Impact of the Iran Conflict on European Energy Prices and Inflation

The ongoing conflict in Iran has triggered a surge in oil and gas prices, reminiscent of the energy crisis following Russia's invasion of Ukraine in 2022. Brent crude oil prices have recently exceeded $90 per barrel, while European natural gas prices have fluctuated significantly, reaching around €70 per megawatt-hour earlier this week before settling at approximately €50. Analysts suggest that the current energy price shock may not lead to a crisis of the same magnitude as in 2022, primarily due to differing global economic conditions. James Smith, an economist at ING, noted that the global economy today is less susceptible to inflationary pressures than it was during the previous crisis.

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The European Union has warned that prolonged high energy prices could push inflation above 3% this year, impacting economic growth forecasts. Valdis Dombrovskis, the EU's economy chief, indicated that if Brent oil prices remain around $100 per barrel and gas prices stay elevated, economic growth could be reduced by up to 0.4 percentage points. The EU's inflation projection for 2026 may also increase by 0.7 to 1 percentage point due to these factors. The International Energy Agency has responded by releasing a record 400 million barrels of oil from emergency reserves to stabilize the market.

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European governments are under pressure to support households and businesses amid rising energy costs. However, many countries, including France, Greece, and Poland, have limited fiscal capacity due to high budget deficits. Measures such as oil price caps and profit margin restrictions have been introduced, but these are less extensive than the broad support provided during the 2022 crisis. Analysts suggest that if high prices persist, governments may need to reintroduce subsidies, but fiscal constraints will limit their ability to do so.

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Critics argue that subsidies and price caps could inadvertently increase energy demand, exacerbating the price situation. Georg Zachmann, a senior fellow at the think tank Bruegel, emphasized the need for strategies that incentivize reductions in energy demand rather than merely providing financial support.

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The situation remains fluid, with conflicting reports on the potential duration and impact of the conflict on energy supplies. The shutdown of Qatari liquefied natural gas production and disruptions in the Strait of Hormuz could prolong the energy crisis, affecting European energy security. As the European Central Bank prepares for its next meeting on March 19, the economic outlook remains uncertain, with inflationary pressures and growth forecasts closely tied to the developments in Iran.

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• “the impact on the European economy will depend on the duration, scope and intensity of the conflict.” — Valdis Dombrovskis, EU Economy Chief

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• “If you get an interruption for more weeks of gas deliveries from Qatar and gas prices go higher, it's likely you will see governments stepping in and reintroducing some subsidies,” — Frank Gill, S&P Global Ratings

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• “In the short term, the best option is to enable and incentivize reductions in demand,” — Georg Zachmann, Senior Fellow at Bruegel

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