The economics of oil

The economics of oil

Rising tensions in the Middle East amid Iran’s missile attack on Israel and Israel’s advance into Lebanon have sent the oil price higher, with benchmark Brent crude closing up almost 8.0% on the week.

• Iran is a significant producer of oil, accounting for about 4% of global production. Major attacks on Iranian oil facilities would be likely to push prices significantly higher, partly on concerns that Iran would step up its efforts to disrupt oil production and shipping across the Middle East. It is such region-wide disturbance that could push the oil price above the $100 a barrel level that could prove more damaging in the West. 

• Iranian-backed Houthi rebels in Yemen have been attacking shipping in the Red Sea for almost a year and Iran is believed to have launched a drone attack in 2019 that temporarily disabled one of Saudi’s Arabia’s main oil facilities.

• Over the last 40 years Iran has repeatedly declared that if it were threatened it would close the Straits of Hormuz, the narrow sea lane between Iran to the north and Oman and the UAE to the south. As Iran’s then president, Hassan Rouhani, said in 2018, "if someday, the United States decides to block Iran's oil [exports], no oil will be exported from the Persian Gulf." About 20% of global oil and liquefied natural gas production are shipped through the Strait.

• Higher oil prices dampen demand and lower growth in consuming nations. A 1990s study of postwar oil prices by Professor Andrew Oswald of Warwick University showed that every major surge in energy costs had been followed by recession. Conflict in the Middle East, and the ensuing spike in oil prices, have been harbingers of western recessions in 1973, 1979 1990.

• The world is better placed to deal with disruption to oil supply than in the past. Energy markets are more efficient, integrated and contestable than they were in the 1970s. Shale fracking has led to a huge increase in US energy production, weakening OPEC’s hold over supply. Oil’s share of global energy supply has fallen as a result of greater efficiency in consumption and as countries have switched to gas and renewables. Consumer nations now have petroleum reserves that can be used to protect against shortages.

• These factors helped protect the West against the worst effects of the energy shock of 2021-22. Oil and gas prices surged in response to a rebound in demand following the end of lockdowns and as supply from Russia was restricted after it invaded Ukraine. Growth suffered, particularly in Germany, but unlike previous such shocks no major consuming nation fell into recession.

• Surprisingly, a year of elevated geopolitical risk in the Middle East, and OPEC production cuts designed to bolster prices, have seen oil prices drift lower, not higher. Even after last week’s rise, the oil price on Friday was 10% lower than it was on the 6 October last year, the day before Hamas’ attack on Israel. Part of the reason is that oil demand from China, the world’s second largest oil user, has softened in the last year. Some smaller OPEC producers have exceeded their production quotas that has reduced the effectiveness of OPEC’s attempts to bolster prices. Last month the Financial Times reported that Saudi is likely to abandon its unofficial oil price target of $100 per barrel (last week Brent crude closed at just under $78) as it prepares to raise production from December. This story has also weighed on the oil price.

• So far financial markets have remained calm in the face of rising risks in the Middle East.  US equities, for instance, closed on Friday almost unchanged on the week. The relationship between oil prices and western growth seems to have weakened and energy markets are more resilient and diversified than in the past. Yet the Middle East remains a vital energy producer and rarely has the risk of direct conflict between Israel and Iran been greater. The global economy may be better placed to cope with oil shocks, but it is not immune from them.

OUR REVIEW OF LAST WEEK’S NEWS
The UK FTSE 100 equity index ended the week down 0.5% at 8,281.

Economics

• The US economy added 254,000 jobs in September and the unemployment rate dipped to 4.1%, beating expectations and bucking the recent trend of a slowdown in the labour market
• Bank of England governor Andrew Bailey said the BoE could be “a bit more aggressive” on cutting interest rates if price pressures continue to ease but warned the bank is monitoring the situation in the Middle East amid concerns about an oil price shock
• The Bank for International Settlements warned greater volatility in the global economy and a more protectionist trade environment may lead to more frequent periods of rapidly rising prices in the future
• Euro area inflation fell below the European Central Bank’s target to 1.8% in September. Markets expect the ECB to cut rates by a further 25bps at the next meeting on 17 October
• UK private sector pay growth moderated slightly to 4.1% in the three months to August from a year earlier, the lowest level in two years, according to a survey by Incomes Data Research
• UK GDP growth for the second quarter was revised slightly lower, to a quarterly rate of 0.5% from 0.6%
• UK house prices rose by 3.2% in September, the strongest annual increase for nearly two years following an improvement in mortgage affordability, according to Nationwide
• Euro area house prices rose by 1.3% in the second quarter from a year earlier, the first increase in over a year
• EU members agreed to impose tariffs on imports of Chinese electric vehicles, following the European Commission’s proposal to impose a tariff of up to 35.3%, on top of the existing 10%
• In a sign of continued caution on the part of European consumers the euro area household saving ratio rose to a three-year high of 15.7%, well above its pre-pandemic average of 12.3%.
• Global manufacturing conditions worsened, according to high frequency PMI data, with the index falling to 48.8 in September from 49.6 in August, indicating a further decline in activity. UK manufacturing bucked the trend, recording a modest expansion driven by healthy domestic demand
• PMI data indicate UK construction sector activity accelerated in September to its fastest rate of expansion since April 2022 while momentum in the services sector remained positive but moderated somewhat
• Chinese equity markets continued to rally following last week’s announcement of substantial fiscal and monetary stimulus, the Shanghai Composite index has risen by nearly 20% since the package was announced
• Private equity firm Blackstone warned that despite a recovery in the commercial property market, some over-indebted office owners would still end up taking losses on their investments
• Chinese outbound investment rose 12.5% in the first eight months of the year from the same period in 2023, due in part to companies in its fast-growing renewable energy sector setting up manufacturing operations abroad following tariffs from the US and EU US imports of Indian solar panels and cells surged last year as the US sought to diversify away from Chinese suppliers. According to BloombergNEF US imports of solar panels and cells from India rose seven-fold between 2022 and 2023
• The Wall St Journal reports that new census data show 14.4% of U.S. households have incomes in excess of $200,000. The Journal describes the growth in the US of the so-called HENRY – high earner, not yet rich – household that it defines as: ‘feeling a gap between what you have and what you think you need to be comfortable’.

Business

• OpenAI, the artificial intelligence business, raised $6.6bn in a funding round that values the firm at $157bn
• Starling Bank was fined £29m for ‘shockingly lax’ financial crime screening by the Financial Conduct Authority
• The UK bosses of carmakers BMW, Ford, Jaguar Land Rover and others wrote to chancellor Rachel Reeves arguing for tax cuts to boost demand for electric vehicles
• UK housebuilder Barratt’s £2.5bn acquisition of its competitor Redrow was given the go ahead by the UK’s Competition and Markets Authority
• British Airways has suffered a doubling of delays and cancellations to and from London Heathrow since the pandemic, according to the Financial Times

Global and political developments

• Iran fired around 200 ballistic missiles at Israel in retaliation for the assassinations of senior Hamas and Hezbollah leaders, sparking international condemnation. Israel vowed to respond
• Israeli troops entered Lebanon, targeting Hezbollah positions that have been used to attack northern Israel. Hundreds of thousands of Lebanese citizens are thought to have been displaced
• Russian forces captured the Ukrainian city of Vuhledar in the Donetsk region and are now likely to intensify their assault on the strategically important city of Pokrovsk
• Former Dutch prime minister Mark Rutte took over from Jens Stoltenberg as secretary-general of NATO and vowed to continue supporting Ukraine
• The British government announced it would pass sovereignty of the Chagos Islands in the Indian Ocean over to Mauritius in return for a 99-year lease of the strategically important UK/US base on the largest island of Diego Garcia
• Shigeru Ishiba was sworn in as Japan’s new prime minister and immediately called a snap general election for 27 October
• Claudia Sheinbaum was inaugurated as president of Mexico and pledged to maintain the social policies of her predecessor Andrés Manuel López Obrador
• Canadian prime minister Justin Trudeau survived a second vote of no confidence amid calls for him to step down
• In an interview UK Chancellor Rachel Reeves told the Financial Times that she would not be “ideological” about taxing the wealthy. The FT said that government sources were looking for a compromise on taxing gains from private equity that would help raise revenues without damaging the UK competitiveness.
• Keir Starmer’s Chief of Staff, Sue Gray, resigned after only three months in the job

And finally... the stately home of Tatton Park in Cheshire has been forced to cancelled planned charity fun runs due to unusually aggressive rutting deer. The deer, who have been resident since Edward I declared it a deer park in 1290, have already caused several injuries - stag-gered start