Key Takeaways
- Oil is now trading above $100 per barrel and stands around 76% higher year-to-date.
- Oil prices at these levels typically lead to a weak economic backdrop. The headwind is a global one, but Asia and Europe are most exposed to supply issues from the Middle East.
- Some are forecasting further appreciation but how far depends on several factors – the US’s military objectives and ongoing closure of the Strait of Hormuz are key.
- The G7 and International Energy Agency (IEA) are meeting today, and reserves could be deployed to ease short-term supply pressures.
- Uncertainty looks set to weigh heavily on risk appetite in the short term. A sustained period of oil prices above $100 would see us reconsider our broadly constructive economic outlook.
Today we focus on the oil price which, at the time of writing, is trading above $100 a barrel on the back of conflict in the Middle East. It is no surprise to see oil moving even higher versus last week as concerns mount over supplies moving out to the Gulf towards Asian and European markets. The price is up about 47% since the end of February when the US and Israel first attacked Iran, and is up almost 76% year-to-date. While the level is elevated it remains some way off the peak we saw in June 2008 at $147 a barrel. There is, however, plenty of commentary suggesting we will see those numbers once again should there be an extended closure of the Strait of Hormuz.
History shows that in 2008, and then again in 2012-2014 and 2022, that an oil price of more than $100 a barrel leads to a weak economic backdrop. Is the outcome likely to be different this time? Not really. The US is now largely self-sufficient in terms of oil supplies. All the same, the oil price is global and the US will still be impacted. For example, gasoline in the US is now $3.50 per gallon having risen significantly over the course of last week. Oil from the Middle East primarily goes to Asia and (to a lesser degree) Europe, but the impact of global pricing means that economic headwind is felt everywhere, especially in countries that are dependent on energy resources.
The path from here depends on several factors and there are many people predicting that oil will go above $150. For accurate forecasting, however, we will need greater clarity. First and foremost, the direction of the conflict remains a huge unknown. It is not that clear what the US’s goals are, and that means we don’t quite know what they are seeking to achieve before they declare ‘mission accomplished’. Any signals that the conflict is de-escalating will certainly help sentiment. The ‘closure’ of the Strait of Hormuz is crucial – normally about 90 tankers pass through it each day and there are now around 500 tankers ‘stuck’. Reports suggest that 10 vessels have been hit so far. The closure also has an impact on output from Middle Eastern countries given lack of storage. As a result, production needs to be slowed down or completely halted. In addition, there are concerns that Iran will conduct further attacks on oil and gas infrastructure in neighbouring countries, which could have a detrimental impact on production.
What happens next in terms of efforts to mitigate the shock to the oil price? The G7 and International Energy Agency (IEA) are meeting today – the IEA have a significant volume of reserves, which could take the pressure off in the short term. That would be a positive, so the outcome of meetings will be monitored closely. Further mitigation could come from the use of pipelines across Saudi Arabia and the UAE that can avoid the marine pinch point. These have limited capacity, however, and certainly can’t offset the full impact of the Strait’s closure. A longer-term option could be naval convoys mirroring steps taken during the Iran-Iraq war. Such convoys would take time to set up and require significant resources. The US would likely lead the operation, but their military resources are clearly focused elsewhere in the short term. Thus far Iran hasn’t taken steps to lay mines in the shipping channels – this is a positive and would speed up any reopening. Of course, it is crucial for shipping to have insurance and risk tolerance among providers is low. Progress on naval escorts would be very helpful.
In the short term, uncertainty looks set to weigh heavily on risk appetite. If the oil price remains above $100 for a sustained period, however, then we will need to reconsider our global outlook. As greater clarity emerges around the likely duration of the conflict, we will be able to take a more balanced view on the prospects from here.
