Ofgem and the Bank of England are scrambling to model the damage after Vladimir Putin threatened retaliation through the Strait of Hormuz. The market, predictably, has begun to price in a risk premium that could send Brent crude above $100 a barrel. The sabre-rattling from the Kremlin is a reminder that the global oil market remains hostage to geopolitics and that British motorists will foot the bill.
The Strait of Hormuz is the world’s most critical oil chokepoint. Roughly 20 million barrels per day flow through it. That is one fifth of global consumption. A disruption there would be a liquidity crisis for the oil market. Putin knows this. His threat is an attempt to weaponise the same dependency that has kept energy prices elevated since the Ukraine invasion.
The immediate reaction in the futures market was a 5 per cent spike in crude benchmarks. The British wholesale gas price followed suit. For the Bank of England, this is a nightmare scenario. Inflation is already sticky above target. A sustained oil spike would refuel the cost of living crisis and force the Monetary Policy Committee to keep rates higher for longer. The bond market sold off on the news with the two year gilt yield climbing 12 basis points.
The Treasury is now facing a fiscal double hit. Higher inflation raises index linked benefit payments while slower growth dents tax receipts. Jeremy Hunt’s fiscal headroom which was already wafer thin has evaporated. The market is beginning to demand a higher risk premium on UK sovereign debt. That is capital flight by another name.
The irony is that the United Kingdom is less exposed to Strait of Hormuz disruptions than it was a decade ago. North Sea production has declined but domestic renewable capacity has increased. The real vulnerability is the European interconnected gas system. Britain imports liquefied natural gas and electricity from France. Both become more expensive if the Hormuz route is blocked.
The regulators are now stress testing scenarios. Ofgem is examining contingency plans for emergency gas rationing to industry. The Treasury is modelling the impact on inflation forecasts. The Bank of England is ready to intervene in the gilt market if the sell off becomes disorderly. That is how quickly a geopolitical threat becomes a financial stability risk.
Investors should brace for volatility. The options market is pricing in 10 per cent daily swings in oil. The safe haven bid for gold and the US dollar is already evident. The pound sterling is taking a hit. It is down half a cent against the greenback this morning. The carry trade is unwinding.
The bottom line is this. Putin has thrown a grenade into the global energy market. The shrapnel will hit British households through higher petrol prices and gas bills. The fallout will test the credibility of the central bank’s inflation fighting credentials. Fiscal discipline will be strained. This is not a drill. It is a reminder that the cost of energy independence is still a work in progress.
