Oil prices are up sharply since hitting a recent low in June. By the end of September, Brent crude had risen from $72 per barrel to a 2023 high of $96, with the outbreak of violence in the Middle East triggering another spike in oil prices in early October.
Higher fuel and energy costs may not have an impact on the current “higher for longer” stance of central banks. However, if rising oil prices hit consumer spending, they may serve as a reminder to policymakers to be mindful of the downside risk to growth.
Reduced supply and rising demand have driven oil prices higher
The latest run up in oil prices reflect constraints on supply and rising demand. On the supply side, on 5 September Saudi Arabia extended its 1 million barrels per day cut in production for the rest of the year, alongside Russia’s 300,000 barrels per day reduction. The production cuts are aimed at lifting oil prices to support fiscal revenues. At the same time, the dramatic drop in the US strategic oil reserve – which has served as an additional buffer against external oil supply shocks in the past – has added to supply concerns.
On the demand side, meanwhile, tight oil supplies have been exacerbated by stronger-than-anticipated oil demand, which has grown sharply in 2023, driven by China. Global demand for oil expanded by 2.1million barrels per day in the first eight months of the year. Despite China’s lacklustre economic recovery, demand for transport-related fuel has been strong as domestic travel restrictions have been lifted.
More recently, the potential role of Iran and other Middle Eastern nations in the Israel-Hamas conflict has sparked further oil supply concerns. While Iran has so far denied direct knowledge of the attack on Israel, Tehran has been a supporter of Hamas. The oil market could potentially be impacted by the stronger enforcement of the ban on Iranian oil exports, or via disruption in the Strait of Hormuz, a critical shipping channel. While these risks appear low for now, they deserve monitoring as events continue to develop.
Some supply concerns have been eased as many oil producing countries – both members of the Organization of the Petroleum Exporting Countries (Opec) and non-Opec members – have steadily raised their own production. This supply response, and expectations for a possible slowdown in the global economy in the next 12 months, could help to cap oil prices. However, geopolitics is once again the source of uncertainty in the weeks and months ahead.
How may central banks react?
The rise in energy prices since June has prompted concerns that central banks may keep interest rates higher for longer to tame inflation. In the US, the Federal Reserve is indeed advocating a higher-for-longer interest rate policy, although higher energy prices may have less to do with this stance. Since hitting a high of $4.35 per gallon in June, the average US gasoline price has since settled at around $4.26, which is still about 3% lower than a year ago, and 22% lower than the June 2022 peak.
CRUDE OIL AND US GASOLINE PRICES
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