What do rising oil prices mean for you?

The price of oil is continuing to rise in the wake of the war in Iran – the global supply of oil is still heavily constrained due to the Strait of Hormuz, a critical waterway for transporting oil, having been shut for over a month.

Combined US-Israeli air strikes on Iran on 28 February, followed by the killing of the country’s supreme leader Ayatollah Ali Khamenei, led to an outbreak of wider hostilities throughout the region.

While some had hoped the war would last just a few weeks, that now seems less likely as the conflict enters its second month.

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Much of the world’s supply of oil is sourced from the Middle East, and increased risk has led to a hike in global oil prices.

The price of Brent crude oil, a global benchmark for the price of oil, reached over $115 a barrel on 30 March. That is a rise of more than 64% compared to the approximately $70 it cost on 27 February, before the conflict.

Higher oil prices can very quickly make their mark on your finances, even if the conflict is happening halfway around the world. That is because oil is used in the manufacturing process of many everyday items.

A rise in oil prices often means a hike in the price of petrol and diesel, but it can also lead to an increase in the price of products as varied as backpacks and pencils.

We look at why oil prices are rising and what it could mean for UK inflation, interest rates and prices at the pump.

How the conflict in the Middle East has impacted oil prices

Since the war began on 28 February, the price of oil has been creeping up as hostilities continued through March.

Oil prices have jumped and dipped as new developments and speculation of peace talks emerged, but have consistently remained north of their pre-war level.

There are two key reasons that the price of oil has increased.

The first is that the conflict is bad for business. A great deal of the world’s oil is harvested from countries near Iran and war in the region means it becomes much less safe and much more risky to continue normal operations.

The second is that Iran has closed the Strait of Hormuz, a narrow sea lane between Iran and Oman, through which around one fifth of the world’s oil is transported.

This has hit the global oil supply, as almost all the ships transporting oil through the strait have been left stranded in the Persian Gulf.

While the oil supply has been reduced, the demand for it has remained the same, meaning the price of oil has increased.

How does the oil price affect the price of petrol?

One of the most direct consequences of higher oil prices is the impact on what you pay at the pump, given that oil is the key ingredient in petrol and diesel.

Since the war began, the average price of a litre of petrol has increased by 19.2p, while diesel has increased by 38.8p, according to RAC Fuel Watch.

That is a significant increase, but is not quite as much as you may expect with oil prices jumping by around 64%.

That is because more than half the price of a litre of petrol is tax. Fuel duty accounts for around two fifths of what you pay at the pump, while VAT accounts for a further 17%.

One surprising benefit of being taxed so heavily on our petrol is that pump prices aren’t quite as sensitive to oil price increases as they are in other countries.

The price of the oil itself only accounts for 26-29% of the price of a litre of petrol in the UK. In theory, that means a 10% rise in global oil prices might increase the price of petrol by up to 3% (though it isn’t necessarily that straightforward in reality).

Could higher oil prices increase inflation?

You don’t just feel the impact of higher oil prices at the pump. Any process that consumes oil or energy as an input will become more expensive, likely leading to increased inflation.

Many economists are warning that the war in Iran poses a significant threat to the UK economy as they project inflation to rise.

The Bank of England said it expects inflation to reach 3.5% in the third quarter of the year due to the war, a projection that is echoed by Deutsche Bank.

Much of this increase will come from rising energy prices. These increased energy costs will not only affect households, but also businesses. Firms will likely hike their prices to make up for increased energy costs.

The war is also constraining the supply of other vital goods like fertiliser, which could also lead to higher prices.

With inflation expected to rise again, most economists agree that it will be quite some time before we see the Bank of England cutting interest rates again.

Could higher oil prices increase your energy bill?

The conflict is expected to have a significant impact on the next Ofgem energy price cap.

Ofgem determines the price cap by working out the average wholesale price of energy in a three month period, and the observation period for the July price cap will include the war and its consequences on energy prices.

As such, the July price cap is expected to reach £1,972 per year – an increase of 20%, or around £331 per year, when compared to April’s level, according to energy consultancy Cornwall Insight.

Read more about the future of household electricity and gas bills in our energy price forecast.