This is no ordinary power attack. Rising oil and LNG prices are underpinning the strengthening US dollar, greatly increasing the burden on export-dependent economies while others are under pressure. The result is an unbalanced, fragmented crisis in which demand shocks can arrive sooner and more strongly than expected, spilling beyond capacity into the wider global economy. Unlike previous setbacks, there are few signs of coordinated leadership to manage the fallout. If these conditions continue, the current crisis could turn from a supply scare to a dollar-driven recession with the effects of a global recession.
This power crisis differs from the previous one in some critical ways. First, the amount of lost oil and LNG supplies appears to be greater than in other disasters and, due to Iran’s attacks on Gulf energy facilities, lasting longer. Many knowledgeable observers believe that lost supply will lead to a long period of high oil and gas prices. Crude oil and LNG prices will be pushed higher, possibly much higher, when measured in US dollars.
The increase in the dollar price of oil and LNG also poses an unknown threat to the world economy, because the US dollar is only the world’s reserve currency. The dollar exchange rate will rise as LNG and crude oil prices rise, absent the US Treasury or Federal Reserve. A strengthening dollar will put a lot of pressure on the economies of countries that have to import oil and gas. It will also put more pressure on the non-power sectors of the American economy.
The unbalanced impact of the supply area caused by the attacks on the structures in the Mideast Gulf and the closure of the Strait of Hormuz also distinguishes this crisis from previous episodes. Nations responsible for a third of the world’s oil consumption have not seen an impact on their oil supply, leaving countries using the surplus to bear most of the shortfall, most of them in Asia. The impacts are similar to natural gas.
Together, these characteristics lead to one conclusion: In this problem, price volatility for global consumers is much higher than previously thought. Simply put, oil and LNG consumption will decline faster than most studies project. The decline will occur because the real prices of petroleum products and natural gas in many countries will increase to an absurd extent as the value of the dollar rises. A global recession could follow if these issues are not addressed soon.
It’s Not Your Grandfather’s Trouble Oli
Many commentators look back to the 1973 oil embargo or the 1978 Iranian collapse to find instances of disruptions that closely resemble current events. However, the comparisons miss one important point: the US was an oil exporter during the previous events.
The supply cuts at the time were evenly distributed around the world as the US imported more oil. In addition, the dollar weakened as high oil prices increased the US trade deficit. These adjustments moderated the effect of the increase in the price of oil outside the US because oil, then, was bought in dollars.
This trend was evident between the Arab embargo in 1973 and the start of the Iran-Iraq War in 1980. In those eight years, the dollar lost about 30% of its value against the Japanese yen and the German mark, while it dropped 40% against the Swiss franc. The strengthening of those currencies reduces the impact of price increases by a third or more, limiting the economic consequences of the crisis related to the interruption of the oil market.
The current situation is very different. The emergence of the US as a major oil and LNG exporter had a major impact during this period because the dollar exchange rate increased, rather than decreased, with the prices of crude oil and LNG. A strong dollar magnifies the impact of higher oil and natural gas prices on nations that rely on imports from the Mideast Gulf.
The situation in Japan provides an example of the difference between the exchange rate between 50 years ago and today. In the 1970s, the yen appreciated by 60% as the US energy deficit rose. The exchange rate has fallen by 50% in the past year since the US became an exporter of oil and natural gas and lost another 4% in March. It may fall further in the coming months and years.
The situation in other oil and LNG importing countries is similar. Rising oil and LNG prices are boosted by a strengthening dollar. South Korea also fell 4% in March, while the euro lost 3%. More drops may follow.
Lazy answers
The effects of the current disruption will be magnified by policymakers’ sluggish responses to supply losses.
European nations, working mainly through the EU, have responded slowly to the chaos caused by the Iran war regardless of the problem caused by supply. Asian nations, lacking any coordinating body, responded independently.
Some countries are now jealously guarding their property. For example, South Korea has limited oil exports from the previous figure. China, a major exporter of petroleum products in Asia, has banned exports and is considering price controls. Thailand, a major exporter of petroleum products to Vietnam, has imposed a “temporary” ban on exports.
International oil companies also no longer control global distribution. Instead, it’s every community, every businessman, every company for it. This creates a series of different situations in which some countries and other consumers can meet their needs without difficulty, although at a high price, while others find that their goods are reduced, if they are available at all.
The situation in Europe is better than in Asia at the moment, but it will probably worsen in April after the last cargo of jets and diesels leaves the Strait of Hormuz before the war reaches the region.
Vacancy in Global Leadership
Although previous US presidents and/or secretaries of state, treasury and energy departments have worked to coordinate the global response to disruptions, the current administration seems indifferent, as Energy Secretary Chris Wright made clear with this statement at the recent CERAWeek conference by S&P Global in Houston: “Markets do what markets do. It wants logical destruction.”
At the same meeting, Secretary of the Department of the Interior, Doug Burgum, spoke in the following words: “President Donald Trump is very sensitive, as we all are, about the fact that there has been a temporary increase in prices.” Neither Wright nor Burgum spoke of a global disruption. However, others said: “Fuel supply shortages will spread to Europe in April if the war continues,” Shell CEO Wael Sawan said, adding that “countries cannot have national security without energy security.”
Sawan repeated the words spoken in 1974 by Henry Kissinger before a joint committee of Congress, where Kissinger described the construction of international “cooperative foundations” after World War II and added this advice: “We are facing another such time today.
Kissinger also realized that “international cooperation, especially among the industrialized countries of North America, Western Europe and Japan, is an unavoidable necessity,” warning that “dangerous political consequences” would follow, in the absence of cooperation, as well as global collapse. It is clear that those in the Trump administration have decided to test Kissinger’s ideas.
Philip Verleger is an economist who has written about energy markets for more than 40 years. A graduate of MIT, he has served two presidents, taught at Yale and helped develop energy markets since 1980. Kim Pederson is the managing editor of PKVerleger. The opinions expressed in this article are those of the author.
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