The war in Iran and its surrounding region has caused a significant reduction in the supply of fuels, as well as some other goods, which has, as expected, led to a rapid rise in their prices worldwide.

Because these are key input goods, the price increase is spreading both geographically and across sectors. No one knows how long the supply problems with oil, gas, and other raw materials will last. Even if the fighting ends, supply problems may not be resolved quickly, as rebuilding destroyed production capacity could, in the worst case, take several years.

The heightened overall political volatility in the region (and in fact across the world) has not strengthened confidence that even the slightly more distant future will be more stable. As a result, the fear factor stemming from poor outlooks and uncertainty has driven prices and price expectations even higher.

This is a strong supply‑side price shock. That determines which actions can help contain price increases and which cannot.

One of the fundamental laws of economics is the relationship between demand, supply, and price. More specifically, price depends on the balance between demand and supply. This relationship has always held and will continue to hold in the future; all attempts to break or bend this rule have ended badly.

Economic logic and past practice confirm that when price increases are driven by the supply side, the solution can only be to increase supply, substitute goods, or reduce demand. Of course, it is possible to do more than one of these at the same time.

Increasing supply means developing new production capacity or bringing into use capacity that was previously idle due to lack of competitiveness. The same applies to substitute goods: in many cases, their production volumes must also be increased, which means investment.

There may be idle production capacity, but it is idle because its use has not been price‑competitive. Bringing such capacity back into operation therefore requires investment and also implies a higher price level than before. Fuel imported from the US or elsewhere is more expensive than fuel from the Middle East, so even if lost Middle Eastern supply could be compensated with fuel from other regions, the resulting price level would still be higher due to increased production and transportation costs.

To some extent, fuels can be substituted for one another, and this is certainly happening now. When Russian natural gas became toxic for Estonia in 2022, alternatives included importing gas via other countries (Estonia–Finland and Poland–Lithuania), building LNG capacity, and replacing gas consumption with other heating options where possible. This is a costly and time‑consuming process when capacities still need to be built. At present, however, these alternatives already exist.

Major crises inevitably also lead to changes in consumption, meaning reduced demand for goods that are in short supply. For example, one consequence of the fuel crises of the 1970s was, among other things, more rational and efficient fuel consumption, including cars with lower fuel use. It can be assumed that the current crisis will also change fuel and energy consumption — not immediately, but with some delay, as substitute goods must be found, investments made, and habits changed.

It can be assumed that much of Europe is currently considering the development of domestic capacities, particularly looking for ways to increase electricity generation without using imported fossil fuels. This naturally also means that transport and heating systems must become significantly more electricity‑friendly and less dependent on imported fossil fuels.

These solutions are long‑term and costly, but crises like the current one have previously ended with very fundamental changes in consumption patterns. In the short term, however, this means that energy prices will initially remain very high and will begin to fall gradually as new suppliers are found, new production capacity is built, and demand changes.

Our homegrown political "economic experts" have concluded that the supply problem should be solved by suppressing prices through tax cuts or by imposing price caps. Increasing subsidies has also been proposed as a way to boost demand.

In theory, prices can be pushed down by lowering taxes or through government price subsidies. Both measures have an impact on the state budget, but these rather expensive policies may provide little real relief to consumers. The reason is that supply does not increase, and demand does not decrease significantly; the mismatch between demand and supply remains or even widens, leading to continued price increases. The cost is real, but the benefit is virtually nonexistent.

It must not be forgotten that in an open market, artificially suppressed prices increase demand from outside Estonia as well. Residents and businesses from neighboring countries will simply come to Estonia to buy cheaper goods.

From the perspective of consumers and society, an especially harsh solution is when the state sets a price ceiling for a good. This means the state must cover the difference between the mandatory retail price and the market price from the budget. The more of such price‑suppressed goods are purchased, the more expensive this is for the state and the greater the strain on public finances.

A few years ago, Hungary imposed a price cap on fuel, and residents of neighboring countries naturally started buying gasoline and diesel in Hungary. Demand increased, but supply remained the same. To limit the growth of budgetary costs, purchase limits were introduced. Bribery and cronyism flourished, and goods went to those who had the right connections or enough money to pay black‑market prices. An official price emerged alongside a real market price on the black market — the former did not get you the product, the latter did.

Demand also increases when income is boosted indiscriminately by handing out subsidies to everyone or nearly everyone. In that case, the supply problem is not solved; instead, people's ability to buy expensive goods increases — that is, demand rises. The imbalance between demand and supply worsens, and price increases accelerate.

This does not mean that vulnerable population groups cannot be supported; what matters is that support measures are precisely targeted. Otherwise, poorer and more severely affected groups end up being hit even harder by rising prices.

Thus, mitigating the effects of supply‑side price increases can primarily be achieved through expanding supply, substituting goods, and limiting consumption — although higher prices themselves already reduce demand. To a limited extent, it also makes sense to use targeted support and compensation measures. From this set of tools, Estonia must choose how to respond to the consequences of the war in Iran.

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