It is now clear that Donald Trump is not a reliable source to understand what developments we should expect in Iran: sometimes he promises détente and negotiations, sometimes he threatens to strike Iran’s energy infrastructure worsening the ongoing crisis, sometimes he considers a ground invasion with thousands of soldiers, though still too few for a country of 90 million inhabitants.
Therefore, the only sensible thing to do to reason about what lies ahead is to analyze the dynamics of the possible evolution of the economic consequences of a war that, after three weeks of fighting, would no longer be classified as short even if it ended tomorrow.
The OECD’s estimate for Italy’s GDP is a growth of 0.4 percent with oil at 100 dollars and a price shock that is absorbed within six months, but depending on the forecasting institute, very different results are obtained.
“These inconsistencies among forecasters are a symptom of high uncertainty,” notes economist Sergio De Nardis in the newsletter In Più. And indeed, the indicator measuring market uncertainty – the so-called “fear index” Vix – is above 30 points, sharply increasing but still far from the peaks around 60 it reached in the early days of the Ukraine war in 2022.
The parallel with the energy crisis five years ago always serves to downplay the scale of the current one.
The European Central Bank has an energy price index which is a weighted average of gas and oil prices. Even in the worst-case scenario, of a sustained and lasting increase in crude oil and derivatives prices due to the closure of the Strait of Hormuz, it would reach just over half the 2021-2022 level.
A recent presentation by the ECB’s chief economist, Philip Lane, helps to understand how they think in Frankfurt: the worst scenario is that of a relatively quick crisis, which does not have lasting implications like that of 2022 when the whole of Europe had to change gas and oil suppliers after deciding to cut ties with Russia.
The problems lie in the more negative scenario when sustained prices for a long time can generate “second-degree non-linear effects,” meaning that price increases and scarcity of some primary goods can create supply bottlenecks that cause very serious consequences.
It is one thing to pay a bit more for energy, another to be completely without essential products, regardless of their price.
The sector where these “non-linear” effects could materialize is that of fertilizers. Nobel laureate economist Paul Krugman has also written about this:
“The reason we are importing fertilizers, especially from Qatar, is that these fertilizers — particularly urea and other products — are made from natural gas. Natural gas can be exported, and indeed it is, in large quantities from the Persian Gulf — or at least it was before this war began.
However, it is an expensive process: the gas must be super-cooled, liquefied, and transported via specialized terminals and ships.
Of course, it is a feasible procedure and has become crucial for a large part of the world. But there is also another possibility: the natural gas available in the Persian Gulf area can be directly converted into fertilizers, which are much easier to transport.
For this reason, a significant share of global fertilizers comes precisely from that region and, under normal conditions, is shipped through the Strait of Hormuz.”
These spring months are, in many parts of the globe, the time for sowing, after which fertilizers are needed. And what if these are missing?
Farmers usually – as happens for almost all raw materials – hedge against price fluctuations with long-term purchases and derivative contracts that sterilize fluctuations, but what happens if at the moment of obtaining the fertilizer it is missing because the ships that were supposed to transport it never passed through Hormuz, blocked by Iran?
If fertilizers arrive even just three months late, the damage can be huge, because the seasons’ evolution does not stop, and if the plant’s life cycle requires the soil to be fertilized in May and instead the fertilizer arrives in October, productivity will be much lower. In short, at harvest time there will be less production.
The Kiel Institute, one of the most serious think tanks on the economic implications of geopolitical tensions, has written that some of the products transiting Hormuz simply have no possible substitutes:
“Qatar’s petrochemical production requires decades of infrastructure investments. The role of the United Arab Emirates as a hub for diamond and gold trade is based on regulatory and logistical ecosystems that cannot be replicated overnight.”
Both Iran and Qatar host some of the world’s main sites for converting natural gas into fertilizers that help make soil more productive and feed billions of people.
2022 turned upside down
Even regarding fertilizers, the comparison with 2022 can lead to wrong conclusions. Four years ago, the shock hit energy prices in Europe and exports of corn, wheat, and sunflower oil from Ukraine, once known precisely as the “breadbasket of Europe” due to the importance of its grain production.
Today the impact of the crisis is very different: the wealthy Gulf countries are important importers of agricultural products they cannot grow, but crucial exporters of fertilizers and liquefied natural gas, as well as oil.
As the FAO, the UN agency dealing with food, observes, “the current conflict in the Gulf region is generating a shock of similar magnitude to that of 2022, or perhaps even greater, on energy and fertilizer markets. However, the dynamics of the food market are completely reversed.”
Globally significant agricultural countries like Brazil now find themselves with a surplus of food to export – because demand has decreased due to the war – but with the risk of a shortage of fertilizers crucial for upcoming harvests. Two factors that could push to reduce production, with repercussions for the rest of the world.
India and China depend on the Gulf for about 20 percent of their fertilizer needs, Pakistan sources all its liquefied natural gas imports from Qatar and the United Arab Emirates.
Poor and troubled African countries, lacking a developed industrial economy and close to subsistence, also depend on the Gulf for fertilizers: Sudan, already suffering a bloody civil war, imports 54 percent of its fertilizers from the Gulf, Kenya 40 percent, and also imports 90 percent of the wheat it consumes, thus exposed both to price shocks on intermediate goods and shocks on finished products.
Somalia practically imports all its fertilizers from the Gulf, to which it exports all its agricultural production abroad.
And these are not even the most at-risk countries, according to the FAO analysis. Bangladesh, which still has very high poverty rates, depends on the Gulf for 53.3 percent of its fertilizers used at a rate of 170.35 kilograms of nitrogen per hectare, and depends on Qatar for two-thirds of its liquefied natural gas consumption.
Thailand also uses a lot of fertilizers, 120 kilograms of nitrogen per hectare, and depends on the Gulf for 35 percent.
What can happen – in the FAO’s analysis – is that already very poor countries find themselves facing higher energy costs and lacking the necessary fertilizers when needed to sustain soil productivity, resulting in farmers becoming poorer, producing less, and having to sell at higher prices.
Also because, obviously, if there are few fertilizers on the market, the richer countries with greater spending capacity will be able to grab those available.
The only hope therefore seems to be that the war ends soon and everything returns to normal. But the more days pass, the clearer it becomes that the new normal could be very different from the past.
As Gideon Rachman observes in the Financial Times, it is already clear that Iran could emerge strengthened from the conflict, whatever the internal regime: it has shown it can carry out the threat to choke the global economy by closing the Strait of Hormuz and that it can also open transit to countries that make advantageous deals or pay substantial sums.
As far as is known, Iran currently demands 2 million dollars in toll from each ship crossing the strait. It is easy to do the math: with 50 ships a day for 30 days a month, that potentially makes 3 billion dollars a month, 36 billion a year, an enormous sum for a country with an annual tax revenue equivalent to 14 billion dollars, paid moreover in the local currency, the devalued rial.
Just as the 2022 crisis filled Russia’s coffers, at least in the short term, thanks to the spike in gas and oil prices, so the attack by the United States and Israel on Iran could translate into an unexpected source of revenue for the dying ayatollah regime. A revenue derived from a tax on the global economy, particularly on oil, gas, and fertilizers that must necessarily transit through Hormuz.
The long-term damages of the attack by Trump and Israeli Prime Minister Benjamin Netanyahu, in short, could prove much greater than currently predicted.
(Excerpt from Notes)
