Why is the supply of oil rising?

A “boy-who-cried-wolf mindset” has set in on energy markets, says Matt Egan for CNN. Traders, caught out by previous false alarms, have become increasingly “numb to the cascade of crises” afflicting the world – a growing war in the Middle East is thus not causing the oil market the panic you might expect. “Pre-shale revolution, this type of situation would have sent prices well above $100” a barrel, says Helima Croft of RBC Capital Markets. Still, as Bob McNally of Rapidan Energy Group puts it, “the story of the village boy who cried wolf did not end well – for the village or the boy”. While markets aren’t yet panicking, they are feeling nervous following comments from Joe Biden that Israel discussed striking Iranian oil facilities in retaliation for last week’s missile attack. 

Brent crude prices topped $80 a barrel recently for the first time since August, before easing back mid-week, say Rafe Uddin and Jamie Smyth in the Financial Times. Oil rose 8% last week for its biggest weekly gain since the start of last year, and has climbed almost a fifth since hitting a year-to-date low last month. Iran accounts for roughly 2% of global crude exports, or two million barrels per day (mbpd), says Anthony Harrup in The Wall Street Journal. 

A six-month halt to that supply could see Brent “temporarily rise to a peak of $90”, assuming other oil producers step in to fill some of the shortfall, say Goldman Sachs analysts. In the short-term, markets will need to put more “risk premium” on oil – the extra paid to cover the risk of supply disruptions, says David Oxley of Capital Economics in a note. “Depending on how things pan out, this “could conceivably” be in the order of “another $20 a barrel to oil prices”.

MoneyWeek

Subscribe to MoneyWeek today and get your first six magazine issues absolutely FREE

Get 6 issues free

Sign up to Money Morning

Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter

Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter

Sign up

Why is there a high supply of oil? 

One reason for the market’s relative calm is that there is plenty of extra oil sloshing around, says The Economist. The Opec+ grouping of producers is collectively sitting on more than five mbpd in unused production capacity, which it has been withholding to prop up prices. That is “more than enough to make up” for any eventual loss of Iranian crude. But the situation is fragile. A regional conflagration could see Iran close the Strait of Hormuz, the shipping lane through which 30% of the world’s seaborne crude oil flows. That could send prices surging toward triple digits. For all the excitable talk, Opec quietly abandoned its quest for $100 a barrel oil in June, says Javier Blas on Bloomberg. 

In view of global oversupply heading into next year, “given a binary choice between $100 and $50 for next year, I’d take the latter bet”. As a rule of thumb, a 5% rise in oil prices adds approximately 0.1% to inflation in advanced economies, says Roger Bootle in The Telegraph. That is much less than during the 1970s energy crises, when Western economies were more “oil intensive” than they are today. These price rises, therefore, don’t yet represent a major inflationary risk. Indeed, given weak global oil demand and rising supply, “over the next year the likelihood is that oil prices will soften”.

This article was first published in MoneyWeek's magazine. Enjoy exclusive early access to news, opinion and analysis from our team of financial experts with a MoneyWeek subscription.