steel — become increasingly difficult to justify in Europe.”
As the prices of basic inputs rise, the effect will quickly spread up the value chain to the rest of the manufacturing sector.
And that’s not to mention the surging cost of other petroleum derivatives like fertilizers, plastics and even helium, an essential component of semiconductors. Plastics are “particularly exposed to supply disruptions because we are heavily dependent on oil and gas imports to meet both our energy and feedstock needs,” PlasticsEurope Managing Director Virginia Janssens told POLITICO.
The same goes for fertilizer producers, which were already wrestling with the EU’s high energy prices. “Current developments only put upward pressure on nitrogen fertilizer costs, where energy accounts for approximately 60-80% of operating costs,” said Łukasz Pasterski, director of communications and public affairs at lobby group Fertilizers Europe. “Because fertilizer markets are global, disruptions anywhere in the system are likely to quickly have knock-on effects on the input costs.”
Higher prices in agriculture, transport and manufacturing will simultaneously crush businesses and force them to jack up prices, passing the higher costs on to consumers. And that’s where the menace of inflation could reappear — barely 18 months after central bankers declared victory over the inflationary bout triggered by the last energy shock.
As the EU’s Economy Commissioner Valdis Dombrovskis warned ministers at a meeting of eurozone finance ministers last week, this round of inflation might resemble something closer to stagflation — the deadly mix of stagnant growth and high prices that wreaked havoc on the economy in the 1970s, and which policymakers have historically struggled to address.
The Commission predicts the war will cut EU economic growth to 1 percent this year. It expects inflation to go up, possibly spurring the ECB to raise the cost of borrowing, which would further cool the economy while driving up mortgage rates and making it more expensive to run a business.
That’s a problem not just for consumers and entrepreneurs, but also for governments. The heavy debt burdens they’re carrying from previous crises will get more expensive to service, and with little room for further borrowing, they could be forced to make cuts in public services to make ends meet.
And even if the war were to end today, it would take a year before the economy was back on track, IEA boss Birol told the same meeting of finance ministers. The longer the conflict continues, the worse it’ll get.
For now, as the final Gulf tankers finish unloading their cargo this week, the clock officially starts ticking for Europe’s policymakers. The continent has weeks, not months, to brace for an impact that could reshape its economy for a generation.
“Nobody knows how long the crisis will be, but I think it’s very important to underline that it will not be short,” EU energy chief Jørgensen told reporters following an emergency ministerial conference on Tuesday. “Because even if there was a peace tomorrow, there will still be consequences, because energy infrastructure in the region has been and continuously is being ruined by the war.”
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