Why This Energy Crisis Is Different
By Gene Frieda, Project Syndicate.
CANNES – The ceasefire in the Gulf lasted barely three weeks. After Iranian attacks on three merchant vessels in the Strait of Hormuz, the United States struck more than 80 targets, revoked the oil sanctions exemption for Iran, and declared the memorandum of understanding “expired.” Yet the market reaction was revealing: Brent crude rose to around $79 per barrel, a significant rebound but well below the $120 peak reached in April, when the strait was completely closed. That gap between the resumption of war and the moderation of prices poses a key question for policymakers: Is this the path back to blockade, or a violent renegotiation of the terms of passage?
Five months into the war, the severity of the underlying crisis is beyond doubt. This is not 2022, when Russia’s invasion of Ukraine diverted supply and the world absorbed a costly but manageable adjustment. The current crisis is destroying supply rather than diverting it, and the loss of oil production already exceeds that of the OPEC embargo of 1973–1974. If you include liquefied natural gas, fertilizer inputs, and freight transport, the global energy bill is at least double the crude oil price that appears on quotation screens.
There are two diametrically opposed interpretations of Iran’s intentions. According to the first, Iran seeks total control of the strait. That path leads to a larger conflict, another blockade, and a return to the price dynamics of March, when oil prices soared. On the other hand, Iran is behaving less like a blocker and more like a toll collector, maximizing the revenue it can obtain from the traffic passing through the strait. Sporadic attacks on shipping thus keep the risk premium alive without strangling the flow; oil prices remain high and volatile, rather than spiking.
The evidence so far tentatively points to the second interpretation. US attacks have deliberately avoided Iran’s energy infrastructure; Iran’s attacks on shipping have been more demonstrative than systematic; its parliament has debated imposing tolls on “hostile” vessels; and the memorandum of understanding itself provided for Iran’s assistance in managing strait traffic. None of this rules out escalation—miscalculation is the default risk in the Gulf—but for now, both sides seem to be haggling over the price of passage rather than passage itself.
For central banks, the two paths lead to very different destinations. If Iran collects tolls, high energy prices with a general ceiling act as a chronic tax: painful, but not a reason to resume aggressive monetary tightening. Interest rate expectations would stabilize roughly where they were two weeks ago, and attention would focus on second-round effects: whether rising fuel, transport, and food costs feed wage pressure. If Iran ends up taking control of the strait, central banks will be forced to act forcefully to prevent a temporary disruption from becoming entrenched inflation.
That is why markets react so intensely to every headline. Investors are not fine-tuning a single forecast; they are oscillating between two scenarios, and every oil rise asks the same question: Is this a step from toll collection to blockade?
As a result, interest rates have become unusually sensitive to oil. Positioning, at least, is healthier than in the spring: in March, many investors had effectively sold insurance against large swings in interest rates, and when oil spiked they were forced to buy it back at any price, amplifying every move. That exposure has been largely removed, so the same headline still moves markets but without the forced liquidation of March.
Yet neither scenario resolves the underlying policy dilemma. With inflation above central bank targets and public finances under pressure worldwide, none of the usual answers work. Aggressive monetary tightening, inevitable in the blockade scenario, hampers growth and undermines debt sustainability. Expansionary fiscal support stokes inflation and raises financing costs, now that foreign central banks no longer buy government debt at any price. And doing nothing invites a procyclical adjustment, in which financing costs rise even as the economy slows.
To navigate this treacherous economic terrain, fiscal and monetary policies must reinforce each other rather than counteract. That means targeting support to the most exposed households and sectors rather than blanket cash transfers, and issuing debt that resists the temptation of cheaper short-term securities, which only concentrate refinancing risk when the next crisis hits.
It is in the blockade scenario that this logic reaches its unorthodox conclusion. With central banks tightening even as the crisis worsens, rising state financing costs would displace the most necessary targeted fiscal support unless central banks cap increases in short- and medium-term interest rates. If such intervention remained firmly under central bank control and with a clear exit strategy, this would not compromise central bank independence, and the alternative—letting them bear the adjustment burden alone—is worse. Acknowledging this trade-off now, while the “toll collector” is still in control, is preferable to facing it in the midst of a blockade.
That option is not available to all countries: success depends on the starting fiscal position, institutional credibility, and investor confidence that the intervention will be temporary. The United States has the greatest scope for maneuver, thanks to strong global demand for Treasury bonds, even as the dollar’s privilege is gradually eroding. The Federal Reserve has kept interest rates steady, and markets, which began the year expecting cuts, now contemplate hikes—the direction will depend on which Gulf scenario prevails.
The eurozone faces a more complicated trade-off. The fragmentation of its sovereign debt markets means any conditional intervention immediately raises the question of which government is being supported and why. The European Central Bank’s recent 25-basis-point rate hike has highlighted the dilemma: the ECB has no choice but to tighten monetary policy, but helping the governments that most need fiscal support would reignite the fragmentation fears that its 2022 Transmission Protection Instrument was designed to contain.
Japan is in a stronger position: its ample foreign exchange reserves allow policymakers to resist yen depreciation before energy costs pass through to domestic inflation. In either scenario for the strait, the United Kingdom has the tightest margin: a limited fiscal cushion, a persistent external deficit, and inflation above the Bank of England’s forecasts point to a wider gap between UK and German government bond yields as well as a weaker pound.
Even the most favorable scenario offers little comfort as winter approaches. Europe’s gas reserves are at their lowest for this time of year since 2011, while Qatar would need two months to restore LNG exports even after a lasting reopening of the strait. Regardless of how the latest escalation is resolved, Europe’s energy bill will not come down significantly before winter.
That is why the sequencing of measures matters. The economies most likely to need this tool kit lack the institutional credibility to use it, while those with greater credibility are the least likely to need it. And the path forward will not be announced in advance: by the time markets know which road they are on, the room for a measured response will have shrunk, and it will be ordinary borrowers and savers in the most exposed economies who bear the cost of delay.
Gene Frieda is a Senior Visiting Fellow at the London School of Economics.
Copyright: Project Syndicate, 2026.
