From Strait to Supply Chain: How the Iran Oil Disruption Is Feeding Inflation

Last week, the International Energy Agency (IEA) published their report on the effects of surging oil prices as a result of the recent war in Iran.

In March, we saw the single highest monthly increase in oil prices following the most severe oil supply shock in history. The continued US/Israeli strikes on Iranian energy infrastructure and the ongoing restrictions on oil tanker movement through the Strait of Hormuz have been the driving force for upward prices.

At the time of writing, oil prices have eased slightly. Brent crude, which previously peaked at around $147 per barrel, is now trading just above $99 - still representing an increase of roughly 60% since the start of the year.

The IEA predicts that oil supply will fall by 1.5 million barrels a day (bpd) through 2026. That is equal to roughly 1.5% of global demand and opposes their earlier prediction of a 1.1 million bpd supply growth.

Consumer Price Index (CPI) inflation information released by the Office for National Statistics shows a 0.3% rise in inflation from March to February (3.3%).

This highlights an immediate effect of a global oil supply shortage. Food and non-alcoholic beverage inflation (3.7%) sits 0.4% higher than CPI inflation, indicating higher levels of upward prices on these goods.

But why?

Food and drink production is more susceptible to oil price instability due to its highly globalised supply chain. Oil and fertiliser prices affect different stages of the production process.

Modern agriculture relies heavily on energy-intensive processes, oil derivatives are required in a range of modern fertilisers used globally. These, along with natural fertilisers, are massively restricted through the closure of the Strait of Hormuz.

Secondly, the cost of transportation surges following a rise in petrol and diesel prices. A global supply chain means that food and drinks are widely exported. Palm oil from Indonesia, grain from Russia, and beef from Brazil travel thousands of miles before reaching the next stage of their production process.

Despite the wave of food and beverage production price rises, other sectors are not yet feeling the strain of massively reduced supply.

Sectors that currently rely on oil futures will not see cost increases for the next few months.

Oil futures (or hedges) are standardised, exchange-traded contracts where a buyer and seller agree on a set quantity and price for a set time in the future. This helps protect firms against price volatility as well as allow them to speculate on the future prices of oil without having to take a physical delivery.

Prices in sectors that utilise these futures, such as air travel, have not yet surged, although some airline CEOs have warned that fares could rise once their fuel hedging contracts expire.

Michael O'Leary, CEO of Ryanair, warns of a massive shock to air travel consumers in June following the end of the current Ryanair oil futures.

Donald Trump

The ceasefire agreed earlier this month between the United States and Iran has been repeatedly strained by violations on both sides. This has subsequently been met with the continued closure of the Strait of Hormuz after its brief opening earlier this week.

Iranian lead negotiator Mohammad Bagher Ghalibaf spoke late on Wednesday, outlining that it is currently "impossible" for the strait to be reopened for tankers. This is likely to place sustained financial pressure on global industries in the coming months.

Even if the strait were to reopen immediately, the effects of the disruption would continue to feed through into prices.

Tankers held up in ports within the Middle East would have to begin their journeys, often taking weeks to reach destinations. In addition, insurance premiums and shipping costs will remain high until the risk of future conflict stabilises.

The IEA's most recent report assumes a resumption of regular oil and gas deliveries to international markets by mid-year, although not to pre-conflict rates. This suggests a strain on supply at least into the second half of the year.