Fossil fuels have become a macroeconomic risk

Key points

• Fossil fuel dependence is now a critical macroeconomic risk that drives global inflation and erodes financial stability, as recently highlighted by the European Central Bank.
• Ongoing geopolitical conflicts have exposed the fragility of global energy supply chains, resulting in immediate financial losses and pushing financially vulnerable, import-dependent economies in poorer countries closer to crisis.
• The only route to long-term energy security and resilience is a structural renewable energy transition. Scaling up solar, wind and storage capacity is the fastest and most cost-effective way to reduce exposure to volatile fossil fuel markets and avoid “fossilflation”.

Last week, the European Central Bank warned that fossil fuel dependence threatens macroeconomic stability, turning the phase out of fossil fuels into a matter of monetary policy. Central bankers do not do advocacy; they describe risks.

And amidst the war in south-west Asia, they are telling us that the fossil fuel energy system itself is driving inflation and eroding the economic and monetary foundations on which societies depend.

This war is causing deaths, devastating families and shattering futures in Iran and Lebanon due to American and Israeli bombs. But it also lays bare the macroeconomic risks of fossil fuels far beyond the region: oil and gas shocks ripple straight through to prices, public budgets and household bills far beyond Europe, 75% of people live in countries that are net-importers of fossil fuels. These effects are felt even stronger by people in poorer countries who make up the global majority. This fossil fuel crisis is at its core an economic system failure built on volatile fuels.

Together with colleagues at climate advocacy group 350.org, we have calculated that rising oil and gas prices have already cost consumers, states, and businesses an additional US$104–$111bn in the first month of the war alone.

To put this number in perspective, $111bn could instead build enough solar power to supply around 40 million households in high-energy consumption countries such as Germany or Denmark, or about 150 million households in countries in the global south with lower consumption levels.

Notably, this does not even include wider knock-on effects, such as rising fertiliser and food costs, declines in economic output and employment, or broader inflation driven by volatile fossil fuel prices. As a result, the true economic damage is significantly higher than the losses from oil and gas prices alone. We can already see the start of huge humanitarian fallout, and this week the IMF warned of an impending global recession.

Fossil fuel shocks push millions closer to the edge

In 2022, the oil price shocks caused by the war on Ukraine sent 70 million people across the globe spiraling into poverty. If the war in south-west Asia continues on its brutal trajectory, the global economy will be in deep trouble, with those at the bottom – chained most to the fossil fuel economy – sinking the fastest.

We are already witnessing the deeper vulnerability of economies built around fossil fuel dependence.

The pressure is dangerous in import-dependent and financially fragile economies. Egypt’s pound has fallen more than 10% since the start of the war, while Pakistan’s gross foreign exchange reserves stood at just $16.4bn at the end of March, 18% of which is a $3.5bn United Arab Emirates loan which is due to be repaid this month, adding yet more pressure. This is what fossil fuel dependence looks like in practice: currencies under strain, reserves drained, and governments pushed closer to crisis because energy systems remain tied to imported fuels.

This crisis is playing out most visibly in Asia, where nearly a third of its liquefied natural gas imports and about 60% of its crude oil passes through the Strait of Hormuz. In India, hikes in the price of cooking gas are shutting down restaurants and hotels. Bangladesh has closed universities and started rationing petrol. Public officials in Pakistan will have their salaries cut as part of sweeping austerity measures. In the Philippines and Thailand, government offices have been told to cut back on air conditioning and limit travel, while in Myanmar vehicles can only be driven on alternate days, based on their licence plate numbers.

The food system is next in line. Around one third of fertilisers transported by sea move through Hormuz, and natural gas is a key input for nitrogen fertilisers such as ammonia and urea. When gas prices rise and shipping is disrupted, fertiliser becomes more expensive, food production costs rise, and the pressure lands hardest on countries already exposed to hunger and import dependence.

History is repeating itself

This is the second massive fossil fuel crisis within four years. The supply chains are inherently fragile and the Strait of Hormuz is only one of many critical and highly risky choke points.

We have entered an era of sharper geopolitical tensions and volatility, making dependence on oil and gas a growing liability rather than a source of security.

Following the Trump administration’s military intervention in Venezuela in January, we analysed how much of global oil and gas sits within countries it seeks to bring into its sphere of influence – and therefore how exposed global energy markets are to geopolitical pressure. We found that around 68% of global oil production and 81% of reserves lie in countries within the US aspirational sphere of influence, including Iran. What has unfolded since is a sobering confirmation of just how quickly geopolitical risk can materialise when so much of the world’s energy system is concentrated in politically contested regions.

If there is a lesson here, it is not that the analysis was right, but that the system itself is the problem. An energy system exposed to power politics and conflict was always going to prove fragile. We are now seeing the consequences play out in real time – in markets, in prices and, most importantly, in the human cost of a crisis that extends far beyond the battlefield.

The answer to this instability – beyond buffering the immediate shock – is not marginal reform, but structural change. Renewable energy is now the fastest and most cost-competitive route to long-term energy security, resilience and financial stability. Scaling up wind, solar, hydro, geothermal and storage reduces exposure to volatile fossil fuel markets, limits the transmission of price shocks into inflation, and strengthens the macroeconomic foundations central banks are increasingly concerned about. The Climate Change Committee which advised the UK government has found that a single fossil fuel price shock can cost more than the entire transition to net zero. It’s not that we can’t afford the transition – we can no longer afford not to.

Renewable energy allows countries to rely on their own homegrown energy. The longer the transition is delayed, the longer economies remain exposed to fossilflation – inflation driven by fossil fuel crises – as well as fiscal strain and financial instability.

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