High oil price not the albatross it once was for US economy

The global oil price is trading at its highest price in more than four years, and it seems that a number of additional price spikes are on the way, as instability and conflict affect several major oil producers.

What has happened? The global oil market has tightened, allowing geopolitical risks to carry a super-sized impact. Many of these risks are exceptional — such as a potential conflict between Iran and Israel — in their capacity to threaten oil supplies.

Now that the U.S. is the world’s top oil producer, however, higher oil prices would have a mixed impact on the U.S. economy.

{mosads}Understanding the global oil price is a lot simpler than it may appear. Like all prices, the oil price reflects supply and demand. On the demand side, with the uptick in the global economy, demand for oil is increasing and poised to continue to grow for the rest of this year and likely beyond.

On the supply side, a surplus that had been in the market for the past four years has now disappeared as reflected in current oil storage data. The global oil market is now tight, and in this state, geopolitical events that can reduce supplies or inhibit shipping can have an extraordinary impact on the global oil price, at least in the short term. 

Such developments are also abundant now. Topping the list is the current conflict in Syria, which could spread to the Persian/Arab Gulf, the center of global oil production. The close proximity of the militaries of the U.S., Russia, Turkey, Israel, Iran and several non-state actors could lead to direct clashes between these forces.

Several direct confrontations have already taken place, including the downing of a Russian jet by Turkish forces and U.S. attacks on Russian private forces as well as direct and intentional targeting by Iran and Israel of each other’s forces.

There is now credible risk that a direct war between Iran and Israel could occur in Syria, which could spread to Iran itself, and thus the Persian/Arab Gulf region, with clear implications for oil supplies. In the Gulf, tensions are still high between Iran and Saudi Arabia and conflict could flare up.

These two conflicts could also interconnect. In addition, Riyadh and Tehran already have proxies fighting in Yemen, and intensification of conflict in this strategically located country on oil’s main shipping lane poses a potential risk to global oil transit.

Iran is the center of additional geopolitical risk to the global oil price. Demonstrations, while not adequately covered by the media, continue to occur regularly in multiple locations in Iran, including in Khuzestan Province, the center of Iran’s oil production.

In addition, by May 12, the Trump administration must announce whether it will continue to waive nuclear-related sanctions on Iran’s central bank and oil exports or start a process of snapping back these and other powerful economic sanctions on Tehran, thereby taking the U.S. out of the nuclear deal.

If Washington decides to reimpose these sanctions, Tehran also has threatened to withdraw from the deal, opening up additional uncertainty and potential instability. 

Additional sources of risk affecting the oil price have emerged outside the Middle East. Due to a domestic economic and political crisis, Venezuela is producing oil at its lowest rate in 30 years, and Washington is also threatening Caracas with sanctions, which could further limit its production and exports.

The latest round of U.S. sanctions on Russian entities and individuals has also added political risk that affects oil production, including rises in other commodity prices. Angolan oil production is also down.

U.S. oil production has so far not ramped up fast enough to offset the new demand and the increasing production risks. While sufficient U.S. volumes could be produced to close the gap, a variety of bottlenecks have emerged including lack of investor enthusiasm, limited pipeline capacity and shortages in materials and qualified labor.

The oil price will most likely continue to trade in the higher band and a number of temporary price spikes can be anticipated in response to geopolitical developments. In contrast to previous decades and common perceptions, higher oil prices have mixed impact on the U.S. economy now that the U.S. is the world’s top oil producer.

Higher oil prices mean higher gas prices at the pump for U.S. consumers, and with the high American driving season still ahead, gasoline prices are set to increase even more.

At the same time, as a major oil producer, the price rise gives an overall boost to U.S. economic growth, having especially strong impact on economic activity in the oil-producing basins, such as Texas, Oklahoma, North Dakota and Pennsylvania.

It is important for U.S. policymakers to recognize the change that has taken place and that currently higher oil prices signify a mixed impact on the American economy.