How China Is Quietly Winning the Iran War Energy Crisis

This transcript was generated using AI and may contain errors.

PATTERSON:
The Iran war, which began on February 28th, shows absolutely no sign of ending soon.

MALLABY:
What have we learned since then? What should we expect the spillovers to be for energy markets, financial markets, shipping, and the world economy?

PATTERSON:
I’m Rebecca Patterson.

MALLABY:
And I’m Sebastian Mallaby.

PATTERSON:
Welcome to The Spillover.

MALLABY:
So, Rebecca, we first discussed Iran on The Spillover quite a while back. I think it was March the 4th, just a few days into the war, and it’s still going on. Five months in, it’s still going on.

And, you know, there was this moment of hope in mid-June when there was a memorandum of understanding that was supposed to be the first step towards a peace deal. Didn’t happen, and we have no idea now how the fighting is going to end.

PATTERSON:
Yeah, that’s right. Unfortunately, you know, hopes have definitely dimmed since the June memorandum. I think people thought it might lead us to a quick end of the war, but now here we are in August and energy prices are rising again.

A barrel of Brent crude oil, the global benchmark, is getting close to $90 again as of August 11th. And, you know, you compare that to around $70 a barrel we saw in early July when analysts, believe it or not, right then were saying we were on the precipice of a global oil supply glut. So, lots of whiplash back and forth on this.

And then, of course, retail gasoline prices in the United States are staying above $4 a gallon, up from $3 or so when the conflict started. And gasoline is, you know, one of those American products where everyone uses it. You know, the vast majority of us living here have our cars, some families, multiple cars.

And for whatever reason, $4 a gallon is this psychological line in the sand. Anything above that, and you quickly hear about it in consumer sentiment surveys and in opinion polls, which obviously right now matter a lot going into the midterm. I think, though, Sebastian, what has really struck me as this war has gone on and on and on is how the financial market reaction function has changed.

You know, the strait has generally remained closed. We’ve had a few periods where more ships got through, but generally speaking, we’ve seen this, you know, the strait closure continue. And yeah, energy prices are rising again, but the magnitude of the market swings has definitely decreased over the course of the war.

The VIX index, which I know you know this, it’s just a measure of expected equity volatility in the short term. It spiked in March when the war started, and now it’s back basically to levels that we saw before the war began. Brent, similarly, Brent crude spiked to nearly around $120 a barrel in March, hit about $126 at the end of April.

But since then, I think as investors have processed all the ways that people are mitigating this crisis, both on the demand side and the supply side, prices have come down. So we keep having these periods of escalation, de-escalation. The financial markets definitely welcome the de-escalation moments, but the escalation moments so far could change, aren’t getting as big a reaction as they were at the beginning.

So I have to think there’s an assumption that people just assume both Iran and the U.S. need an end to the war, want an end to the war. It’ll happen sooner rather than later. And in the meantime, we’ve learned how to mitigate at least some of the risks.

I am not as sanguine as the market, but I understand the logic. And I lost my earpiece. Here we go.

All right. There, now I can hear you again.

MALLABY:
So the question is, you’re very calm in the face of losing your earpiece, but why are the markets calm in the face of, you know, what is actually a renewed war with a lot of the uncertainty, the stop start, the is there a ceasefire, isn’t there, you know, escalation, de-escalation, blockade, et cetera. I mean, we’re kind of back to where we were almost just in, if you look at the geopolitics of it, and in fact, you can see this, the geopolitical risk index created by two Federal Reserve researchers shows that the level of, this is kind of based on news mentions, but the level of geopolitical turmoil is not quite up to where it was in the first three months of the war, but it’s, it’s pretty high.

So it’s, it’s almost, it’s almost there. But as you say, you know, the VIX is way calmer. So there’s, there’s been this divergence between the geopolitical risk index and the VIX on the other hand, and you can sort of dramatize that by comparing a couple of different days.

There was this point in early March when the war escalated and sure enough, the Dow Jones is down 2%. But then you look at it today, more recently, like July 13, when President Trump announced he was reinstating the naval blockade on Iran. That was enough to make the oil price, the Brent oil price jumped by 9.5%, but the Dow hardly moved. It was down like 0.3%. You know, so you look at this and say, are equity investors just inured to the war? You know, are they desensitized? Are they tuning it out?

Are they high on AI? I mean, what’s going on, right?

PATTERSON:
I would vote for, for AI.

MALLABY:
Yeah. High on AI is actually a good explanation for most stuff which is happening in the moment. It’s true.

But look, I think that the issue is, you know, is this a temporary calm and, you know, in a month’s time or something, we’ll be talking about the renewed volatility or is it something about the way that the markets have watched the, the world process these shocks and has learned something about the ability of the global system to absorb the shocks. And then they’re pricing that in a, in a, in a rational way.

PATTERSON:
I mean, I think there’s still the risk of the former that we hit a wall of some sort in the weeks or months if this war continues. But I also believe there’s a lot of truth to the latter point you made, which is the markets are seeing that the world is adjusting. And I think back to the 2025 tariffs, right?

You know, Liberation Day was the shock and awe and, and then things settled and yeah, we had tariffs. We had the highest tariffs in many, many, many decades, even though they weren’t as high as the initial shock and awe and the markets adjusted and eventually just kind of focused on other things for the most part. So I, you know, I think adaptation and pricing in some of the risk is a big part of it.

We know that the Gulf, for example, itself has adapted, you know, at the start of the war, you had about 3 million barrels a day of Gulf oil exported via pipelines, for example. And that’s just a tiny fraction of the 20 million or so going through on ships. But then once the war started, you know, you had two existing pipelines, they got used more aggressively and that pushed up the numbers getting out of the region a little bit more, maybe from 3 million barrels a day to about 5 million barrels a day, maybe even approaching as much as 7 million barrels a day, depending on the period, of course.

But then in addition to that, you know, the shipping companies also got pretty cheeky. You know, you had ships turning off their transponders and so forth to try to sneak through in the dark. So, you know, we’re still a long ways away from the happy times pre-war of 20 million barrels getting through the strait every day, but we have seen some adaptation.

But I think, Sebastian, you’re probably going in a different direction when you talk about adaptation, right?

MALLABY:
Yeah, I think you said part of it on the producer side, and all that is completely true. And then there’s also been additional adaptation on the consumer side. So the consumer countries, you know, right at the start, you had that announcement from the kind of Western consumers led by Washington and Japan, Tokyo, where they basically said, you know, what’s the effect of, you know, we’re going to release 2 million barrels a day from our emergency stocks.

And so that’s going to take some of, you know, some of the hit. But the big surprise has been China, because between February and June, China slashed its crude imports by fully half, so 5.5 million barrels a day. And that’s a big deal.

I mean, to give you a sense, analysts think that that was enough by itself to have shaved maybe $30 off the price of Brent crude. So a big effect from one country. And the remarkable thing is that China was able to do this without apparently impacting its growth much at home, at least not that kind of measurable way.

So China’s ability to toggle the imports up and down, without suffering an economic slowdown, makes China sort of a swing consumer, just like in the past, we talked about Saudi Arabia or OPEC as sort of swing producers. And now that OPEC, by the way, has been weakened by the secession of the UAE, China’s swing consumption is all the more impressive and powerful and influential. And so a recent piece in The Economist quoted an oil executive saying, you know, China is the new OPEC.

And you know, you might think that’s an exaggeration. I mean, consumers traditionally have never been as powerful as producers, because consumers are these disparate companies and individuals making uncoordinated decisions, whereas there’s a handful of producers that they can get together and exercise power. But China is actually big enough and statist enough that it’s sort of an exception, it can adjust its imports on the say so basically of just one man, Xi Jinping.

So it has, in fact, fewer coordination problems around this than the 22 fractious members of OPEC plus, which is the body that includes countries like Russia, Kazakhstan, Mexico, as well as the traditional OPEC.

PATTERSON:
Yeah, the political side of all this, to me, is so interesting. And we see it in more and more industries and issues that their ability to act fast and at scale in part because of their political system. I’m not saying it’s the best political system, but it is what it is.

Their system allows them to move fast and at scale. And I think still today gets underappreciated sometimes. And I think what you just drew for us is a great example.

You know, China also has moved in a huge way to be more self-reliant in lots of arenas, including energy. And so they’ve been looking for new types of energy supply, including solar. I mean, their solar at home is just out of control and then wind, et cetera.

And they’ve also been very active managing their strategic oil reserves. At the start of this year, when oil prices were moderating, what I have read is that they snapped up about 200 million barrels when prices were pretty attractive. And so they were topping up their already ample reserves.

So once its last Gulf cargos had arrived in April, right after the war began, China could start drawing down on these reserves. Now, other countries were doing that, too, but China had more wiggle room. By July, its inventories were down about 70 million barrels, according to Vortexa.

That’s a data firm. And that’s not counting draws from floating storage or hidden caves. You know, if you put that in, you know, China probably tapped about 150 million barrels in those three months.

Now, that’s again, I’m not a deep China oil expert. I’m relying on what I believe are credible sources for that, those exact figures. But, you know, if it’s even close to true, it is pretty remarkable.

MALLABY:
Yeah. I mean, put simply, what it’s saying is that China accumulated additional reserves in February of 200 million barrels, but only ran down 150 million barrels during the war. And so, you know, they came out ahead.

The estimates I’ve seen suggest that China might be able to keep going for another four months of full-on war before Beijing really started to worry that, you know, its stock levels were running low.

PATTERSON:
And I think that is a pretty big contrast to the situation today in the United States, even though the United States is an increasingly powerful net energy exporter and a huge producer. Just in the last week, the U.S. Department of Energy released a report that the U.S. strategic reserves had fallen below 300 million barrels. Now, that might sound like a lot, but the U.S. can’t run that down to zero. We’re actually now at the lowest levels in reserves since 1983. And if we get down too far, it can actually undermine the integrity of the infrastructure for those reserves and they can have operational failure.

MALLABY:
Yeah. And so that gets to the way that, a geopolitical lesson arising from this conflict is that the quality of your energy reserve management really matters. So I think in our first spillover episode back in March, we made the point that China looked vulnerable because it’s so dependent on energy coming through the Strait of Hormuz.

And we also said, yeah, but they have some reserves, but I didn’t think we understood quite how big and important those reserves were, how much resilience it would give China. And by the way, it turns out it’s not just the reserves that give China this resilience. Because of the status nature of the economy, the government could order petrochemical plants to stop using oil to manufacture additional petrochemicals.

Weirdly, because actually China has a lot of overcapacity in some of these industrial sectors, there were stocks of petrochemical products lying around that could absorb, you know, it didn’t really feed through into a growth crunch because there were these excess stocks lying around. And then in addition, China ordered a cutback in exports of refined oil products like, you know, jet fuel. And so that shifted some of the pain of adjustment to China’s trading partners, but it protected China.

So the point is that one way or another, because of good reserve management, because of its statism, because of its ability to take sort of centralized decisions, China showed that it can cut oil imports by fully 50% and not have a recession. That’s how resilient the Chinese system is. And it really shows the advantages that China has at a time of geopolitical and geoeconomic stress in the whole world system.

So I think, you know, whatever your estimate was of the relative strength of China and the United States and their different economic systems, you know, in a good environment, in a good state of the world, right? You have to be a bit more pessimistic about the US prospects in a bad state, because the US system is very, very good at optimizing and being efficient through market signals. When it’s a question of, you know, happy times, stability, then you get, you know, business processes being optimized, you get supply chains being optimized for efficiency, it’s all great.

But what the market system doesn’t do is generate price signals that force you towards resilience, insurance, redundancy. And these are the things where, because of the Chinese statism, they think about the worst case scenario, and they plan for the worst case scenario, they insure themselves against it. And that just doesn’t happen in the US private sector.

And by the way, you can sort of say the same for the US government sector, in the sense that US politicians, you know, because they face reelection all the time, they have sort of a market feedback signal in that sense. And they are thinking short term about how can I deliver stuff that the voters want, whether that’s welfare payments, or mortgage interest deductions or other goodies. And they’re not thinking about how can I spend money on some sort of strategic insurance policy, like a strategic energy reserve, which may not actually be used.

I just think, you know, just to sum that up, in a bad state of the world, with geoeconomic tensions left and right, China’s relative strength goes up a bit.

PATTERSON:
Yeah, I mean, we could spend a whole episode talking about the pros and cons of different political systems. But I think what you’re highlighting here is really important and has obviously come into play during the war. I think there’s a couple other good lessons we’ve gotten from these last five months with the war in Iran.

And one is simply how war is fought today. You know, I don’t think anyone at the beginning of March, thought Iran would be able to do as much damage as it has done and continues to do with the weaponry it has, when you thought about it versus the combination of the US and Israel, you know, everybody was focusing on the possibility of a nuclear weapon over the coming years, no one was thinking drones. And so it’s been pretty incredible how that game has changed.

We saw it in Ukraine, and continue to and now we’re seeing it in Iran as well. You know, I think Iran too, has learned that that combination of cheap, but flexible, effective weapons in the country’s physical ability to control traffic through the strait is more effective than any nuclear arsenal it could have. And I think, you know, when I put my head and think about warfare in general, I think another lesson learned is the costs associated with it.

And I’m not talking about just right this second or longer term. And I’m not just talking about the federal budget, although all those things are important. This is so much broader than that, Sebastian, you know, it’s everything from summer tourism travel and the price of jet fuel to what we might be paying a year from now for chicken or beef or pork, because fertilizer costs now affecting the crops that feed the animals that will then end up in our grocery stores next year.

I mean, all these costs, holistically are, I think, greater than people probably were thinking about at the beginning of the war. And then I guess one last lesson, if I’m just kind of thinking about, what do I know now? I didn’t know at the beginning of March, you know, the complexity and the importance of the Middle East for so many things today, from the safety of American AI infrastructure that’s now located in the Middle East, to the region’s capital and how much it has spent internally, domestically, versus having the ability to keep putting money into American investments, both physical and financial.

So I think there’s a lot from these last five months as a researcher, as an investor, I think for businesses, policymakers, you know, we’re all learning on the fly here.

MALLABY:
Yeah, yeah. So a lot of spillovers. And the more you kind of come to the conclusion that we’re in this time of a lot of geoeconomic tensions, the more these spillovers are important to understand.

I think, you know, another one is, you know, we should think about is that the disruption in the Strait of Hormuz may turn out to have, you know, kind of contagious nature. Because one thing is, if you start blocking transit through one waterway in the world, you know, the way market signals are going to work is that they’re going to, you know, drive up demand for goods and so forth to be transited through other waterways in the world. So there’s gonna be more stress on other choke points.

And the other thing is that, you know, Iran’s success in weaponizing the Strait of Hormuz and potentially extracting commercial advantage by charging fees to go through the Strait, that could be an example that, you know, other powers learn from and seek to emulate as they try to turn their own local choke point waterway into some sort of advantage.

PATTERSON:
Yeah, no, I have to think all of this makes the Pacific waterways, especially those in China’s orbit, much more important to watch. And I also have been trying to follow the various macro drivers around the Panama Canal since President Trump came in for a second term. You know, he very quickly started focusing on the Hong Kong-owned ports around the Panama Canal, which obviously is another critical waterway for global shipping.

MALLABY:
Yeah, and on the question of waterways, it’s a good moment to bring in our guest today, who is an expert on this very topic of maritime choke points. Kristian Coates Ulrichsen is a fellow for the Middle East at Rice University’s Baker Institute for Public Policy and co-director of the Middle East Energy Roundtable. And Kristian published a paper early in the conflict about maritime choke points and global energy.

So he’s the perfect person to give us more clarity here. Welcome, Kristian. Thank you for having me.

PATTERSON:
Hey, Kristian, thank you for me as well. It’s great to have you with us today. Your paper was incredibly helpful.

We’re going to put it in the show notes for people who want to click and read it through later. But right now, I’d love to take a quick tour around the world with you, if we can, in terms of these maritime choke points. You know, what we need to be thinking about in each of these places, which ones might be underappreciated in terms of risks.

And let’s just start in the Middle East, since that’s top of mind. What about the ongoing war in Iran, not just Hormuz, but also the Red Sea, the Suez Canal? What of those gets most of your attention right now?

Do you think Iran or Iran and Oman are actually going to be able to extract some sort of rent going forward from ships? And can the rest of the world accept that?

ULRICHSEN:
Well, the negotiations between Iran and Oman would have to be approved by other Gulf states, of course, by the US as well. And we have seen, especially from a US perspective, President Trump seems to flip and flop on almost a daily basis, which has made some of the negotiations more challenging. I think certainly a lot of countries around the world, especially China, will be watching to see whether a fee structure will be implemented, because that have repercussions significantly beyond the Strait of Hormuz.

Now, before the war began, the shipping lanes in and out of the Gulf were actually largely in Oman’s territorial water. The Strait of Hormuz runs between the coast of Oman and the coast of Iran. But what Iran has done over the past five months is to really weaponize that control and effectively, very aggressively, at the state of the day, rather than Oman or any international consensus, are the ones who can determine what happens next.

And that, of course, has implications for transit passage, for the notions of sovereignty, how that relates to a passage into an international strait, because this is not a canal, for example, like the Suez Canal, which is located fully within the territorial jurisdiction of one country. It’s always been an international waterway. And it happens to be an international waterway that is so critical, not just for oil and gas, but for so many other products.

As you’ve already said, aluminum, fertilizer, helium, for example, all the products imported into the Gulf from outside, food, for example. So for all those reasons, what happens in terms of a fee structure, should that emerge, will really have a precedent setting context that I think will be extremely closely watched.

MALLABY:
Question. Maybe I could just follow up on that, because I want to understand the extent to which sort of international norms and international law and the law of the sea and so forth is really the governing authority here. Or might we be in a new world where might is right that, you know, whatever the niceties of Iran is supposed to talk to Oman and have a joint agreement, which would include various other countries.

If Iran is, you know, got its fighters there on the coast hidden at various points with drones, and they can attack shipping in the waterway, they can close the strait and that’s it. And unless they agree to open it unilaterally, and it might be on the terms of some sort of commercial fee, can’t they just impose that fee without reference to some larger negotiation? I’m not stating I’m, you’re the expert.

I’m just asking the question. No, that’s quite, that’s quite right.

ULRICHSEN:
And what I think has been the most consequential development post February 28, is the ease with which the strait can effectively be blocked. I mean, we’ve been talking about a theoretical closure of the strait since the Iran-Iraq war in 1980s. The strait wasn’t closed during that war, Iran did mine some of the approaches to the strait, they laid mines within the Gulf itself, hit shipping, hit tankers, which led to the convoy operations led by the US Navy in 1987, 1988.

But they never actually closed the strait. And so what we’ve seen is in practice, it’s been so much easier to close the strait simply by lobbying missiles and drones and attacking shipping and thereby affecting insurance, affecting the willingness of shippers to go in and out of insurance companies to offer war risk premiums. That’s been a restriction.

You don’t have to have a physical closure, a physical blockage. And as I think you said earlier on, this has been Iran’s real deterrence over the past six months. The fact that forget about building a nuclear weapon or if that would be detected, Iran would be subjected to an immediate military response long before they could get to that point.

Blocking the strait has been an act of deterrence that has really allowed Iran to wreak this havoc on the global economy without any real pushback. I mean, certainly, we have had workarounds, we’ll talk about that in a minute with some of the pipelines in the UAE and in Saudi Arabia to the Red Sea. But for example, there are no equivalent pipeline workarounds for liquefied natural gas.

So Qatar, which was one of the largest exporters of LNG in the world, has no other outlet other than through the Strait of Hormuz. The same goes for the UAE, Abu Dhabi is also stuck in terms of their LNG all being based inside the Gulf, all the fertilizer and factories in Saudi Arabia are also on the eastern side of Saudi Arabia on the Gulf Coast. So these are the challenges that Iran has shown willingness and intent to block.

So yes, the might is right, unfortunately, has really laid with Iran in this conflict. No matter what the Omanis or the US have tried to do, put in place a new shipping lane that hugs Iran at the Omani coast, that’s shown still to be vulnerable to attack and has largely been abandoned. Then of course, the other problem is if Iran does introduce fees, that likely would involve shipping companies having to take risks of breaching sanctions regulations, which would be a compliance issue, which I think they would very much, again, risk averse, try to avoid.

So there are so many dimensions, I think, which complicate any resumption of what you might term some sort of new normality.

PATTERSON:
I think the potential sanctions point is a really good one that I haven’t heard a lot of discussion over yet. So I’m really glad you raised that. I’m sure we could spend another hour just on what’s happening in the Middle East.

But just real quick, one thing on the Red Sea, obviously, there’s been some military action there as well. You have a lot of traffic going through that port as well. Anything there that you’re worried about or focused on that we should be thinking about too?

ULRICHSEN:
Yes, I think obviously, China’s ability to really reduce its own oil imports from the Gulf has been one factor that you’ve talked about in really mitigating some of the complete disruption of the crisis. The other has been the fact that the Saudis have been able to max out their capacity through the east-west pipeline that takes oil from the east of Saudi Arabia to the Red Sea coast. The Saudis have been exporting up to 5 million barrels through the Red Sea.

The problem is that the Red Sea is almost unique in the sense it has choke points at either end, the Bab al-Mandab in the coast of Yemen and the Horn of Africa, and then the Suez Canal. You may remember that between 2023 and mid-2025, the Bab al-Mandab was effectively closed to a lot of international traffic by the Houthis in Yemen who were attacking shipping in their view as a response to the war in Gaza. We saw, I think, oil transits falling by more than 40% through the Red Sea at that time.

Almost all liquefied natural gas carriers were rerouted as well. Now, they could be rerouted around the Cape of Good Hope, for example, but it added time and added cost to the journeys. We have seen an increase in fighting in Yemen over the past month.

We’ve seen a breakdown of the fragile truce between Saudi Arabia and the Houthis, which has been in place since 2022. We’ve seen indications that the Houthis are progressively firing on ships again in the Red Sea. So, if that workaround through the Red Sea is now at risk, that will really do away with one of those mitigating factors that meant that the initial disruption was far less than expected.

Now, the other part of that equation is the Saudis will then have to reroute their own exports north through the Suez Canal, then around the Mediterranean. That adds, again, time and money. We had, two weeks ago, an attack on Egypt on the Egyptian Mediterranean port of Damietta, which I think, again, was a proof of concept from Iran or its proxy allies around the Middle East that not even that workaround is necessarily safe, because these workarounds are still within range.

And it was a warning shot that even if you try and reroute, we can still hit you if we want to. So, there are all these interlinked dimensions which could certainly come into play, should the security situation in the Red Sea deteriorate significantly.

MALLABY:
Yeah, what you’re saying, Kristian, actually reminds me of another contrast I should have made earlier about this sort of Chinese attitude to bad stuff happening in the world and the American attitude to bad stuff happening in the world. Because the Chinese, they see that things can go wrong and they build in resilience. The US administration just recently has been saying words to the effect of, hey, don’t worry about the Strait of Hormuz.

It’s a depreciating asset. The ability to use that as a choke point or some sort of power for Iran is going to go down because we’re going to route around it. There’s going to be more pipelines and so forth.

But as you’re pointing out, that’s not terribly convincing because you can attack the pipelines at either end, both the refinery at the one end and the terminal at the other. And you can even go as far as the Suez Canal and use proxies to attack that. So long as you have an enemy in the Middle East which has the ability to mount attacks and that’s quite cheap and not that difficult, it seems, this problem ain’t going away.

And so when the US administration is saying it’s a declining problem, it feels to me like this contrast with China where they’re going, no, no, no, this is a problem and we’re going to do some resilience. Why doesn’t the US do more resilience rather than pretending that things are going to get better?

ULRICHSEN:
Well, yes. One of the challenges is to build additional pipelines which themselves will still be within range of Iranian missiles. That will take time.

Abu Dhabi is building a new pipeline, a second pipeline to its coast off the Gulf of Oman which is outside the strait that will connect its offshore oil fields. Currently only the onshore fields are connected to the pipeline. That’s still within range.

We’ve seen Fujairah, the outlet for the Abu Dhabi pipeline, being hit repeatedly over the past six months. Just over the last two weeks, we’ve seen Abqaiq in Saudi Arabia which was a hit in 2019 which temporarily led to a 50% fall in Saudi oil production. That was hit a couple of weeks ago and that’s a land-based choke point in the sense that Abqaiq is a processing facility for all the oil from different Saudi fields before it’s then sent either east for shipping through the Gulf or west to the pipeline.

So we have all these interconnected issues. And I think the challenge for anyone from the Gulf states or for the US is that these workarounds, these resiliences and redundancies will take time to construct, to take time to design. And for the moment at least, time is not on our side.

Time is very much on Iran’s side. They can string this out for as long as they need to and they look like they’re willing to do so.

MALLABY:
And it takes time to construct and might not even work. Let’s switch to a different part of the world, if you don’t mind. We have various waterways to think about.

Taiwan Strait. To me, the interesting question about the Taiwan Strait, which people often talk about as another choke point, another waterway, is that actually, if there was a crisis in the Taiwan Strait, it wouldn’t necessarily be a throughput crisis. It would be an output crisis.

Meaning, the Taiwan Strait matters because of the incredible concentration of high-end manufacturing on both sides of the Strait. On the Chinese side, you’ve got the Pearl River Delta. On the Taiwanese side, you’ve got most of the world’s advanced chip manufacturing fabrications.

So if you disrupt that part of the world, there’s going to be this seismic shock to global manufacturing. And that’s going to be a massive deal. People estimate at least 5% of global GDP would be taken away by disrupting that manufacturing thing.

But it is a bit different to Suez, which is a channel, because it’s the disruption of an industrial center as opposed to just a waterway. I mean, if you look at the Taiwan Strait as a waterway, well, there is a way around. You just go around the other side of Taiwan to the east, and it might take you a couple of extra days, but you can do that.

ULRICHSEN:
I think that’s right. The Straits in South Asia are hugely important to international shipping. We have huge concentrations of ships transiting those straits every single day.

But as you say, they can just reroute if they have to. So the full impact of any potential disruption in Taiwan or in the Strait more generally would be, as you say, on supply chains. It wouldn’t necessarily be on the transit itself.

And that’s actually what makes Hormuz unique among global choke points, is that there’s no other way around, at least by sea. There’s only one way in and out of the Gulf. You can’t find another sea route.

You have the pipelines, but they’re within range. Of course, with Taiwan, with the South China Sea, with the Strait of Malacca, the Singapore Strait, there are other ways to get around. So it would be disruptive, but the full disruption would be in terms of the impact on supply chains, which would have an immediate knock-on effect, rather than on the transit itself.

PATTERSON:
You mentioned the Strait of Malacca. It is interesting to me, earlier this year, when a minister from Indonesia just kind of threw out a little trial balloon saying, hey, look at Hormuz. Maybe we could make some money off our waterway as well.

It seemed to get shut down very quickly by Indonesia’s neighbors, and the local officials publicly admitted that they are indeed legally bound under the UN Convention of the Law of the Sea. But it’s interesting to me that that conversation has now started. And as you and Sebastian were talking about earlier, it gets back a little bit to this might is right.

But in the case of that waterway, that choke point, are you less concerned about that one? As you said earlier, it might add cost, but they can go around a different way. Is there anything about that particular maritime choke point that stands out to you that we should be thinking about?

ULRICHSEN:
I mean, there have been instances of low-level security risks, attacks on ships, for example, especially in the Singapore Strait. We’ve seen recurring attempts by the countries that share sovereignty, the coastal states, to work together. That hasn’t always worked.

I mean, I think those comments that you referred to were concerning, just because they may have been a trial balloon to see how they went down. But certainly by raising the issue, it’s now out in the open. And again, that’s another example of some of the knock-on effects.

Once you start weakening some of those conventions and legal conventions and norms that have structured maritime trade for decades, once you weaken it in one area, you begin to weaken it potentially in many others too, especially where you have straits, international waterways, where you have multiple countries having coastal sovereignty. So I think that’s going to be something that again, countries around the world will be looking at what happens in Hormuz with Iran, with Oman, to see how they can maybe play this to their advantage in this new world of geopolitical competition, where as you say, might is increasingly being seen as right.

MALLABY:
Kristian, maybe just one more question for you, if we may, which is sort of an open-ended one. You know, as you look to the future, we’ve got, you know, climate change is changing some of the waterways that people are going to be using, and there’s the Arctic passage and so forth. Are there other choke points as you look around the world where we should be focusing more than we are?

ULRICHSEN:
Well, as you say, the Arctic passage will be opening up with climate change that will obviously have an effect on Russia. And clearly Russia is in a confrontational stance vis-a-vis much of the rest of the world in the same way that Iran is. And so the Russian leadership probably needs no incentive to try and assert its might is right, especially in terms of some of the European states.

So I think that’s something that we will be looking at very closely. I mean, the impact of climate change is going to be something that we’ll have to take into account. For example, in 2023-24, there was a drought in Central America, which led water levels in the Panama Canal to go down significantly, which actually did lead to a significant shortfall in passage through the Panama Canal for about a year.

And on that occasion, ships, for example, carrying energy from the US Gulf Coast to Asian markets had to reroute through the Strait of Gibraltar, the Suez Canal, and the Red Sea. Until then, the Red Sea attacks with the Houthis meant they had to reroute around the African coast. So we see how things are so interconnected that even a blockage or a restriction in one choke point can have those knock-on effects.

With climate change, we may see that increase in regularity. Even just right now, we’re seeing with the heatwave in Europe, how water levels in the Rhine and the Danube rivers are falling to almost record lows, and that’s affecting river transport in those Central European arteries as well. So I think that’s something that we will have to begin to consider, that climate change, which is going to affect both the range of waterways open to shipping and then, of course, open up new ways for disruption, especially by actors in the international system such as Russia, which perhaps don’t need any excuse to try and increase their points of influence even more.

MALLABY:
So, wow. So I mean, that’s a good place to end. It just shows how interconnected all these choke points are.

And it kind of reminds me, actually, that there’s a reason why the United States became the policeman for the law of the sea. And it had an interest in making sure this system hangs together, because if you have trouble at any one corner of it, it creates stress on the other corners, as you’ve been saying. So thanks so much for joining us today, Kristian.

It’s been great talking to you. You’ve given us a lot of food for thought. And thanks for the paper, which we’ll put in the show notes, and we look forward to tracking more work that you do in the future.

Thank you for having me.

PATTERSON:
Well, Sebastian, I know we could spend several more episodes on this broader topic. I mean, you and I, especially spending more time thinking about how these geopolitical risks tie to technology. There’s just so much here.

And when we talk about the waterways, I also think about things like undersea cables, right? That’s the backbone for global internet communication. I think about technologies for surveillance of these waterways.

I mean, it’s been amazing during the course of this war to see those little maps with the little red triangles for all the ships and the real-time movements through the straits. I mean, we didn’t have that even a few years ago, or the risks around it. And of course, my head always goes to fiscal policy.

If governments have to spend more on security for supply routes, which it sounds from Kristian like that’s certainly a risk, how does it get paid for? At some point, governments are going to have to rethink what they spend and how they spend in terms of defense. Iran and Ukraine have shown that you can spend money on lots of cheap things instead of maybe as many massive ships.

And the hard part here, in my mind, is just in most of the advanced economies, how deeply embedded these processes are. You have multi-year contracts with companies that have been producing for the government for decades and decades. And even if technology is moving quickly, the contracts, the processes don’t.

But I would love to come back to that on another episode this fall. For now though, Sebastian, I’m just curious if anything about this conversation today with Kristian is stuck in your head, something new that you’re going to lose sleep at night over.

MALLABY:
Well, I mean, I just come back to this point that the war has shown us that different countries do better than others in times of geoeconomic uncertainty. And China seems to be good at planning for the worst. And America doesn’t always seem to be quite so focused on the downside scenarios and buying insurance against them.

But in a way, I think it’s kind of the same point that you’re making, that the strange thing about the US system is that it’s incredibly adaptive and resilient and fantastic in lots of ways. Companies respond very aggressively, very quickly to market signals. They restructure, they adopt technology pretty quickly.

It’s all super impressive. But then there are other areas like modernizing the defense stack, which just gets stuck forever. And of course, the more government adjacent they are, the more regulated they are, the less likely they’re going to adapt.

But this is the nature of the US almost double-headed schizophrenic system. Super impressive, but at the same time, alarmingly complacent in other areas. And you just have to guess what I’m adding to that is just to say the balance of whether the impressive sides matter or the sclerotic sides matter changes in different states of the world.

And my worry is that with a geoeconomic stress period, maybe the bad sides come through more.

PATTERSON:
That’s definitely good food for thought. That’ll keep me up at night for a few days at least. Okay.

Sebastian, before we wrap, I always enjoy hearing what you have thought was interesting or noteworthy in the previous week, and I’ll share mine as well. And maybe I can kick us off. So I’m just going to highlight one small thing that just made me hopeful and smile.

And that was the opening of a new library. Yes, I said library with actual physical books. Thanks to Axios for flagging it.

It’s called the Anythink Nature Library, and it’s just outside of Denver. And along with borrowing books, you can also borrow snowshoes and take hikes on nearby trails. And frankly, I’m just excited about anything that gets people reading beyond a multi-hundred character tweet or Twitter or whatever.

And I’m also excited about things that pull people together as a community. So that’s my thing this week, a happy library.

MALLABY:
All right. So my thing of the week is a story from Australia. Apparently an AI executive in Melbourne has the idea of telling his AI agent to go book him a gym class.

And so the agent goes off and books the gym class and sees that there’s a waiting list on the gym class and to boost his bosses or its bosses‘ chance of actually getting in the class. What does the agent do? The agent deletes the reservation made by somebody else who is higher up on that waiting list.

So when I heard this story, my first reaction was, I want an agent like that who sticks up for me. But then my second reaction was, oh my God, if everybody starts using these agents, the entirety of the global queuing system is out the window. And Rebecca, you know that I, as a Brit after all, cannot face the idea of a world without a functioning queuing system.

So there you go. That’s my thing for the week. And with that, I’ll read the credits.

This episode was produced by Molly McAnany and Gabrielle Sierra. Our video editor is Claire Seaton. Our sound designer and audio engineer is Markus Zakaria. Research for this episode was provided by Liza Jacob and Jack Heaney.

You can subscribe to the show on Apple Podcasts, Spotify, YouTube, or wherever you listen to podcasts.