FOR a brief period of time, there was hope that a tentative easing of tensions in the Persian Gulf would lead in the direction of the end of the global energy crisis caused by the Israeli-US war against Iran. In the past week, however, that hope has unraveled in the face of a volatile, multi-front disruption to the global energy supply network and the broader economy that might be even more severe than what initially followed the outbreak of war at the end of February. Even if the current situation were to immediately improve — and there is little indication as of today that it will — the effects will linger for several quarters, which is why most economic analysts have already shifted to their “worst-case scenario” forecasts. The government should strongly consider doing the same.
The most obvious indication of what is happening from the perspective of the everyday consumer is this week’s noticeably lopsided increase in fuel prices. Gasoline prices increased by P3 to P4 per liter, whereas diesel and kerosene prices increased by P10 to P12 per liter. There are three reasons for this. First, as is already well-known to the public, the strategically vital Strait of Hormuz has again closed due to the breakdown of the temporary ceasefire between the US and Iran, cutting off oil and other shipping from the Persian Gulf. While it is hoped that the current flare-up in hostilities will end sooner rather than later, the start-stop nature of the war has constrained petroleum supply chains enough that commodities markets have already priced in the volatility through at least the end of the year, meaning that oil prices will likely remain above $80 per barrel for the next two or three quarters.
That is bad enough on its own, but over the weekend, the Houthi rebels of Yemen ended their four-year informal truce with Saudi Arabia, firing missiles at Saudi targets after accusing Riyadh of striking a Houthi-controlled airport in Yemen. The Houthis have subsequently declared a maritime blockade of Saudi Arabia, which they can effectively accomplish by closing the narrow Bab El-Mandab Strait at the mouth of the Red Sea.
This development is particularly alarming, because Saudi Arabia’s East-West Pipeline, serving the Red Sea port of Yanbu, has been the lifeline for Saudi oil and some supplies from other Gulf states during the Hormuz crisis, capable of moving about seven million barrels per day. A simultaneous disruption of Hormuz and the Red Sea, even for a short period of time, would be catastrophic: Most modeled scenarios show oil prices hitting record highs, global inflation increasing by 3.2 percentage points or more, and global gross domestic product (GDP) declining by at least 2.0 percent.
Diesel critical for PH
The third shock, which does more to explain the sharp increase in diesel prices than the other two factors, is that Russia has suspended exports of diesel fuel, a result of critical fuel shortages in that country due to Ukraine’s massive campaign against Russian petroleum infrastructure. Russia is the second-largest exporter of diesel after the US, accounting for some 12 percent of the world market, and its suspension of exports comes at the worst possible time. Middle Eastern heavy crude (ideal for diesel production) is constrained, Chinese fuel exports are restricted, and roughly 10 percent of global refining capacity is offline due to attacks. Russia’s ban on exports is supposed to be temporary and expire at the end of July, as it desperately needs the income, but the damage already done to refinery capacity, and what still might be done by Ukrainian attacks makes an extension of that ban likely.
Diesel is critical for freight, agriculture, industry, and to some extent here in the Philippines, electricity generation, and so elevated prices and constrained supply pose the greatest macroeconomic risk. Higher refined-fuel prices will feed quickly into transport and production costs, lifting inflation and weighing on economic growth. So far, our policymakers have recognized this to some extent, but our concern is that contingency planning has not gone far enough. Key economic forecasters have already warned that a higher-for-longer fuel price profile indicates a growing tail risk of acute diesel shortages, which very well may make even the lowered growth projections for this year and next look optimistic. The consequences of what is happening now will ripple through the economy long after the missiles stop flying, and our policymakers charged with responding to impacts on the economy need to take that into account.
