As the conflict between the United States and Iran enters its fourth week, it’s shockwaves are having effects thousands of miles from the Persian Gulf.
On Monday afternoon, President Donald Trump issued a statement that he is in talks to end hostilities with Iran, a claim which Iran has so far denied. The move comes as a result of mounting pressure on the president due to increased energy prices caused by Iran’s blockade of the vital Strait of Hormuz.
Unable to compete with America and Israel in a conventional military sense, Iran’s response to strikes against its regime has been to blockade the Strait of Hormuz. The Strait of Hormuz is the narrow corridor through which the Persian Gulf empties into the Indian Ocean via the Arabian Sea.
At its narrowest, it is only 21 miles wide, with the portion that is navigable for ships being even smaller. Over the course of the last three weeks, Iran has utilized missiles and drones to target ships attempting to transit the strait, with over 20 ships hit so far.
Energy costs surging as a result of instability in and around the Persian Gulf is not a new occurrence — the 1979 Energy Crisis that resulted from Iran’s Islamic Revolution is a notable example.
America is a largely energy-independent nation and is the world’s biggest oil producer, accounting for around 20% of global production in recent years. This has led many to question why a restriction in oil supply originating from the Persian Gulf is having a significant impact on gas and energy prices in America.
Timothy Fitzgerald, an associate professor at the The Baker School of Public Policy and Public Affairs, specializes in natural resource economics and energy economics. He spoke to this issue by stating that the global market for oil and natural gas is heavily interconnected and that buyers who would normally buy from Gulf States are now looking elsewhere.
The United States is one alternative supplier, particularly given its level of production. Therefore, demand for American oil exports has increased and, consequently, has also raised prices domestically.
“If American buyers tried to purchase U.S.-produced oil at below-market rates, producers would simply export it to the higher-paying international market. Oil is a globally traded commodity, and its price is set by worldwide supply and demand,” John-Patrick Paraskevas, an assistant professor of supply chain management, said.
To help increase supply, President Trump authorized the release of 172 million barrels of oil from the Strategic Petroleum Reserve.
“The SPR is a government-owned inventory created to help mitigate price spikes in cases just like this,” Fitzgerald said.
The conflict also has the potential to increase the prices in other markets as well.
“There are many downstream impacts of oil prices,” Paraskevas said. “Oil is a major input in transportation, especially trucking, and most of our goods we purchase in a retail setting are delivered via truck. So while we likely wouldn’t notice an increase in prices of our daily goods in the short-term, eventually prices of the goods we purchase would be impacted.”
Maritime shipping in particular has already begun to see increases in cost, especially for ships operating near the Persian Gulf. Outside of increased fuel costs, relevant insurance costs have also risen substantially.
“Right now, I’ve seen some rates on some of the larger oil tankers, they’re running upwards of about $250,000 a day. And if you want me to go through the Suez, you’re looking at a half a million dollars per day just to sail through that area … That does not include my fuel costs, that does not include any additional insurance costs,” Don Maier, an associate professor of practice in the Haslam College of Business’s supply chain management department, said.
Maier explained that insurance for maritime shipping is a very complex issue, with ships needing multiple policies for different items such as the ship itself, the crew, the cargo and any potential hazards created if the ship or cargo cause external damages. Currently, the biggest issue facing maritime insurance brokers is that many of the institutions that usually provide the financial backing for their policies are wary of doing so. Given the likelihood of ships transiting near Iran being attacked, policies for voyages in the region are nearly impossible to get.
Maier highlighted the sheer amount of capital that is invested in international shipping. He noted that, although President Trump has mentioned the possibility of the government providing the backing for insurance policies to get more ships to transit the Strait of Hormuz and relieve pressures on the markets, the likelihood of this having a significant impact is low. Insurance companies are still unwilling to take what Maier characterizes as a “bad bet.”
All three professors were keen to point out that, with the ever-increasing role that international trade is having in the lives of people globally, disruptions such as this one are more likely to occur in the future.
“I do think that the interconnectedness and complexity of our supply chains does make disruptions like this more likely. A disruption in one part of the world can impact supply chains on the other side of the world,” Paraskevas said. “I don’t anticipate this changing.”
