Oil prices spike on Middle East conflict

Oil prices spike on Middle East conflict

The outbreak of hostilities between Israel and Iran last Friday has lifted the oil price to $75 a barrel, up 19% since the start of this month. By the standards of recent years’ oil prices, which hit a peak of $129 a barrel three years ago, these are still subdued. Still, with both sides talking of escalation, the risks to energy prices lie squarely on the upside.

• Iran produces around 3% of the total global oil supply. Over the weekend Israel attacked Iranian oil and gas processing facilities in a move that the Financial Times described as suggesting “Israel is attempting to weaken and disrupt Iran’s domestic gas and fuel supply chains to cause shortages, rather than pursuing the country’s oil and gas production… which would rock the markets”.

• The big risk for the global economy is that Iran itself seeks to destabilise oil production and shipping across the Middle East to hit back at western governments which it sees as enabling Israel.

• In 2019 a drone and missile attack on Saudi oil facilities resulted in a temporary halving of Saudi oil output, equivalent to 5% of global supply, and a near 20% rise in the oil price. Western countries blamed Iran for the attack. Relations between Iran and Saudi Arabia are more cordial today and attacking energy facilities would run the risk of dragging Saudi, a major military power, into the current conflict.

• Iran could also seek to disrupt energy supplies by closing the Strait of Hormuz, the narrow sea lane between Iran to the north and Oman and the UAE to the south, through which about 20% of global oil and liquified natural gas flows.

• Iran has repeatedly made this threat in the last 40 years. Closing, as opposed to disrupting, the Strait would be a formidable task given the weakened state of Iranian forces and the near certainty that the US and its allies would resist any attempt to stop traffic. Iran has never previously been unable to close the Strait, despite laying mines, occasional seizures of vessels and the use of missiles against western vessels. International naval coalitions, led by the US, have ensured the waterways continued operation. There is little doubt that Iran has the capacity to disrupt traffic, possibly significantly, and in a way that could keep energy prices higher for longer. A prolonged closure is what ING-Barings calls an “extreme, worst-case scenario”, albeit one that, the bank estimates, could take the oil price to over $150 a barrel.

• Conflict in the Middle East, and the ensuing spike in oil prices, have been harbingers of western recessions in 1973, 1979 and 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. Consumer nations now have petroleum reserves that can be used to protect against shortages. Oil’s share of global energy supply has fallen as a result of greater efficiency in consumption and as countries have switched to renewables. Global GDP is less oil-dependent than in the past. It takes less than half the amount of oil to produce a unit of GDP than it did in 1970.

• These factors helped insulate the West against the worst effects of the energy shock of 2022. 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.

• Despite last week’s surge and 18 months of conflict in the Middle East, oil prices are still well below the levels before Hamas’s attack on Israel on 7 October 2023. Part of the reason is that oil demand from China, the world’s second-largest oil user, has softened. Some smaller OPEC producers have exceeded their production quotas which has reduced the effectiveness of OPEC’s attempts to bolster prices. Despite low prices Saudi Arabia has increased its production of oil this year, a move the Financial Times said over the weekend, “has prompted speculation that the cartel [OPEC] was responding to White House pressure to boost output ahead of a confrontation with Iran.”
   
• The world may be less sensitive to oil prices than in the past, but it is not immune from them. Uncertainty and volatility in energy and financial markets, particularly if prolonged, will weigh on global growth. The conflict between Israel and Iran adds a new source of risk for the global economy.

OUR REVIEW OF LAST WEEK’S NEWS
The UK FTSE 100 equity index ended the week up 0.1% at 8,851. The US dollar fell to a three-year low following US president Donald Trump’s announcement that he would outline new tariff rates for trading partners in the coming weeks. The oil price rose sharply to $75 a barrel following the outbreak of hostilities between Israel and Iran.

Economics

• President Trump said that he would send letters to trading partners in the coming weeks that outline trade agreement terms with the US, as the end of the 90-day pause on the “reciprocal” tariffs approaches
• Mr Trump said he may “have to force something” if the Federal Reserve does not lower borrowing rates. The next Fed interest rate decision is on Wednesday
• The US and China reached an agreement to reduce trade tensions following a recent escalation, including the US imposing an import tariff of 55% on Chinese goods and China imposing a 10% tariff on US goods. The US will also grant visas for Chinese students studying in the US while China will ease export restrictions for rare-earth minerals
• US consumer confidence improved in June for the first time in six months, according to the University of Michigan. The index remains well below last December’s post-election high 
• US inflation rose by a less-than-expected 2.4% in the year to May, up from 2.3% in April
• UK monthly GDP fell by a greater-than-expected 0.3% in April following the imposition of US import tariffs and higher employers’ national insurance contributions
• UK unemployment rose marginally to 4.6% in the three months to April, while the number of payrolled employees continued to decline. UK annual wage growth eased to 5.2%
• UK financial regulators should learn “valuable lessons” from Singapore’s approach to regulation and become less risk-averse to support economic growth, according to the House of Lords Financial Regulation Committee 
• Planning approvals for new UK homes declined to a 13-year low in the first quarter of this year, according to the Home Builders Federation
• Gold has overtaken the euro as the second largest reserve asset for central banks globally, due to a combination of high prices and record accumulation, according to the European Central Bank
• The EU imposed import tariffs on Chinese hardwood plywood over claims that Chinese firms were dumping the construction material in EU markets
• Chinese exports to the US fell by a third in May compared with the same month last year, the sharpest fall since the COVID pandemic amid the imposition of higher US import tariffs
• Chinese consumer prices continued to decline in May, albeit marginally, by –0.1% from a year ago, the fourth consecutive month of deflation, in part due to weak domestic demand

Business

• Facebook’s parent company Meta announced a $15bn investment in start-up company Scale AI as it faces strong competition among tech firms in developing Gen AI models, the FT reports
• US quantum computing company IonQ announced it will buy UK start-up Oxford Ionics for £1.1bn, while US semiconductor company Qualcomm agreed to buy UK chip designer Alphawave for $2.4bn, continuing the recent trend of US firms acquiring UK technology companies
• A consortium led by UK engineering company Rolls-Royce won a UK government contract to build three small modular nuclear reactors, producing enough energy for 1.5m homes, with the government pledging £2.5bn over the next three years to support the project
• UK chancellor Rachel Reeves announced plans to partially restore the winter fuel payment, with nine million pensioners qualifying at an expected cost of £1.6bn
• Vehicle manufacturers Toyota and Daimler announced a $6.4bn merger of their truck production businesses in response to growing competition from Chinese rivals
• UK retailer Poundland has been bought by investment company Gordon Brothers for 85 pence amid ongoing financial struggles, the FT reports
• UK transport secretary Heidi Alexander announced plans for commercial trials of driverless taxi services next year
• Eurostar said it plans to launch routes from London to Geneva and Frankfurt in the early 2030s following rising demand for more sustainable travel
• Swedish lorry manufacturer Scania said it plans to form a consortium to buy battery maker Northvolt’s research laboratory out of administration to keep skilled battery development expertise in Europe 

Global and political developments

• The US Department of Defence launched a review of the AUKUS nuclear submarine programme between the US, UK and Australia over concerns about America’s own defence readiness
• Mr Trump ordered the National Guard and Marines to Los Angeles to tackle protests over immigration raids. The governor of California, Gavin Newsom, said that Mr Trump’s actions were inflaming the situation
• US technology entrepreneur Elon Musk said he “regrets” some of his previous comments against Mr Trump
• The European Union announced further sanctions against Russia, including restricting imports of refined products that use Russian oil and banning the use of the Nord Stream gas pipeline to Germany 
• The US government said it was concerned over the Chinese government wanting to build its new UK embassy at Royal Mint Court in London, where it could potentially access sensitive communication infrastructure
• The UK, EU and Spain reached an agreement on Gibraltar’s borders that allows open land travel between Gibraltar and Spain in return for Spanish border checks for those flying or sailing into the British territory

And finally… physicists at the University of Loughborough used nanotechnology to create the world’s smallest violin, smaller than the width of a human hair. The development will help research into improving computer efficiency and finding new ways to harvest energy – string theory