How will the Middle East conflict affect the rural economy?

As we all know, on 28 February the US and Israel began military strikes on Iran in the Middle East. In retaliation, the Iranian authorities struck several Middle Eastern states, and closed the Strait of Hormuz, the main waterway for 20% of the world’s oil and natural gas supplies.

We don’t yet know how long the conflict will last or whether it will widen to other countries although Israel has already launched military operations in Lebanon. What we do know is that it has caused major increases in the price of both oil and natural gas that will, inevitably, have negative impacts on the rural economy in the UK.

So, what has been the extent of these price rises? Over the weekend of 7/8 March there was a surge in the price of both oil (Brent Crude) and natural gas. From a base of $71.5 per barrel (Brent Crude) pre conflict, prices peaked of $107 per barrel, falling back to $92 per barrel on 10 March. In terms of natural gas, the price was 75 pence per therm (ppt) before military intervention, peaking at 170ppt and then falling back to 121ppt on 10 March. Looking at heating oil, before the conflict erupted, heating oil was priced at 60.5 pence per litre. It peaked at 133.7ppl before ticking back to 132ppl.

The key is how long the conflict will last. In the short term, we are already seeing increased uncertainty, at a time when rural businesses are already experiencing increasing economic pressure as a result of the ongoing cost of living crisis. The military intervention of the US and Israel along with Iranian retaliation has added further economic challenges.

Rising energy costs remain a constant worry. We have examples where one member’s standing and capacity charges have increased by 33% (from £30,000 to £40,000) even before the start of the conflict. This is simply unsustainable and the Government needs to intervene to cap these charges at a rate that makes business viable.

There are options that the Government can consider that would ease the short and medium impact. The negative economic impacts arising from the conflict will spread through supply chains within the rural economy. For example, rising energy costs will affect milk collection, increase food distribution costs and increase the price of raw materials. However, we believe that these can be mitigated if the Government was to suspend the 5 pence per litre increase in fuel duty scheduled for September this year.

The Prime Minister has already recognised the need for resilience. Businesses within the rural economy are resilient and is built into their operations. But we believe further changes can be taken to underpin this resilience. Speeding up planning decisions that have yet to be agreed could positively impact resilience. Such examples include small-scale regeneration for businesses’ own use, fruit and vegetable production and ancillary infrastructure, particularly if fuel prices increase so will import costs.

The key to the Middle East conflict is whether it will be short-term or become prolonged, with a particular concern being the real possibility that it becomes wider. It has already been noted that if the Strait of Hormuz is effectively closed to shipping for longer than two weeks the economic effects are likely to be severe. This will be particularly the case for the agriculture sector. The adverse economic impacts of the Ukraine conflict showed that the increasing cost of fertiliser led to a reduction in productive capacity, hitting food security and leading to higher food price inflation. Although the UK derives most of its fertiliser requirement from Europe, and supplies through the Strait of Hormuz service the Asian markets, there will be indirect price impacts. The concern remains that the longer the conflict continues, there will be increasing pressure on supply in Asia which will increase prices. Higher prices in Asia could lead to European fertiliser supplies being redirected.

The Chancellor stated in an emergency economic statement to the House of Commons on 9 March that the UK economy will be adversely affected. She noted that it was very likely that inflation will increase, and the British Chamber of Commerce has already said that it believes inflation will remain well above the 2% benchmark, with no evidence that it will begin to fall as forecast by the Office for Budgetary Responsibility in its latest fiscal outlook report.

If there is an increase in inflation, our members are concerned that this will weaken demand for their respective products. It means that members will be looking at reducing production to save on costs as well as seeking to introduce greater resilience to their businesses. As in the Ukraine conflict, members will be looking at diversifying input sources if military action is prolonged.

Business confidence is already at a very low level in the rural economy. The pressures of increases in employers’ national insurance and the National Living Wage, and the reduction in relief on inheritance tax, has now been added major geo-economic challenges through the Middle East conflict.

Investment in the rural economy leads to innovation which leads to growth. But to be able to invest CLA members need access to capital. Although the Bank of England has been reducing interest rates, with the Bank indicating that this policy would continue, it is now highly likely that this will be reviewed. We believe that interest rates are likely to stay at their current level of 3.75% for the foreseeable future. It is also very possible that the Bank of England increase rates to control rising inflation. Any rise in interest rates will dampen the enthusiasm to invest.

Obviously, we will continue to monitor developments and advise members of the potential economic implications. Along with other external stakeholders, including the CBI, we continue to raise the debilitating impact of energy costs on business with Government. But we need evidence of the impact of energy costs on business. Members who can provide that evidence, please contact charles.trotman@cla.org.uk