\n\t\t\t\tGermany\u2019s 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.\t\t\t<\/p>\n
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BRUSSELS \u2014 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.<\/p>\n
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\u2019s leaders.<\/p>\n
If the war drags on, it will place a burden on the European economy \u201cas heavy as we recently experienced during the Covid pandemic or at the start of the Ukraine war,\u201d German Chancellor Friedrich Merz told reporters Monday.\u00a0<\/p>\n
\u201cI\u2019m living with the reality of this war and its consequences 24 hours a day,\u201d Italian Defense Minister Guido Crosetto told the La Repubblica newspaper<\/a>. \u201cI\u2019m forced to know things that don\u2019t let me sleep.\u201d The conflict could last \u201cyears,\u201d 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.”<\/p>\n 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\u2019s permission. On Tuesday, U.S. President Donald Trump posted a message<\/a> to countries suffering from fuel shortages from Iran\u2019s closure of the strait. \u201cYou\u2019ll have to start learning how to fight for yourself,\u201d he wrote on Truth Social. \u201cThe hard part is done. Go get your own oil!\u201d<\/p>\n 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\u2019t include shortfalls in other resources caused by the closing of the strait, including fertilizer and helium, which is used in the manufacturing of microchips.\u00a0<\/p>\n 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<\/a> to \u201cpressures in the global economic landscape\u201d).\u00a0<\/p>\n POLITICO outlines the risks facing the European economy should what Fatih Birol \u2014 the executive director of the International Energy Agency \u2014 has described<\/a> as \u201cthe greatest threat to global energy security in history\u201d persist.<\/p>\n Unlike previous crises \u2014 chiefly the oil shock that followed the OPEC oil embargo in 1973 and the gas shock that followed Russia\u2019s invasion of Ukraine in 2022 \u2014\u00a0the current panic affects all energy supplies equally, ranging from crude oil and natural gas to refined products like jet fuel and diesel.<\/p>\n \u201cMarkets are now grappling with a scenario long discussed in theory but rarely thought of as a legitimate possibility \u2014 the effective shutdown of the world’s most critical energy chokepoint,\u201d 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.\u00a0<\/p>\n 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.\u00a0<\/p>\n Europe\u2019s security of supply was rarely questioned, with officials pointing to the continent\u2019s 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\u00a0\u2014\u00a0only then would supply seriously become a concern.\u00a0<\/p>\n 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.\u00a0<\/p>\n 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.\u00a0<\/p>\n With almost all global suppliers at maximum capacity, European leaders are beginning to \u201crealize that the LNG supplies they were counting on were not coming here as expected,\u201d said Jaller-Makarewicz. \u201cIt’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 \u201cthis coming month\u201d \u2014 perhaps within a few weeks.\u00a0<\/p>\n \u201cThe very worst case is that the Strait of Hormuz remains closed for at least another month,\u201d 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.\u00a0<\/p>\n But even then, the executive warned, prices could remain structurally higher \u2014 perhaps\u00a0 forever.\u00a0\u00a0<\/p>\n 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 \u2014 including diesel and aviation fuel. \u201cIf the strait remains closed there’s basically no alternative options,\u201d 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 \u201cremains closed longer, we will see higher prices \u2014 and that will translate into a worse economic crisis.\u201d\u00a0<\/p>\n 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.<\/p>\n 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<\/a> to EU data.\u00a0<\/p>\n European governments have tried to keep down prices, slashing fuel duties and warning against gouging. But unless new flows arrive, they\u2019ll likely have to reach for an unpopular tool: demand destruction.\u00a0\u00a0<\/p>\n Already, EU energy chief Dan J\u00f8rgensen has advised EU governments, in a letter<\/a> 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 \u201cenergy lockdowns\u201d are approaching.\u00a0<\/p>\n 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<\/a> above $1,700 per metric ton. Though it has dropped slightly<\/a> in the last week, European airlines have been forced to jack up prices<\/a>.\u00a0<\/p>\n \u201cIt\u2019s been a double hit from the blow to refining capacity as well as crude production,\u201d said Willie Walsh, director general of airline lobby IATA. \u201cThere\u2019s no way the industry can absorb that increase, so prices will rise.\u201d<\/p>\n Draconian measures, such as cutting routes, have been taken by some Asian airlines<\/a>. In Europe, meanwhile, Lufthansa Group has discussed<\/a> 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\u2019s 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.<\/p>\n \u201cWhat’s happening in Eastern markets is sort of a preview of what’s potentially going to happen in European markets,\u201d said George Shaw, senior oil analyst at Kpler.<\/p>\n The pain has already started to ripple through European manufacturing. It\u2019s already visible in what European Commission President Ursula von der Leyen has called the \u201cindustry of industries\u201d \u2014 the energy-intensive chemicals sector that underpins much of the continent\u2019s manufacturing.\u00a0<\/p>\n \u201cThe cost increases we are experiencing \u2014 from rerouted logistics, raw material price spikes, and sustained energy price elevation \u2014 are substantial and need to be reflected in our pricing,\u201d said a spokesperson for German chemicals giant Covestro.\u00a0<\/p>\n 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, \u201cthe risk is clear.\u201d\u00a0<\/p>\n \u201cEnergy price volatility is now one of the biggest risks for industrial investment in Europe,\u201d he said. \u201cWithout stable and competitive electricity prices, investment decisions \u2014 including in low-carbon steel \u2014 become increasingly difficult to justify in Europe.\u201d<\/p>\n As the prices of basic inputs rise, the effect will quickly spread up the value chain to the rest of the manufacturing sector.<\/p>\n And that\u2019s not to mention the surging cost of other petroleum derivatives like fertilizers, plastics and even helium, an essential component of semiconductors. Plastics are \u201cparticularly exposed to supply disruptions because we are heavily dependent on oil and gas imports to meet both our energy and feedstock needs,\u201d PlasticsEurope Managing Director Virginia Janssens told POLITICO.\u00a0<\/p>\n The same goes for fertilizer producers, which were already wrestling with the EU\u2019s high energy prices. \u201cCurrent developments only put upward pressure on nitrogen fertilizer costs, where energy accounts for approximately 60-80% of operating costs,\u201d said \u0141ukasz Pasterski, director of communications and public affairs at lobby group Fertilizers Europe. \u201cBecause fertilizer markets are global, disruptions anywhere in the system are likely to quickly have knock-on effects on the input costs.\u201d<\/p>\n 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\u2019s where the menace of inflation could reappear \u2014 barely 18 months after central bankers declared victory<\/a> over the inflationary bout triggered by the last energy shock.<\/p>\n