Europe faces new energy shock as Iran war sends prices soaring

Europe has scarcely recovered from the last energy crisis triggered by Russia’s invasion of Ukraine in 2022. Now, a fresh geopolitical shock—the American and Israeli assault on Iran—is threatening to destabilise its economy once again. Sharp rises in oil and gas prices over the past two weeks risk halting economic growth, already fragile, and reigniting inflation. For European industries contending with American tariffs and Chinese competition, the consequences could be severe.

“For Europe, this [crisis] is, of course, existential,” Simone Tagliapietra, an energy specialist at Bruegel, a think-tank in Brussels tells The Economist.

Yet Europe’s response has been muted. Diplomatically, member states are divided, with some applauding the attacks while others condemn them. Militarily, European forces are overstretched; even if leaders wanted to heed Donald Trump’s March 14th request to help secure the Strait of Hormuz, Europe’s navies are unlikely to fill the gap left by the U.S. navy.

As The Economist notes, “The European Union and European governments have been left scrambling to protect their economies from a war over which they have no influence, and to which they are unusually vulnerable.”

The continent’s exposure stems largely from its reliance on imported fossil fuels, especially natural gas. While only a small fraction comes from the Middle East—roughly 200 million cubic metres per week out of a total 6.5 billion—gas-storage levels are near their 2022 lows. Efforts to cut Russian imports have also increased reliance on the global spot market. The EU plans to end imports of Russian liquefied natural gas (LNG) by year-end and pipeline gas next year. Replacing Russian supplies, mostly with American LNG, had already doubled prices to €40 per MWh; the war pushed them to €50 per MWh by March 13th.

Europe is in a somewhat stronger position than in 2022, when high demand and labour shortages sent annual inflation to 11%. According to Oliver Rakau of Oxford Economics, a short-lived conflict would only lower GDP “marginally.” A prolonged disruption, however, could be far more damaging. The consultancy estimates that if oil hits $140 per barrel for two months, economic growth would fall 0.6 percentage points in 2026, with euro-zone inflation climbing to 4.3% from last year’s 2.1%.

Fiscal options are limited. After a decade of low interest rates, governments spent heavily in 2022 to shield consumers and firms. Today, debts are high and budgets tight. Germany has already relaxed its deficit rules to fund defense and infrastructure, while France’s deficit exceeds 5% of GDP.

The European Central Bank remains cautious; Isabel Schnabel, of the bank’s executive board, has urged central banks “to resist the temptation to fine-tune” economies. Yet Mr. Rakau warns that the more governments spend to protect consumers, “the more the ECB will be forced to step in.”

Europeans are also divided diplomatically. Ursula von der Leyen has supported the attacks, declaring on March 9th that there “should be no tears shed for the Iranian regime.” Germany’s Friedrich Merz initially downplayed the situation, while his vice-chancellor, Lars Klingbeil, questioned its legality. Spain’s Pedro Sánchez called the war “illegal…and contrary to the interests of humanity.”

Complicating matters, European involvement is growing. Iran’s missile strikes on Gulf countries and a British base in Cyprus have prompted European countries to dispatch fighter jets, warships, and an aircraft carrier. Emmanuel Macron acknowledged French ships might escort vessels through the Strait of Hormuz, but only “after the most intense phase of the conflict has ended.” 

As Julien Barnes-Dacey of the European Council on Foreign Relations puts it, “We will sail our armada to the Gulf and then we will sit tight until others have managed the situation.”

Europe, The Economist concludes, is once again navigating an energy shock with little leverage, exposed both economically and diplomatically to crises far beyond its control.

By Sabina Mammadli