Coping with the economics of war

Conflict in the Middle East (ME) is nothing new. For thousands of years, wars have been fought in the region that is one of the cradles of civilization. The wars have been fought by major powers and empires, and the economic spoils are divided among the victors.

The impact of these wars has far-reaching socio-economic and political implications not just for the region but for the world.

In any war, there are winners and losers, but when it comes to the Middle East, the Philippines falls under the list of countries that must bear a huge economic cost. It is thus incumbent for Filipino investors and consumers to be aware of the risks that are growing with each passing day and prepare for the worst-case scenario.

There is reason to be risk-averse. Around 20 million barrels of crude oil pass through the Strait of Hormuz, or about 20 percent of the world’s consumption of this fossil fuel. Iran has threatened the closure of this body of water in retaliation for the attacks.

There are some views by experts, however, that Iran no longer has the naval or artillery capacity to fully close the strait. But the threat alone is enough to push freight insurers to no longer underwrite insurance for tankers. Tankers are unwilling to run the “gauntlet” because they are not insured.

If oil cannot move to customers and storage is running out, oil production may be shut down. Why is this important?

The Philippines maintains 45-60 days of fuel. This buffer is not what is worrisome. Firstly, if oil production is shut down, it takes several days before production can be reestablished.

So if the war ends and oil production facilities in the affected ME countries were to be switched back on, we could still be facing a shortage that cannot be immediately resolved.

Secondly, 40 percent of households use liquified petroleum gas (LPG), also known as propane, to cook food. It is the preferred fuel source of restaurants and urban areas. But we only have 30 days of LPG inventory.

The ideal situation is that the war would be resolved in less than a month. However, the objectives or even the reason behind the war are unclear to most of the world.

This uncertainty over the end state of the conflict enhances how investor sentiment moves markets. These shifts in investor sentiment drive the volatility in oil prices.

Since sentiment carries a lot of weight, investors should not get stuck. Instead, investors should maintain a high level of diversification and calibrate expectations on returns. Trying to time the shifts in sentiment is a fool’s errand at this stage. Just diversify.

But sitting still is not advisable. Perhaps investors are still thinking that crude oil prices are below their recent 2022 peak, and maybe it will not be as bad as before. While that is still a possibility, all this is dependent on how long the conflict will last and when the flow of oil through the Strait of Hormuz will restart. Prolonged wars lead to new economic issues.

There are many serious “ifs” for the Philippines. If supply fears intensify, countries can start hoarding. As an oil importer, we do not have any leverage, and we will have to bear with higher energy costs for much longer in the worst case. We can create some leverage by pushing for faster shifts towards renewable and electric vehicles, but that will take some time.

Growing fears over these adversarial foreign policy changes that are linked to trade can also force a reassessment of how bodies of war and sea lanes can be used as leverage. As we are partly dependent on the trade in rice, oil, semiconductors, and agricultural products, any regional attempt to control vital trade routes poses a major strategic risk we need to consider.

The bottom line is that we need to be prepared for higher inflation. Even though the Philippines is a firm believer in diplomacy and peace, the country must acknowledge that war, no matter how far it is from our borders, inflates the cost of doing business.

Inflation is the economics of war.