After 180 missiles were fired by Iran into the night sky over Israel on Tuesday, fears are mounting that oil prices will rocket too.
In turn comes the risk of higher petrol prices, higher inflation and an existential threat to Kamala Harris’s election campaign.
The Iranian missile strikes, in response to Israel’s attacks on Hezbollah in Lebanon, were smaller than the barrage of 300 rockets Iran fired at Israel in April. But the latest attack was more dangerous, launched with less warning and travelled much further into Israeli territory.
Oil prices have since surged by 5pc in two days to $76 per barrel, marking a turning point in what had been a steady decline since April.
A major escalation could easily take the oil price to $100, says Bjarne Schieldrop, chief commodities analyst at SEB.
US website Axios reported on Wednesday that Israeli officials were considering a “significant retaliation” within days that could include targeting Iranian oil refineries.
If prices keep rising, it will create a headache for the Democrats in next month’s US election, which is already on a knife edge between Ms Harris and Republican candidate Donald Trump.
“Voters will see high oil prices and high gasoline prices reflecting that the Biden-Harris administration is not able to control the situation in the Middle East, it will make them look weak,” says Mr Schieldrop.
High oil prices will hit US consumers faster and much harder than those in the UK. In Britain, high levels of taxation mean oil prices make up only around 30pc of the cost to drivers at the pump. In the US, where taxes are much lower, oil prices make up the bulk of fuel costs.
“In the US, a 10pc jump in oil prices is a 10pc jump in gasoline prices. It is much more visible, much more hurtful,” says Mr Schieldrop.
“Also, more Americans live from hand to mouth, on the margin. If they suddenly have an additional outlay for gasoline, they are extremely hurt. And you cannot take the bus there, you have to use your car. It will be negative for Harris.”
Republicans will seize on any rise in oil prices as proof that the Democrats cannot be trusted on the economy or foreign policy, adds Mr Schieldrop.
Shortly before Iran launched its missiles at Israel, US shale magnate and prominent Republican donor Harold Hamm told the Financial Times that the Biden administration had left the US “unusually vulnerable” to an oil price shock from the Middle East. Mr Hamm blamed Joe Biden’s decision to release oil from the US strategic petroleum reserve.
And the US is unlikely to hold much sway on Israel’s next steps in the conflict. “Israel is not listening to the US whatsoever,” says Mr Schieldrop. “Maybe Netanyahu thinks that Donald Trump is a stronger supporter of him and he won’t mind high oil prices hurting Kamala Harris in the run-up to the US election. It is going ahead and doing whatever it wants.”
In turn, the prospect of further escalation is rising. Israel has effectively neutralised Hezbollah in Lebanon and Hamas in Gaza, and Iran looks weak, crippled by more than a decade of sanctions. Oil analysts are relatively sanguine for now, but the geopolitical situation is a wild card.
Iran exports 1.56m barrels of oil per day, primarily to China. This is only 1pc to 2pc of global demand and could easily be covered by the Opec oil cartel’s 6m barrels per day in reserve capacity.
But if the conflict escalates, markets will start to fear a much bigger problem, which is Iran’s capacity to block the Strait of Hormuz, a critical shipping route in the Middle East, says Mr Schieldrop.
“If all of Iran’s export capacity was damaged and they couldn’t export, why would they stand back from blocking the Strait of Hormuz, why should everyone else have oil income? That would be a worst-case scenario, but then the oil price would go ballistic,” he says.
Around 20pc to 30pc of global supply is shipped through the narrow strait at the edge of the Persian Gulf between Iran and Oman. If Hormuz was blocked, oil prices could hit $200 per barrel, says Mr Schieldrop.
“That would escalate in theory to a huge supply shock to the market, but even now I don’t think any trader expects this as a serious consequence, it is a very low probability,” says Greg Newman, chief executive of Onyx Capital.
In the UK, higher taxes on petrol mean oil price rises would have a smaller relative impact than in the US. But if oil prices rose by a further third to hit $100 per barrel, this would add 10pc to the cost of petrol, adding 13p to the cost of a litre, says David Oxley, an economist at Capital Economics. “You’d be looking at around 150p per litre for petrol.”
Higher oil prices could also bring an immediate headache for Rachel Reeves, the Chancellor, ahead of her Autumn Statement on Oct 30. As she scrambles to fill a £22bn black hole in the public finances, there is speculation that Ms Reeves could turn to fuel duty as a revenue raiser. Rates have been frozen since 2012 and were cut by 5p in March 2022 – reversing this cut and adding a further 5pc to fuel duty would immediately raise £5.5bn a year for the Treasury. But doing this would be much harder politically if petrol prices were rising, says Mr Oxley.
But price increases would be a double-edged sword for the Chancellor. High oil prices would also mean Britain’s own North Sea operators would make more profits and so have to cough up more taxes for the Exchequer. Conversely, if oil prices were to fall below $71.40 for more than six months, the Government would have to cancel the windfall tax – a potential disaster for Ms Reeves.
Even with the current escalations in the Middle East, this is still feasible.
The underlying trend with prices over recent months has been strongly downwards – falling steadily from a peak above $91 per barrel in April to a low of $69 in September – because the world is oversupplied with oil.
This is partly because Opec had been failing to persuade its members to cut oil output to support prices.
Saudi Arabia’s oil minister last week made a veiled threat to other members of Opec that the Gulf state could ramp up production and initiate a price war.
Opec and its allies will meet on Wednesday to discuss whether to ease production curbs, which have been keeping prices higher, in December. During a conference call, Prince Abdulaziz bin Salman warned Opec delegates that oil prices could drop to as low as $50 per barrel if members did not honour the cartel’s agreed production limits, the Wall Street Journal reported.
“I think we’re possibly coming up to an inflection point in the market where Saudi Arabia might actually be looking to flood the market with oil,” says Mr Oxley. “Saudi could massively change tack and focus back on market share.”
The downward trend has been compounded by increasing supply from non-Opec countries like the US, and the prospect of additional supply from Libya where once-warring groups have come to an agreement to boost exports.
Mr Newman also points to global trends such as surging supply and falling demand – especially from China where property crises are undermining growth, and Europe, due to manufacturing declines.
Based on those fundamentals, many traders had been expecting oil prices to collapse, falling to between $60 and $65 within a couple of months, roughly where it was before the pandemic and Russia’s invasion of Ukraine.
But analysts said a widening Middle East conflict could reverse that trend.
“In the near term, everything is down to geopolitics,” says Mr Oxley.
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