4 scenarios on how the Iran conflict could reshape energy markets
Associated Press (AP)Associated Press (AP)Associated Press (AP)
· 9 min read
How long will energy prices stay high? With the US alternatively threatening escalation and withdrawal, and the Straits of Hormuz still nearly shut, the energy implications are rapidly becoming economic implications.
A large part of my work involves helping organizations think through uncertainty. Not in the sense of predicting what will happen, but in understanding how different forces interact and what outcomes may follow. That requires a systems view involving an understanding of politics, economics, technology, and social factors.
We frequently develop scenario narratives with clients to help prepare for the complexities of the future. This piece is born from work with financial institutions in trying to consider how the months ahead may unfold.
Iran has demonstrated that it does not need to match the military strength of the United States or Israel to exert pressure. With relatively low-cost tactics, it has been able to disrupt shipping through the Straits of Hormuz, one of the most important arteries in the global energy system.
Threats to the Straits create a cascade of effects. As the risk to shipping rises, insurance becomes expensive or unavailable. Volumes slow even if attacks are rare. Limited oil support and the expectation of shortages drive oil prices skyward. Inflation rises, especially around core goods like food and transportation. Governments are pushed to react, increasing borrowing costs. That’s how drones over the Persian Gulf can affect mortgage rates halfway around the world.
The current situation is highly volatile and unstable. The question is how it changes, and what that means for energy markets.
What follows are four plausible scenarios we’ve developed for how the months ahead will unfold. The scenarios are defined by US actions (withdrawal or escalation) and are separated into an optimistic and pessimistic case. When considering these near-term pathways, don’t focus on a single outcome; instead, examine the similarities and differences across them.
In this scenario, the United States steps back from military operations in the next couple weeks and the conflict de-escalates. Iran curtails its use of drones and other forms of disruption in the Straits. Shipping returns to pre-conflict levels and financial markets settle.
This may be the most positive outcome, but even if it unfolded perfectly, high energy prices would stick around for months and there would be a surge of inflation.
Many people assume price changes in crude lead to immediate changes in core goods from gasoline to food. That is not the case. There is lag in the system in the best of times. The damages to infrastructure and the lingering uncertainty will likely keep oil high through the summer. Insurance premia for shipping will likely also remain elevated.
These price spikes will hit consumers and force Western governments to deal with another affordability crisis similar to what was seen with the Russian Invasion of Ukraine.
Even in this case, new oil and gas projects will not come online in time to make a difference to near-term prices.
We rate this scenario highly unlikely for a few reasons:
Iran has now seen practically the leverage it can exert on the Straits is its best defense.
The expectation of future conflicts may keep prices high even if the Straits reopen. Think about the COVID shortages to see how expectations can drive demand.
All this presupposes that the US will withdraw and not escalate.
In the second scenario, the US disengages regardless of whether the Straits are reopened. An emboldened Iran recognizes that control of the Straits is an even better defense than developing a nuclear program. In addition, it chooses to use this control to discomfit its Gulf rivals and exert influence over global oil prices.
In the months and even years ahead, shipping is not halted, but it is consistently threatened. Drone activity, even potentially attacks, and the risk of escalation create an environment where safe passage cannot be assumed.
Energy markets are forced to adjust to a new normal.
In this case, oil and energy prices will not fall back after a spike. They reset higher. Insurance becomes structurally more expensive. Shipping companies factor in persistent risk, slowing volumes and increasing costs.
This creates a different kind of energy shock. Not one defined by immediate shortages, but by ongoing instability.
For importing countries, the effects are significant. Higher energy prices feed into inflation across the economy, with enduring issues around energy affordability. Industrial production becomes more expensive too, raising not only the cost of core goods, but nearly all goods. Without significant shifts, this could trigger a stagflationary storm that could afflict the global economy.
However, this is where structural changes begin to take hold.
Countries that rely heavily on imported energy will accelerate efforts to reduce exposure. This means moving from one-off payments to consumers to battle high energy costs and towards long-term investment in domestic energy production. Many nations will take an all-of-the-above strategy, boosting renewables, nuclear, and even domestic fossil fuels. In this scenario, energy becomes clearly associated with national stability.
There are also geopolitical implications. Gulf states that depend on the Straits to export oil and gas face increased vulnerability and potential risks to government revenues, which may drive new regional dynamics and alliances.
This scenario resembles a prolonged, lower-intensity version of an oil embargo. Scarcity may not fully materialize, but the fear of it is enough to reshape markets.
We consider this a plausible scenario as:
Iran has found that controlling the Straits may be its best defense against attack and that they use the Straits to escalate and de-escalate tensions.
Many nations have already been investing heavily in domestic energy infrastructure and this creates a greater incentive for them to do so.
In this scenario, the Trump Administration is pushed by both political and economic considerations to consider that Iranian control over the Straits is unacceptable. A massive military campaign commences.
The objectives are simple: restore secure passage and remove Iran’s ability to threaten shipping. The execution is far more challenging. Recent conflicts have shown how effective asymmetric tactics can be. Ukraine has effectively used low-cost drones to inflict costly casualties on the Russian military machine. Even with the most advanced military in the world, America will not be able to rely on remote strikes alone to protect the Straits.
Most experts argue that ground forces would be necessary to control the range of islands in the Persian Gulf. Then, even initial success will need to be followed by an ongoing campaign to protect shipping corridors. Even then, the proximity of Iranian territory means harassment remains possible.
If America could not quickly neutralize the Iranian threats, the consequences would be dire for the global economy and energy markets. A ground assault would mark a significant escalation in the conflict and inspire Iran to up its campaign against America’s Gulf Allies.
Pricing the risk from that type of conflict is nearly impossible and oil could rocket over $200 a barrel. This scenario would likely see shortages and energy restrictions across many importer nations. Inflation would gallop and central bank rates would rise to meet it. Global supply chains would crack as well. An energy crisis exceeding the Oil Embargo would likely ensue.
While this scenario would also see prioritization of domestic production, governments would have an energy emergency on their hands. That does not engender effective planning, but rather urgent actions to maintain energy access.
We consider this a realistic possibility of a ground war:
It is clear that with midterms looming, the Trump Administration is feeling pressure both to save face and act decisively to secure energy flows.
The challenge of protecting the Straits in the face of a hostile Iran is immense.
In this scenario, the United States escalates the conflict and manages to secure the Straits relatively quickly.
It is hard to see how the American military can make the Straits risk free without regime change in Tehran. Even if infrastructure in the Gulf is seized, a looming threat of attacks by the Iranian regime or its supporters will continue to loom over the Straits.
Regime change, whether partial or complete, might be one of the few things that could change Iran’s outlook on the Straits. However, that seemed more likely during the protests in January or on the first day of the war, when Ayatollah Khamanei was killed. There are few signs that regime change is imminent, and even a successful operation against Iranian infrastructure seems unlikely to change that.
If this did happen, the new or altered Iranian government might be willing (or forced) to accept temporary American protection in the Straits. An analogy could be made to Venezuela. Even in that case, the logistics around accessing and exporting the nation’s oil remain unclear.
While this might be the best outcome of escalation, it is still fraught with uncertainty.
It is perhaps the least likely scenario in the short-term as it demands:
A highly effective protection of the Straits against asymmetric attacks
A change in the Iranian regime to end the threat
Clarity on what the new status quo would mean for Iran’s oil exports
The scenarios differ in how the situation unfolds, but assessing their similarities is useful too. I always try to look at consistency across scenarios as a way to gauge likelihood. If certain elements appear across a variety of futures, they may be more likely. Using that guidance, we can examine the common aspects of all 4 scenarios.
First, energy prices will remain elevated for longer than many are expecting. Even in the most optimistic case, there is a lag in the system. Infrastructure disruptions, higher insurance costs, and lingering uncertainty will not resolve quickly. In the more pessimistic scenarios, prices do not simply spike; they reset to a higher range.
Second, governments in all scenarios are likely to face renewed affordability pressures. Higher energy costs will strain household budgets by increasing fuel, food, and transportation expenses. This creates political and social pressures that governments cannot ignore, and will need to act through subsidies, fiscal support, or even price controls. Many governments are still dealing with the aftereffects of recent inflation cycles, which further limit their room to maneuver.
Third, an economic slowdown is coming regardless of scenario. Even if energy shortages do not materialize, higher costs will weigh on businesses and consumers. Couple that with the need for policymakers to address rising inflation, and growth will suffer. Even if a full recession is averted, the crisis will knock some points off GDP growth globally.
Finally, accelerating the energy transition provides benefits across all scenarios. Higher and more volatile fossil fuel prices increase the attractiveness of alternatives. Electrification, low-carbon energy, and domestic energy production will become ever more central to economic and national security strategy. Nations with robust renewable capacity will save billions, even more than they did in 2022.
This article is also published on Substack. illuminem Voices is a democratic space presenting the thoughts and opinions of leading Sustainability & Energy writers, their opinions do not necessarily represent those of illuminem.
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