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Oil prices: How the Israel-Iran conflict could affect energy costs Oil prices: How the attacks on Iran could affect energy costs
(8 days later)
Israel's strikes on Iran, and Iran's response, initially caused a shudder on global financial markets. The recent conflict in the Middle East has led to sharp swings in the oil price.
The price of oil in particular surged, but after a weekend of missile and drone strikes between the two countries the cost of crude has fallen back. The price of Brent crude, the global benchmark for oil, hit a five-month high of $81.40 at one point after the US bombed nuclear sites in Iran.
Nevertheless, oil prices are $10 higher than they were a month ago and there are renewed fears increased energy costs could make everything - from petrol and food to holidays - more expensive around the world, including in the UK. But news of a ceasefire has helped the price to fall back to about $69 a barrel.
That is what happened after Russia invaded Ukraine three years ago, affecting people's lives around the globe. The oil price is closely-watched as it can far-reaching consequences for countries across the world, including the UK.
How much have oil prices risen? Higher energy costs can make many goods more expensive, as seen following Russia's invasion of Ukraine three years ago.
The attacks prompted an instant reaction on the markets. The conflict had raised fears that Iran could decide to block traffic going through the Strait of Hormuz, one of the world's most important oil shipping routes.
Brent Crude - the main international benchmark - rose to over $78 a barrel on Friday. Since then, it has fallen back to about $74.50, but it is still $10 higher than it was this time last month. Why is the Strait of Hormuz so important?
The price of oil rises and falls all the time in response to big geopolitical events, and the state of the global economy, so it is not a surprise to see oil prices reacting to the Israel-Iran conflict. The Strait of Hormuz is a channel between Iran and the northernmost tip of Oman, linking the Persian Gulf with the Arabian Sea. At its narrowest point it is just 33km (20 miles) across – about the same width as the English Channel.
However, the price is far below where it was a year earlier. It is also well below the peaks seen in 2022 following Russia's invasion of Ukraine, when it spiked to nearly $130 a barrel. It is one of the world's most important shipping routes. About 20% of global oil and gas flows through this narrow shipping lane.
So will petrol and other prices go up? On any given day, about a fifth of the world's oil and gas, worth $600bn, passes through it, from Gulf states such as Iraq, Kuwait, Saudi Arabia, the United Arab Emirates, Qatar and Iran itself.
When the wholesale oil price goes up, many people notice it first when it leads to higher petrol prices. On Sunday night, Iran's Press TV reported that the country's parliament had approved a measure to close the channel, a move which would have profound consequences for global shipping and international trade if it happens.
But more expensive energy also feeds through to higher prices for almost everything, from farming to manufacturing. Read more on why the Strait of Hormuz matters
When it comes to food, higher energy costs can lead to higher prices on the shelf in many ways. It can make it more expensive to run farm machinery, to transport produce, and to process and package food. US asks China to stop Iran from closing Strait of Hormuz
However, that will only happen if energy prices stay high for a sustained period. Why haven't oil prices reacted more?
Even with petrol and diesel, rising crude prices only have a limited impact. Analysts at Goldman Sachs have suggested a worst-case scenario could lead to the supply of oil through the Strait of Hormuz halving for a month and dropping 10% for another 11 months. This would lead to the price of Brent crude peaking at $110 per barrel, they say.
"A rough rule of thumb is a $10 rise in the oil price would add about 7p to the price at the pump," says David Oxley at Capital Economics. For now, though, traders are content that the risk of Iran actually closing the Strait of Hormuz is limited.
However, this is not just an oil story, he cautions. "It would be difficult for Iran to fully close the Strait of Hormuz for an extended period due to the position of the US Navy's Fifth Fleet in Bahrain," wrote Helima Croft, head of global commodity strategy at RBC Capital Markets.
Many will remember the shock to prices that followed the beginning of the Ukraine conflict. That was in large part a response to higher gas prices, Mr Oxley says. "I think it's pretty unlikely," adds Simon French, chief economist at Panmure Liberum.
Many of us heat our homes with gas, and in the UK electricity prices are also set in relation to the gas price. That's partly because Iran may come under pressure from its allies to keep the channel open.
Gas prices have also risen after last week's attacks. But the impact will feed through to households only slowly, if at all, says Mr Oxley, given the way the market works, including the role of the regulator, in capping prices. "China's role in all this is pretty significant, because they can decide whether they want to provide financial support and military support to Iran, and they won't do that if they think that a key provider of their oil is going to be disrupted," says Mr French.
Could oil prices rise higher? Follow live: Middle East tensions latest
The current situation is "very significant and concerning", says Richard Bronze head of geopolitics at consultancy and research firm Energy Aspects. InDepth: An unprecedented moment - but what the US and Iran do next could be even more momentous
But that doesn't mean it will turn out to have as big an impact as the Ukraine conflict, or even previous troubles in the Middle East. Decoy flights and seven B-2 stealth bombers - how US says it hit Iran's nuclear sites
The main questions are how long Israel and Iran remain locked in this conflict, whether other countries in the region are drawn in, and whether the US steps in to de-escalate the situation. Chris Mason: UK's position on Iran is clear but will the US listen?
Above all it depends on whether we see actual disruption to shipping in the Strait of Hormuz, the waterway off Iran's southern coast, which is the route to global markets for about a fifth of the world's oil production. Watch: How successful have the US strikes on Iran been?
"It's a narrow choke point so it is a significant weak spot for global oil markets," says Mr Bronze. Will this affect energy bills and petrol prices?
That remains an unlikely scenario, but Iran has threatened it in the past and it is now marginally more likely than it was just a few days ago. And that outside risk is part of what is driving up prices, he says. Any conflict in the Middle East is bound to affect global energy prices, which has a knock-on effect on bills and petrol prices.
Without interruption to shipping, oil prices are not likely to stay high. In the aftermath of Trump's so-called "Liberation Day" tariffs at the beginning of April, Brent crude prices dropped as low as $60.
In 2022, following Russia's invasion of Ukraine, there was growing demand for energy as the global economy reopened after Covid. But the conflict in the Middle East has "unwound all the impact of tariffs on energy markets", says Mr French, pushing prices back to where they were at the end of March.
Now the global economy is facing tougher times, and oil producers from Saudi Arabia to Brazil have the capacity to increase oil supply which would help lower prices. One of the biggest concerns for British households would be if the price of liquefied natural gas (LNG) rose. Although the UK procures most of its LNG from Norway, any blockade in the Strait of Hormuz would push up prices around the world.
What does it mean for the global economy? Craig Lowrey, principal consultant at Cornwall Insights, says household bills are safe from any volatility for now, because the energy regulator, Ofgem, has already announced the energy price cap for July until September. But if this conflict continues past September, household bills could rise.
The scale of any energy price rises, and the wider impact, will depend on the magnitude of what comes next in the conflict between Israel and Iran. And businesses, which aren't subject to the cap, could be hit more immediately. "That would certainly be a challenge," he says.
But it does have the potential to be "a bad shock for the global economy at a bad time" says Mohammed El-Erian, chief economic adviser at asset manager Allianz. Consumers could see a more immediate effect in prices at petrol pumps . "There's a lag of three or four weeks as the oil goes through the refining system," says Mr French.
"Whichever way you look at it, it's negative short-term, it's negative longer-term. If Brent does reach $100, "you're staring down the barrel of 155p, 160p at the pump, which will be quite a shock", he says.
"It's another shock to the stability of the US-led global economic order at a time when there were already a lot of questions." Prices at the pump have already begun to creep up. "The average price of a litre of petrol has increased by 1.5p to 133.5p in the last week while diesel has gone up by 2p to 140p," says Simon Williams, head of policy at the RAC.
Capital Economics calculates that if oil prices were to return to over $100 a barrel that could add 1% to inflation in advanced economies, making life difficult for central banks hoping to bring down interest rates. However, he adds prices were a "long way off" those seen in spring 2022 when Russia had just invaded Ukraine.
But that's not the most likely scenario in David Oxley's view. What does this mean for global economies?
"Instability in the Middle East is nothing new, we've seen numerous bouts of it," he says. "In a week's time it might have all blown over." Any sustained rise in oil prices will cause the prices of everyday goods to rise in economies around the world as the cost of manufacturing and transporting them increases, which in turn will push up inflation.
In mid-June, Capital Economics suggested that if oil prices were to rise to over $100 a barrel, that could add 1% to inflation in advanced economies, making life difficult for central banks hoping to bring down interest rates.
"In the US, the Federal Reserve has already signalled a pause in its easing cycle, citing 'geopolitical risks to price stability'," says Garry White, chief investment commentator at Charles Stanley Group.
"In Europe, inflation expectations have ticked upward for the first time in months."
Developing economies in Asia and Africa are particularly vulnerable, he adds. "Many rely heavily on Middle Eastern oil and gas imports and lack the financial buffers to absorb sudden price spikes."
If inflation rises, the Bank of England could also slow down, or even halt, its programme of interest rate cuts. Mr French predicts that, if prices rise to $110 a barrel, UK inflation could rise above 4% from its current 3.4%.
"That becomes a very difficult environment [for the Bank of England] to keep cutting interest rates like they have been doing," he says.