WASHINGTON—As diplomacy between the United States and Iran seesaws between apparent breakthroughs and inevitable setbacks, it is easy to lose sight of the larger stakes for the global economy: If the Strait of Hormuz does not reopen soon, then the world will almost certainly face a major oil supply crisis, forcing painful, sustained reductions in demand.
Given the gravity of the situation, global policymakers should prepare themselves and their citizens for a long crisis. Countries have few options, none of them are easy, and some that appear easier in the near term, such as government-provided demand subsidies, carry large costs later. Perhaps the wisest option for leaders is to start curtailing their country’s demand for oil by convincing citizens to reduce consumption.
Market supply risks are real
With the recent US decision to impose a counter-blockade on the Strait of Hormuz, the war in Iran shows few signs of letting up. Oil markets have responded, with the price of Brent crude increasing from less than $70 per barrel to around $95 per barrel today. Yet even with this increase, the worst of the crisis might still lie ahead. Crude oil supply losses are mounting quickly, and oil inventory buffers from sanctions waivers and floating storage will be largely exhausted by late April. Based on Kpler estimates, by the end of this month, cumulative supply losses will amount to around 650 million barrels; daily production outages now surpass 13 million barrels per day (bpd). The US blockade, imposed on April 13, adds an additional 1.3 million bpd of outages as Iranian crude oil will no longer reach the market.
The sharp decrease in oil production can be observed via export data. Global seaborne crude and condensate exports, as tracked by Kpler, ended March down 6.9 million bpd from the previous month, and are down another 1.8 million bpd through April 20. This implies that loadings are down 8.8 million bpd from prewar levels. If the April loading pace continues, then crude and condensate exports will be marginally above lows last seen during the COVID-19 pandemic in June 2020.
Dozens of countries have large strategic oil inventories, but these are no match for massive, sustained production outages. Moreover, drawing on these reserves today necessitates higher future demand when inventories are replenished. We estimate, for example, that refilling inventories with this lost production over the course of a year will take an additional 1.8 million bpd beyond baseline demand. And this assumes the strait could be reopened by the end of April, and that countries will not choose to expand strategic petroleum reserves from prewar levels. The supply gap will only worsen if the strait remains closed into May, or if alternative export routes for oil producers in the United Arab Emirates and Saudi Arabia are disrupted, for example by Houthi forces operating in the Red Sea.
The scale of these observed and potential supply disruptions is without precedent. The 1973 oil embargo wiped roughly 7 percent of global oil production off the market but was politically reversible. The present crisis has reduced 13 percent of global supply, at least temporarily, and it is a physical disruption. The recovery of damaged infrastructure will take months or even years. Finally, the Middle East accounts for about 30 percent of total global oil supply; in a worst-case scenario, virtually all these volumes could be at risk. The Iran war could resolve soon, but a gigantic, sustained disruption exceeding the scale and damages of the 1973 crisis is possible.
Not all policies are created equal
Import-dependent economies need to act now to better manage an extended Strait of Hormuz closure. Policymakers are likely considering a range of options; it is perhaps most useful to start by discarding some of the riskier ones.
Price caps, direct and indirect subsidization, and tax relief, all of which blur the linkages between price and consumption, are effectively a bet that the war in Iran will end soon and the strait will reopen quickly. If oil production cuts persist through May or beyond, however, these demand subsidies could create more acute fuel shortages later this year. In other words, the very policies meant to quell political frustrations could amplify them.
To date, global policy measures have included both demand rationing and subsidization schemes. For example, the Indo-Pacific region faces some of the most acute supply shortages given its reliance on energy via the Strait of Hormuz; it has taken the most aggressive steps to implement work-from-home and rationing policies, although these are somewhat offset by expansive subsidy schemes. In Europe, policies have generally favored consumer price support via both price caps and subsidies, while undergoing a far more limited set of demand suppression policies. Consumer support measures are widespread across the Americas, with Canada, Mexico, Chile, Brazil, and Peru all implementing some form of price cap or subsidy.
Restricting exports of crude or refined products would similarly subsidize domestic demand. Like other forms of demand subsidies, these measures would blunt price signals by front-loading consumption, harm US export markets, and invite potential retaliation from trade partners. In general, export bans should be avoided outside of narrowly targeted circumstances, such as shipping scarce oil resources to adversaries like Beijing.
How countries should respond to the oil supply shock
Instead of subsidizing demand or releasing scarce reserves too quickly, policymakers should emphasize the rationing of scarce supplies.
A first step is to institute tiered transportation fuel rationing to protect essential uses. Food production—especially in developing countries—should be at the front of the line, while marine and logistics supply chains should be prioritized as much as possible. Alternatively, other, less critical use cases, such as vacations with recreational vehicles (RVs) across Europe, may need to be curtailed. On an economy-by-economy basis, policymakers will need to determine which use cases and customers are critical, and which are discretionary and nonessential.
Diesel should receive special attention. Logistics supply chains disproportionately rely on diesel, which faces severe supply stress. The Middle East produces grades of medium-sour crude oil well-suited as feedstock for the production of middle distillates, such as jet fuel and diesel. As the war continues, supplies of these refined products, especially diesel, are becoming tighter; US diesel prices have already reached all-time seasonal highs.
Discouraging nonessential diesel demand is therefore of major importance, but its importance varies by economy. Kpler data indicates that Europe, China, and the United States are the world’s largest diesel consumers, in that order. Accordingly, diesel demand destruction must focus on those economies.
European oil demand is disproportionately weighted toward diesel, as seen below, while developing countries such as India also rely heavily on the fuel for transportation or industrial applications.
To limit oil demand, especially for diesel, all countries should consider stepping up public transportation utilization via subsidies and instituting work-from-home policies for office workers—while still mandating critical in-person functions, such as school attendance.
Appropriate policies will vary on a country-by-country basis. Take Germany, Europe’s largest economy and its largest diesel consumer. Improving the efficiency of freight and passenger train service in Germany could reduce European diesel consumption in the transportation sector. Restoring an effective train system will take years but, in the meantime, Germany should consider emergency rail measures, such as dispatch priority for freight.
In the United States, policymakers should re-examine the Jones Act, which requires all coastwise shipping (domestic shipping between US ports) to be US-flagged, US-crewed, US-built, and US-owned. The Jones Act inhibits coastwise shipping, leading to reliance on less efficient heavy-duty vehicles that contribute to diesel demand and are only 10 percent as efficient as modern container and bulk vessels on a per ton-kilometer basis, according to some estimates. In addition, scrapping the Jones Act could substantially reduce reliance on fuel oil and diesel for power generation across Puerto Rico, Hawaii, and New England, which currently cannot receive US-produced liquefied natural gas (LNG) as no Jones Act–compliant LNG carriers exist. The United States’ east and west coasts, both of which import a combined 2.2 million bpd of crude and transportation fuels from abroad, would also have the option to pull supply from the US Gulf Coast. Under 46 U.S. Code § 501, Jones Act waivers can be issued immediately by the executive branch.
Recognize consumer realities and human psychology
While we believe that demand must be rapidly curtailed, we recognize the reality of public opinion constraints. Countries should attempt to quickly withdraw existing subsidies in place, where possible, but avoid major, sudden price hikes: Gradual trends are more politically palatable than step changes. Take Kazakhstan’s experience in 2022, when the government’s sudden withdrawal of subsidies caused prices of liquefied petroleum gas, used for transport fuel in Central Asia, to double overnight, alarming consumers and almost immediately triggering nationwide protests and political instability. There have been similar examples in many other countries. Wherever possible, then, policymakers should make price hikes gradual—and frequent—rather than sharp and sudden.
In addition, we recognize that some non-price mechanisms—like physical rationing—may be regarded as more “fair” by the public than price-mediated shortages. While voters bristle as pump prices move higher, they may be more responsive to other methods to curtail demand, such as restricting times when they can purchase or consume fuel. With the palatability of price versus physical rationing varying from society to society, policymakers should consider both approaches.
