Do rising oil prices risk disruptions to global trade?

The conflict in the Middle East is heightening concerns around oil price hikes. But what does this mean for global trade and will some sectors be more vulnerable to potential disruption than others?

The price of global oil benchmark Brent crude has risen by around 6% in early October, as the ripple effects of the conflict in the Middle East impact the market. The conflict is geographically limited, at least for now. But there are worries that an escalation could draw in the region’s major oil-producing nations, as well as endangering major oil trade routes.

That could limit global oil supply just as a substantial increase in demand is predicted, pushing prices much higher. The International Energy Agency expects oil demand to increase by 2.2 million barrels per day (mb/d), reaching 102.2 mb/d in 2023 and outstripping supply in the second half of the year.

The World Bank has recently warned that a serious escalation of the conflict could cause oil prices to soar to more than USD 150 a barrel, from around USD 85-USD 90 today. The knock-on effect of that scenario would likely be another serious hike to fuel and food inflation and potential delays to the interest rate cuts that most economists are expecting in 2024.

Oil prices are volatile 

That’s a worst-case scenario and we are not there yet. At the moment, prices remain well below their mid-2022 peak, when Brent crude hit a high of USD 115 a barrel. Futures markets currently suggest an average of USD 80.5 a barrel for 2023 as a whole, down from an average of USD 96.4 in 2022.

But crude oil prices have been volatile in the last two years, leading to significant and erratic fluctuations in fuel and food costs. Oil production responds quickly and sometimes dramatically to geopolitical tensions and government decisions. The price of Brent crude was already rising before the current Middle East conflict began. Prices rose by 4.4% in the summer, as OPEC+ (the Organisation of the Petroleum Exporting Countries plus selected non-members) output cuts of 1.2 million barrels a day, announced in April, kicked in.

Further voluntary cuts by Saudi Arabia and Russia have also fuelled price escalation, despite higher production in the US and the mixed results of Western sanctions on Russian oil, which is now trading above the USD 60 a barrel price cap imposed by the G7.

Oil price impact on a fragile economy 

The global economy is fragile, and a significant upswing in oil prices could hit growth prospects hard. Oil prices have a significant impact on various sectors, including petrochemicals, manufacturing, agriculture, textiles, logistics, and transportation, to name a few. These effects can have severe repercussions, ultimately influencing consumer spending. If businesses decide to pass costs on to consumers, a significant hike in oil prices would exacerbate inflationary pressures, reduce disposable incomes and hit economic growth. If they absorb the costs themselves, they become less profitable and less likely to invest in sustainable growth.

“With profits margins already under so much pressure, the oil prices are adding another layer.  Coupled with shrinking consumption and investments, lower demand will drive fierce competition” says Dimitri Pelckmans, Head of Risk Services Belgium, and Luxemburg.

Rising prices at supermarket tills and petrol pumps could persuade central banks to delay interest rate cuts, or even to raise rates further. That would leave businesses at the mercy of persistently high borrowing costs, dampening the prospects for a sustained global upturn.

Sector impacts 

Rising oil prices are indeed exacerbating the challenge of maintaining the already thin profit margins of businesses. As consumption and investments decline, this reduction in demand is escalating competition within the market. Furthermore, it's essential to recognize that all businesses are influenced to some extent by the effects of rising oil prices, often in unexpected ways. For instance, high inflation generates economic uncertainty, which, in turn, affects the financial stability of buyers. This situation necessitates more precise trade credit risk assessments and management to navigate the changing landscape effectively. This complex scenario is currently unfolding across sectors.

But some sectors are more seriously affected than others. Here are three:

Food

The food industry relies on oil from farm to factory to table, for heating greenhouses, fuelling machinery and powering supermarket fridges. The global food market relies on sea, air and road transport fuelled by refined oil. According to the International Monetary Fund, a 1% increase in oil prices increases food commodity prices by 0.2%. Food is often a low margin business, and many producers and retailers would have little option but to pass increased energy costs to consumers in higher prices.

Dimitri Pelckmans says: “Elevated and sustained oil prices will inevitably lead to increased food costs. Should a significant oil price shock occur, it would further escalate the already heightened food price inflation.”

Manufacturing 

As oil prices rise, manufacturers face a squeeze at both ends. Production and transport costs rise, and consumer spending falls. “Another example of a sector under severe pressure due to oil price hikes is the textile industry – adds Dimitri. The textile sector experiences a broad-ranging impact from increases in oil prices, influencing factors like costs, competitive dynamics, pricing strategies, and consumer demand.”

At the same time, borrowing for investment in extra capacity or increased efficiency is expensive while interest rates remain high. Any delay in rate cuts caused by spiralling oil prices undermines manufacturers’ current productivity and strategies for future growth.

Logistics 

Logistics and transport are on the frontline of oil price hikes. Not only do fuel prices rise, but they also become more unpredictable, which significantly impacts the petrochemical sector. The extent to which oil price changes impact fuel prices differs from country to country, as governments seek to protect consumers and businesses in different ways. They may tighten regulation, lower taxes or freeze prices. On the other hand, they may do nothing. The size, magnitude and duration of these interventions can be difficult to predict, leading to further uncertainty around fuel costs and a more complicated picture for international logistics and transport operations.  

“Escalating oil prices have a profound impact on the logistics industry – concludes Dimitri - driving up operational costs and challenging supply chain efficiency. These effects can ripple through the entire supply chain, ultimately influencing consumers' experiences and costs. Furthermore, it is worth noting that the significant changes in the gas market, brought about by the transition to Liquefied Natural Gas (LNG), have introduced a new level of instability similar to the behaviour observed in the oil market.

This further complicates the logistics landscape, making it essential for the industry to navigate these volatile energy markets effectively to ensure the smooth functioning of supply chains and mitigate cost pressures on both businesses and consumers.”

Uncertainty abounds 

At the moment, we believe the expected loosening of monetary policy in 2024 is still likely. But it may become less certain if the current conflict spreads.

Simulations conducted by Oxford Economics show that if supply factors pushed the oil price to $95 per barrel through to the end of next year, this would add around 0.4ppts to the baseline forecast for world CPI inflation in 2024. A sharper rise in the oil price to $110 would raise world inflation by 0.9ppts to 5.1% on average next year, only a little below this year's expected 6.1% increase.

“In both scenarios, the modelling also suggests that the impact on core inflation next year would be small,” adds Theo. “Weaker GDP growth would also lessen underlying inflationary pressures further out, so there would be no substantive change to the baseline path for policy rates in the US or Europe.”

In summary, oil price peaks of around USD 90 per barrel wouldn’t be enough to prompt the broad and substantive shift in prices and wages that might trigger policymakers to hold rates higher for longer. However, if oil prices rise beyond USD 110 per barrel or more, and stay there for the foreseeable future, the European Central Bank (ECB) and Federal Reserve could be tempted to push back rate cuts further into the second half of 2024.

At present, however, nothing is certain. The eyes of the world remain fixed on the Middle East, in the hope that a terrible but geographically limited conflict is contained and quickly resolved.