Oil prices set to rise as Middle East tensions worsen, adding to cost-of-living crisis

Iran’s missile attack on Israel has caused global oil prices to spike this week amid growing fears a retaliation could put the global oil supply at risk.

Almost one year ago to the day, I wrote how an isolated conflict between Israel and Hamas would likely not cause a sustained increase in oil prices.

This was because neither Gaza nor Israel produces much oil. But this time, it’s different.

What’s changed

Iran is a major player in the global market for crude oil. The latest data from the US Energy Information Administration lists Iran as the ninth largest oil producer, accounting for about 4% of world oil production last year.

While this may sound like a small share, research has shown events like Iran’s nationalisation of the BP-owned Anglo-Iranian Oil Company in the early 1950s, the Iranian revolution in the late 1970s, and Iran-Iraq war of the early 1980s, all caused crude oil price to rise.

The extent to which Israel responds to the latest escalation could therefore have a genuine impact on oil prices in coming days.

A complex world

Of course, the difficulty in assessing any situation is such events do not happen in a vacuum.

While recent events could spark a reduction in global oil supply, putting upward pressure on the price, other factors, such as weak oil demand due to slowing state of the global economy, and record high US production of crude oil, have pushed prices down throughout the year.

Still, the current tensions can only add to the already tightening oil market following Libya’s recent shutdown of the El-Feel oil field in August this year.

There’s no doubt these events will be a top priority at the next panel meeting of the Organisation of the Petroleum Exporting Countries Plus, which committed to achieving and sustaining a stable oil market earlier this year.

What does this mean for Australia?

Last week, the Reserve Bank of Australia said inflation is still above target, and returning to target is their number one priority, despite a highly uncertain economic outlook.

There’s no doubt these events only add to the uncertainty of that outlook, and any oil price surge can only add to the current cost of living crisis faced by Australians.

Let’s be clear. While Australia does not import any crude oil from Iran, we are heavily reliant on our trading partners for the resource. According to the most recent data from the Department of Climate Change, Energy, the Environment and Water, about two thirds of our oil supply currently comes from South Korea, Singapore, Malaysia, and India.

This reliance on foreign oil makes us especially exposed to rising oil prices.

The main channel through which higher oil prices could impact inflation is fuel prices. It is well understood that higher oil prices are associated with higher fuel prices.

Research by the Australia Institute, found Australia currently imports about 91% of fuel consumption. The transportation sector accounts more than three quarters of total fuel consumption, with road transport making up more than half of that number.

The Australian Competition and Consumer Commission is undoubtedly closely monitoring prices as it follows international events.

However, the silver lining is research suggests the likely flow on effects of oil prices on inflation in Australia is relatively smaller than some might expect.

A major reason for this is Australia’s electricity generation mix is predominantly comprised of coal, natural gas, and renewables. This is in contrast to countries like the United States, where oil and related products are the main contributor to the energy mix.

To give a rough number, the research suggests a sustained increase in the oil price by 10% would translate into Australia’s inflation rate being about 0.6 percentage points higher.

This means the Reserve Bank will also be closely monitoring the oil price over the next few weeks ahead of next month’s cash rate meeting.

Jamie Cross does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.