An oversupply of oil has kept prices under US$80 a barrel, while the risk premium has already been priced in following the initial exchange of fire between Israel and Iran earlier this month, say Schroders’ senior economist George Brown and fund manager Malcolm Melville.
This would explain the markets’ “muted” reaction to the US strikes on Iran over the weekend, with the oil price falling back after an initial surge beyond US$81 ($103.76) a barrel.
The global economy currently enjoys a healthy oil surplus, write Brown and Melville in a June 24 note. “This helps keep prices in the mid- to low-US$70s, a historically moderate range. Despite the events of recent days, there has not yet been any significant disruption in oil flows from the region.”
Furthermore, Schroders’ calculations suggest that today’s oil price already includes a 20% “risk premium”, which takes into account possible future disruption. “With no short-term supply disruption and this additional risk already priced in, the market remains relatively stable for now,” say the analysts.
Further risk ‘overstated’
Brown and Melville believe concerns over the strategically important Strait of Hormuz being shut “may be overstated”.
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About 20 million barrels of oil, or a fifth of daily global production, flow through the Strait every day.
The Strait of Hormuz is not owned by a single country; Iran controls its northern side. Pundits have stated that Iran could “close” the Strait of Hormuz, blocking the sea passage critical to global oil transit.
However, the Strait is a “comparatively wide channel” of international waters and cannot, in practice, be “closed”, say the analysts.
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More importantly, while Iran targeting shipping remains a theoretical risk, much of the oil passing through the Strait originates from Iran’s neighbours, say Schroders’ analysts.
Schroders estimates for June
“Disrupting the Strait of Hormuz would require aggressive action against international shipping, risking further isolation for Iran and the potential to draw other parties into wider conflict due to breaches of international maritime law,” they add.
US$100 price level
Brown and Melville believe oil prices will need to top US$100 for energy inflation to rise significantly. “As we have pointed out before, the relationship between oil prices and inflation suggests that every 10% rise in oil prices adds just 0.1% to wider inflation.”
Since Israel’s attack on Iran on June 13, Brent crude oil price has jumped 10%. If it settles at this level, it implies that G7 energy inflation will be a little over 5% over the next year, according to Schroders. “This is not likely to lead to broader inflation pressure.”
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Historically, a material inflationary threat typically only emerges when oil prices rise by 50% or more, say Brown and Melville. “This would require Brent prices to move above US$100 per barrel, which would need to happen before we see a pronounced impact on energy inflation rates.”
Charts: Schroders
