Economic shock shuts down factories and raises prices

Kevin Kelly is in a tough spot. He says unprecedented price spikes in the weeks since the United States went to war with Iran mean the California-based manufacturer of plastic grocery bags could be forced to cancel contracts it can no longer honor with its customers.

Thousands of miles away, in India, gas shortages have forced the closure of dozens of factories that export aluminum products around the world. In Britain, some farmers are trying to stretch out fertilizer supplies as prices soar.

As the war enters its sixth week, and nearly a fifth of the world's oil supplies are affected by Iranian restrictions on shipping through the Strait of Hormuz, the fallout is spreading from financial markets to the real economy, raising the risk of a global economic slowdown - or even recession.

Kelly said the sharp jump in the price of plastic resin, from 45 to 85 cents per pound in just a few weeks, meant it would be economic suicide for his family's company, Emerald Packaging, which has annual revenue of $92 million, to maintain the prices agreed to in existing orders.

“We will simply declare force majeure,” he said in an interview at his factory in Union City, near San Francisco.

When a company declares force majeure, it informs customers that it cannot fulfill its contractual obligations due to circumstances beyond its control.

"The price increases are so high that if we lose a customer because of it, we will simply have to accept it," he said, adding that he expects most of his long-time clients to be understanding and accept the changed terms.

Even if the conflict ends quickly, the International Monetary Fund is prepared to lower its global economic growth forecast and raise inflation expectations, Kristalina Georgieva said.

Countries in Asia and Europe are more exposed to the effects of the Gulf energy shock than the United States. Still, analysts warn that a decline in spending among American consumers is inevitable as inflationary pressures mount. In a sign that the problems facing Emerald Packaging are more widespread, the prices companies pay for inputs rose in March by the most in more than 13 years. Goldman Sachs has raised its estimate of the risk of a U.S. recession to as much as 30 percent.

US President Donald Trump is keeping investors in suspense while simultaneously talking about negotiations with Iran, but also threatening to destroy its civilization and return it to the Stone Age with increased attacks, including on bridges and power plants.

Risks to the global economy increase further if oil prices exceed $110 or $120 per barrel, warned Nathan Sheets, chief global economist at Citibank and a former US Treasury official.

“As this shock becomes larger, the risks of recession increase significantly... There are likely certain thresholds beyond which certain types of economic activity are no longer justified, leading to a sudden and nonlinear slowdown,” Sheets said.

The war, if it continues or escalates, is likely to test the price level at which global oil demand will have to adjust to the suddenly limited supply, which means a reduction in economic activity.

If current supply disruptions continue, 13 analysts surveyed by Reuters estimate that oil prices could be between $100 and $190 a barrel this year.

Attacks that have severely damaged refineries, ports and oil storage facilities in the Gulf region mean energy supplies could take months to return to previous levels even if the fighting stops, pointing to a prolonged period of high prices, state-owned oil and gas companies in Kuwait and Qatar said.

Even if the conflict ends quickly, the International Monetary Fund is prepared to lower its global economic growth forecast and raise inflation expectations, IMF Managing Director Kristalina Georgieva told Reuters on Monday.

Before the war, the region exported about 20 million barrels of oil and refined products daily. Now, only a small fraction of that reaches global markets through alternative pipelines.

“A disruption of this magnitude will require a significant reduction in demand to rebalance the market,” said Travis Flint, an investment-grade credit analyst at Columbia Threadneedle, referring to the decline in consumer and economic demand that typically accompanies prolonged high prices. He compared the situation to the Covid-19 pandemic.

Uneven economic impact

Regardless of the scenario, the consequences will not be evenly distributed.

In the United Kingdom, which depends on energy imports, the Organization for Economic Cooperation and Development cut its economic growth forecast for this year to 0,7 percent, from 1,2 percent previously - the biggest cut among major economies.

For cut flower grower Matthew Naylor from the East Midlands in England, rising fertilizer prices and limited supply mean he is working his fields using existing supplies. He says he has heard some farmers are considering whether it would be more profitable to sell fertilizer than grow crops.

“The best we can do is be extremely frugal with what we have and hope that reason will prevail internationally,” he said.

In some parts of Asia, the impact is particularly strong.

In the Indian state of Gujarat, many aluminum processing plants were shut down “four to five days after the war began due to gas shortages,” said Jitendra Chopra, president of the Aluminum Profile Manufacturers Association of India.

India is one of the world's leading exporters of this product, which is used in construction, solar panel frames, transport equipment and consumer goods, and problems in that country could eventually lead to a rise in global prices.

China and the US in a relatively better position

By contrast, the world's two largest economies could fare relatively better. China, with its lower dependence on Gulf oil and high levels of electrification, appears better positioned than others to withstand a global shock. The United States, now a net energy exporter, is also less exposed to supply disruptions.

Rising costs have a double effect in the US, hurting consumers but also strengthening domestic energy companies, potentially boosting wages for workers in the sector and creating new jobs.

The US economy “has weathered numerous crises over the past six years and, provided the war ends relatively quickly, should be able to weather this one as well,” Matthew Martin, senior US economist at Oxford Economics, wrote in a recent analysis.

However, he warned that the duration of the war is crucial.

"The longer it goes on, the more likely it is that something will give way and the economy will head into recession," he said.

In the coming weeks, the blow to US family budgets will likely be felt in the hospitality, tourism and accommodation sectors - both due to fuel prices that have risen by about 30 percent, from less than three to more than four dollars per gallon, and due to falling stock values ​​that are affecting the spending decisions of wealthier households.

While many American households are benefiting from larger-than-usual tax refunds thanks to legislation passed last year, consumption growth this year is likely to be around 1 percent, less than half the pace of last year, with “fears of a growth slowdown” in the coming months, said Sam Tombs, chief U.S. economist at Pantheon Macroeconomics, in an analysis.

"It would be surprising if spending on non-essential services remained stable over the next few months, given the pressure on household cash flows," Tombs wrote.

Kelly, the factory owner, expects the price hike in the plastics industry to last throughout the summer.

“You can end the war tomorrow, but it will still happen,” he said, explaining that a large amount of plastic is tied to the Middle East. “We have created huge problems for ourselves that will be reflected in the coming months,” he added.

Translation: NB