The U.S. Federal Reserve just cut interest rates last month. The European Central Bank cut rates, too, in recognition of tamer inflation. Now, this may be about to change if violence in the Middle East escalates further.
Brent crude topped $80 per barrel on Monday, rallying on reports suggesting Israel may respond to Iran's missile barrage attack from last week sooner rather than later. West Texas Intermediate climbed closer to $77 per barrel. By early Tuesday, the benchmarks were slightly down, but the rally had in no way fizzled out. If it holds, prices at the pump are next—and so is the price of everything else.
Israel has yet to make its move, but there is little if any doubt that it will make a move. Tel Aviv cannot afford to let the Iranian attack go unanswered—similarly to how Iran couldn't let Israeli attacks on its territory go unanswered in the local political context. The only two questions are how severe this move will be and whether it will target Iran's oil infrastructure.
While analysts ponder the answers and traders watch the news, prices are climbing. "While the national average dipped slightly in the last week, Iran's attack on Israel has at least temporarily caused oil prices to surge to the highest level in months, which could cause the declines to cease for now and could lead to a rise in gas prices for many Americans," GasBuddy's Patrick De Haan said this week, as quoted by the Aspen Times.
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According to AAA figures, the national U.S. averages this week are so far below the average for last week, but this could yet change—the week has just begun. More importantly, the rally could extend beyond a single week, especially if the conflict between Israel and its neighbours leads to Iranian production disruption.
Iran's oil industry makes perhaps the most sense as a target for Israel. It is a key industry for the country, even under U.S. sanctions, and an attack on it would hurt Iran. However, the pain would spread globally and reach the U.S., where Israel's staunchest allies are preparing for an election. Higher prices at the pump are not something Democrats want to see right before the November vote.
Some analysts point towards OPEC's spare capacity as a reason to keep calm and carry on watching Chinese oil demand. ANZ said in a recent note cited by Reuters that OPEC had as much as 7 million barrels in spare production capacity that could be put into use in case of disruption in Iranian supply.
This statement, however, assumes that all OPEC members with spare capacity will immediately react to a potential supply disruption by flipping a switch on all their spare capacity. The assumption is a little bit eccentric, given that OPEC has been curtailing production for years now in a bid to push prices higher rather than lower. Granted, at some point, OPEC would react to a hypothetical Iranian supply disruption, but that point will not be immediately after the disruption occurs—if it occurs at all.
Whatever happens next in the Middle East, the West has just got a reminder of how essential crude oil remains for the health of any economy, even economies marching happily on to a future that, on the face of it, relies a lot less than oil than the economies of the recent past did. Oil prices are still part of the foundation for inflationary movements—and a very big part. It's good to be reminded of that once in a while.
As Reuters columnist Jamie McGeever put it in a recent column, "There's barely any corner of the economy that oil doesn't reach. It heats homes and businesses, powers factories and every means of transport, and is a key input in the production of chemicals, plastics, materials and all manner of goods." If oil's up, everything else goes up, too.
By Irina Slav for Oilprice.com