The current geopolitical tension between Israel and Iran is not an exclusively Middle Eastern problem; it holds deep-seated implications for businesses globally.
This is even more so for the UK because, in the slightest conflict, it would mean oil price inflation and energy availability crises that would badly dent British businesses. Such crises are likely to be played out in the backdrop of an already fragile oil market that is already threatening to undermine the UK economy.
Oil prices: A fragile balance
The international oil market is susceptible to political turmoil, and the Middle East is a particular flash point. The region contains the world's largest oil supplies, and Iran is one of the most important countries in this regard. Nearly all the instability within this region touches on Iran directly or indirectly and then reverberates into the oil market.
Any military situation impacting these countries results in a steep rise in the price of oil, thereby contaminating the supply chain.
The possibility of conflict may be enough to drive oil prices through the roof. Think, for instance, about the recent heightened conflict between Iran and Israel. Also, anticipating a supply shortage, traders in the futures market may boost the prices of oil.
Oil-exporting nations, seeing this as an opportunity, can reduce output to make a bad situation appear worse which, consequently sends the prices up.
Inflationary pressures in the UK
Higher oil prices automatically translate into increased energy, transport, and manufacturing costs, which are all basic components of inflation. In the UK, businesses rely on imported oil for transportation and energy, so the steep increase in the price of oil would eventually filter through into the general economy.
How will this affect businesses?
Energy costs
Most of the companies in the UK have fixed-term energy contracts, sheltering them from short-run fluctuations in price. With a severe rise in oil prices, energy providers might pass higher costs to their customers at the time of renewal of contracts. Even companies that have long-term fixed-rate contracts may be subject to renegotiation clauses that could provide for price increases in extreme conditions.
Transport costs
This would also squeeze UK businesses, especially those in the line of logistics, shipping, and transport. As the increased oil prices set in, so will increased fuel costs, hence increasing the cost of moving goods and services around. This extra cost would then eventually be passed on to consumers, fuelling inflationary pressures.
Manufacturing
The cost of raw materials and production may rise as the increase in energy and transport costs is absorbed by manufacturers. This would affect industries such as construction, automotive, and chemicals especially, which rely on energy as a major part of their production process.
UK inflation: Perfect storm
Inflation in the UK has already been uncomfortably high, partly due to lingering disruptions in supply chains from the pandemic and partly due to post-Brexit consequences. If conflicts in the Middle East result in a sudden and potentially steep rise in the price of oil, this will make inflation all the more unmanageable and increase the pressure on the Bank of England to continue hiking interest rates.
The consequence would be higher borrowing costs for businesses and possibly reduced investment, holding down economic growth.
SMEs form the backbone of the UK economy and would also be more vulnerable. With increased energy and transport costs, smaller enterprises would have less room to absorb such rises, unlike much larger companies that may have more robust pricing power or the ability to hedge against price fluctuations.
Energy contracts: The fine print
UK companies often take fixed-term contracts to protect themselves against short-term market volatility. In periods of fluctuation instance, in the case of a conflict in the Middle Energy suppliers may declare "force majeure” and pass price rises on due to circumstances beyond their control.
Companies renewing their energy contracts in such a period of price instability may find higher rates. For businesses that can neither renegotiate nor absorb such extra costs, serious financial strain could mean cutbacks in staff, scaling down operations, or insolvency in extreme cases.
For energy-intensive industries such as manufacturing, hospitality, and transport, these price hikes have the potential to impact profitability. Moreover, the costs will likely need to be passed on to consumers, further driving up prices in the UK economy and hence driving inflation.
Wider economic impact on UK businesses
Other than the direct rise in cost, businesses would have to bear the indirect challenges, too. With the rise in inflation and energy prices, it's going to decrease consumer purchasing power; UK households would have lower disposable incomes to spend. That would lead to lower demand for goods and services, especially in discretionary industries like retail, entertainment, and hospitality.
Larger firms can try to counteract this by diversifying energy resources or increasing investments in renewable energy. These strategies require capital, which may be hard to spare for small businesses during an economic downturn.
Furthermore, any business operating in global supply chains might be influenced by the conflict that disturbed shipping routes, which offer a passage to the Indian Ocean. The strait is extremely important in global oil transit, and any blocking of this chokepoint is bound to increase the price of raw materials and goods, hence clogging supply chains and affecting businesses in the UK and worldwide.
What can UK businesses do?
Given the potential significant economic disruption, UK businesses need to be out in front, taking proactive steps to mitigate the risks of a possible oil price surge. Some strategies could include:
An alternative source of energy
Companies should look for renewable sources of energy to reduce their reliance on oil and gas. Solar, wind, and hydroelectric power sources, though considered more expensive at this time, could be integrated into operations to hedge against future unpredictability in prices.
Cost management
This can provide a complete review of energy consumption, supply chains, and transport logistics. For this, companies can estimate where they can cut costs or find better efficiencies in preparation for the eventual price hike.
Contract negotiation
Firms currently negotiating energy contracts must be especially attentive to the terms and conditions to prevent astronomical price jumps.
A clash between Israel and Iran is one of the possible flashpoints that could make the world market of oil unstable and thus have a chain reaction of economic consequences for the UK. Energy prices would, therefore, likely surge and, in turn, drive up inflation beyond its current level, heaping more ills upon businesses. The effects will have to be proactively considered by UK businesses in how best they might mitigate these risks through energy diversification, hedging strategies, or contract negotiations.
While this may be a political conflict that is thousands of miles away from the UK, the consequences might be felt keenly across British industries; thus, it is also an international problem that self-evidently needs careful monitoring. The ability of UK firms to adapt and prepare for such external shocks will, accordingly, determine the best position they are in to weather this period of heightened uncertainty.
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