Critical briefing: energy price shocks

As a recent Cambridge study — and our April cover essay by Chris Bayliss — show, British energy policy is deeply chaotic and fragmented. The impacts of the war in Iran are yet to be felt, and the uncertainty around the duration of the conflation — following contradicting statements from the Trump administration and the Iranian regime on the progress of peace talks — means there is a feeling we are in the calm before an energy storm. In a characteristic understatement, Sir Keir Starmer has warned that dealing with the effects of the war ”will not be easy.”

What happened

To exert pressure on the US and Israel, Iran has moved to control the Strait of Hormuz — the sole maritime gateway to the Persian Gulf — while harassing and damaging vessels across the region, using everything from small boats along its extensive coastline to drones capable of striking from up to 1,200 miles away; since the war began, it has attacked at least 22 ships to underline its intent.

Due to the threat environment, few ships dare to make the voyage without Iranian permission, whilst insurance is either prohibitively expensive to obtain — or refused entirely. 

Roughly a fifth of the world’s oil and liquefied natural gas (LNG) normally passes through the strait en route to global markets, especially in Asia. Alongside the closure, Iran has struck key energy infrastructure across the region: the Ras Laffan LNG complex in Qatar, the Yanbu terminal on Saudi Arabia’s Red Sea coast — the terminus of the pipeline that bypasses the strait — and Fujairah in the United Arab Emirates, through which Emirati crude can be exported outside it. The aim is twofold: to cut the volume of oil reaching the market now and to extend the disruption long after the strait reopens, as damaged facilities will take months or even years to restore.

This means the global oil market is facing a supply disruption greater than those seen during the 1973 and 1979 oil crises combined. In total, the world is short roughly 11 million barrels per day (mbd) — about 11% of global supply — compared with the approximately 20 mbd that passed through the strait before the conflict.

Why it matters

The energy implication of the war have markedly strengthened the Iranian regime’s hand: because the strait remains physically navigable, Iranian oil continues to reach global markets — in even greater volumes than before the conflict. Whist the regime is therefore under significant military pressure, it is under less financial stress than the US and Israel appear to have planned for, with the Trump administration pursuing both a peace deal and the further involvement of allies hard. It may be that the US and Israel will not solely dictate when this conflict will end.

The main impact, however, is economic. Compared with other regions, Europe is somewhat insulated from the gas supply disruptions because only 8% of EU LNG imports come from Qatar. 

Unlike the 2022 energy crisis — triggered by Russia’s invasion of Ukraine and the subsequent cutoff of pipeline gas to Europe, when the continent increased LNG imports to make up the shortfall — Europe’s gas supply is not in immediate jeopardy.

However, because wholesale electricity prices in Europe are already highest when natural gas sets the market price, it faces the its second major energy shock in four years, raising concerns about the impact of energy costs on European competitiveness and living standards. 

If the conflict continues, Europe’s heavy reliance on gas imports means rising competition for unaffected energy supplies could sharply increase prices. For example, a doubling of gas prices would add roughly €100 billion to EU gas import costs over the next 12 months, on top of the €117 billion spent in 2025. Prices climb further, or, in a worst-case but conceivable scenario given the limited number of suppliers, threaten supply security if sufficient gas cannot be sourced. Tighter global oil markets, also disrupted by the Iran conflict, may exacerbate these pressures.

With a quarter of its gas imports coming from the United States, Europe’s problems may be further exacerbated by increased competition from Asia, which is bearing the immediate brunt of the shortfall.

Countries across the region are taking drastic steps to curb LNG demand and are turning back to coal to cover massive energy shortfalls. South Korea is postponing the shutdown of coal-fired plants, and the Philippines plans to increase output from its coal stations.

There are also already efforts to curb usage: in Pakistan, schools have closed to conserve energy, while India faces a shortage of liquefied petroleum gas used for cooking. Australia has temporarily cut its fuel excise by 50% for three months and unveiled a national fuel security plan, urging motorists to “only buy the fuel you need” to mitigate the impact of rising prices.

Ironically, China — which decoupling from Iranian energy supplies was widely assumed to be a  driving factor in President Trump’s decision to start the war — is less vulnerable to the crisis than its neighbors. In recent years, it has significantly expanded energy production across fossil fuels, nuclear, and renewables, while also building a substantial strategic oil reserve. State-run refineries have steered clear of Iranian crude to avoid jeopardizing access to international markets, but independent “teapot” refineries continue to process it for domestic use.

What happens next

A prolonged disruption could trigger a worldwide recession as economic activity slows in response to soaring fuel prices. Rising fertiliser prices could curb food production; however, futures prices for food commodities — even for contracts maturing next year — have increased only modestly, indicating that strong harvests and ample grain reserves should provide a buffer.

Domestically, there may be massive repercussions: household energy bills are forecast to rise sharply, with estimates suggesting an increase of around £288 a year from July as soaring wholesale costs driven by the Iran conflict feed through into Ofgem’s price cap. It is now expected to reach around £1,973 in July, which actually represents a modest reduction from earlier forecasts. Even so, the prospect of a sharp increase in gas and electricity bills has prompted the government to consider further targeted support as part of its contingency planning. Likewise, across Europe, several governments have introduced fuel subsidies and tax cuts to shield consumers from rising prices.

The impact for industrial businesses are likely to be much worse: Britain already has the much higher industrial energy prices than comparative nations — 50% higher than in France or Germany, for instance — and further price rises will be a savage blow to competitiveness.

The war has prompted a vigorous debate on Britain’s energy future, including in these pages. Whilst many have used the impact of the war as evidence to call for a doubling down on renewable energy, Conservative Leader Kemi Badenoch has launched a “get Britain drilling in the North Sea” campaign, whilst Nigel Farage has called for Britain to ”follow Norway“ and allow drilling in the region. SNP leader John Swinney has also hinted at a shift in position, repeatedly declining to reaffirm the party’s commitment to its earlier stance. While the Scottish government set out a presumption against licensing new offshore fossil fuel developments in 2023, he has since argued that energy security should play a role in any future decisions on further exploration.

There has likewise been pushback on the continent: whilst the EU has renewed calls to accelerate the transition to a clean, domestically powered energy system, some member states have moved in the opposite direction. Italy has postponed its coal phase-out by more than a decade, while Germany’s chancellor, Friedrich Merz, has suggested keeping coal plants online for longer and speeding up the construction of gas-fired power stations.

In the short term, Rachel Reeves has opened a rift with Ed Miliband by signalling support for North Sea drilling. However the broader instincts of the Labour government — and in particular the strong political position of Miliband — are likely to block any new access to existing energy resources.