The Strait Of Hormuz May Be Open, But It's Not Necessarily Smooth Sailing For The Economy

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The economic costs of the Iran war could linger long after the Strait of Hormuz reopens to commercial shipping traffic, economists said Friday.

Iran's announcement that the crucial shipping lane was open to commercial traffic came as a relief to financial markets, with major stock indexes ripping higher and oil prices falling on the news. Brent crude oil, the international benchmark, fell more than 8% to over $90 a barrel as of Friday afternoon, down from its recent peak of $118 in March.

However, that was still above the $65 price at the beginning of the year, a sign that the effects of the war continue to linger even if the shooting part of the conflict has stopped. Even if there are no setbacks, the economic shockwaves of the war could continue to ripple for months or even years, economists said.

The reopening of the strait is a major milestone in the conflict, since 20% of the world's oil normally travels by ship through the waterway on its way to international markets from the Persian Gulf. The restriction of the supply and oil and other supplies during the war was its most significant economic impact, pushing up energy prices and causing the price of a gallon of gasoline to surge by more than $1 on average in the U.S. according to AAA.

But, as with the supply chain disruptions caused by the COVID-19 pandemic, untangling the mess could take a long time.

"It's a relief, and it's a step in the right direction," Jon Hilsenrath, senior advisor at StoneX, said in an interview. "But I'm not going to be convinced that the strains that it put on energy supply chains and other supply chains, and the strains that it put on prices, are going to be completely resolved overnight."

The reopening of the strait reduces the risk of a worst-case scenario for the economy, in which soaring oil prices trigger a recession.

Oil prices, for instance, are expected to gradually decline in the months ahead. Brent crude will fall like a feather and still average $88 a barrel by the end of the year in ING's forecast.

"This signals that the worst is perhaps, you know, behind us, and there is clearly an appetite to get deals done from both sides, and that removes or boosts the chances that we will see a meaningful re-escalation," James Knightley, chief international economist at the bank, said in an interview. "But that doesn't necessarily mean we're going to get anywhere back to $65 a barrel of oil where we started the year anytime soon."

There are multiple factors keeping crude prices elevated even with the strait said to be open for business. As of Friday, it remained to be seen how many tanker captains would take their chances on the voyage. Not only that, but oil facilities on both sides of the war were blown up in the fighting, and the extent of the damage is still being assessed, Knightley said. Furthermore, countries that drew down their stockpiles during the war will look to replenish them once the strait reopens, keeping demand for oil high and putting upward pressure on prices, he said.

And even if shipping returns to normal, the very fact that the strait was closed off demonstrates that it could be again at some point in the future, or that Iran could charge a toll to allow ships to pass—a risk that will likely be priced in to oil in the future, Hilsenrath said.

"Even if they don't charge a toll for transportation through the strait, the mere fact that we know that there is some risk of a conflict that disrupts transportation through the strait ought to create some kind of long-term pressure on prices for shipping and energy that goes through there. There's some kind of tax that now exists," Hilsenrath said.

Some economists kept their forecasts for the economic outlook unchanged, since they had already assumed the strait would reopen at some point in April or May. The announcement of the strait reopening reduced, but didn't eliminate, the chances of peace talks breaking down and the fighting starting again—a worst-case scenario for the economy that could lead to soaring gas prices and recessions in the U.S. and global economies.

"The development increases the risk that a more lasting deal could be brokered, reducing the likelihood of extreme downside scenarios crystalising,” Ryan Sweet, chief global economist and Ben May, director of global macro research at Oxford Economics, wrote in a commentary.

The trajectory of the economy hinges on whether the guns stay silent and how quickly shipping returns to normal levels, they wrote.

“The first of these is far from a foregone conclusion, and we remain cautious over a rapid return to normal traffic flows through the strait,” they wrote.

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