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Why the sharp jump in the oil price matter to investors
You may soon be counting the cost of actions thousands of miles away when you fill your car at the pump and the surge in oil prices has significant implications for markets too.
The drone attack on Saudi Arabia’s Abqaiq and Khurais processing plants knocked out half the country’s production capacity in one fell swoop, leading to a 5% fall in global output. At one point the Brent crude price was up as much as 20% in response, the biggest percentage move since the Gulf War in the early 1990s.
Subsequently prices settled slightly lower but they remain substantially higher than their pre-attack levels, reflecting the fact that Saudi Arabia, as broker Cantor Fitzgerald observes, ‘is the world’s biggest oil exporter and, with its large spare capacity, has been the supplier of last resort for decades’.
While oil producers have seen their shares move up as higher commodity prices have been factored in, and airlines have been under pressure on the assumption of a bump in fuel costs, there are wider market impacts to consider.
The resulting impact on inflation, as higher fuel costs feed into the economy, is a potential headache for central banks which have, in most cases, been cutting interest rates in an attempt to stimulate economic growth.
Lifting interest rates is one of the main tools available to combat inflation and so the situation could create a big headache for monetary policymakers.
An increase in oil prices could also send a fragile global economy into reverse, given the direct impact on motorists and as the higher fuel costs are passed on to consumers by the corporate world.
Although the level of disruption was on a different scale, the oil embargo in the 1970s did tip the world into recession.
What happens next depends on several factors which include:
– The length of the outage
– Whether the attacks lead to a material escalation in Middle East tensions
– The chances of further attacks
Saudi Arabia has moved to allay supply fears and says it will maintain exports by tapping into its reserves.
Possibly more relevant is the oil attacks’ impact on simmering tensions in the Middle East. Yemeni rebels have claimed responsibility but their links with Iran has seen fingers pointed in that direction, not least by the US.
For now the Trump administration has dialled down initially aggressive rhetoric but, given the chances of further attacks are hard to predict, the markets are likely to factor this geopolitical risk into oil prices for the foreseeable future.