When oil opened for trading Sunday evening, the price of crude jumped over 12% as traders tried to digest the news of the attacks on Saudi Arabia’s production facilities on Saturday. That jump was one of the biggest one-day jumps in history and the largest in over a decade.
The attack was a huge surprise and the huge jump in oil was shocking, but the effects could mean a lot more to the world economy in the coming months.
First, from a technical perspective, the huge move allowed oil to move above a downward sloped trend line that connected the highs from the past year. It also moved oil above the long-term moving averages—the 52-week and the 104-week.
This doesn’t really mean all that much to consumers, but it means an awful lot to traders as these trend lines could serve as support now and we could be looking at a new upward trend in oil for the coming year. With the world concerned about an economic slowdown turning in to a recession, this is not what consumers wanted to hear.
One big problem from rising oil prices is that it could create cost-push inflation. We sometimes hear the terms “good inflation” and “bad inflation”. Demand-pull inflation is considered good as long as it is modest and reflects a growing economy. Prices increase because there is greater demand for goods and services and therefore it helps the economy grow. Cost-push inflation is considered bad inflation because it causes prices to rise due to supply being cut. It doesn’t lead to economic growth and can, in fact, lead to economic contraction as money that would have been spent on other goods and services have to be redirected to energy expenses.
When the attack became known and the apparent jump in oil prices was pretty apparent, President Trump immediately tweeted that the Fed needed to cut rates.
“The United States, because of the Federal Reserve, is paying a MUCH higher Interest Rate than other competing countries. They can’t believe how lucky they are that Jay Powell & the Fed don’t have a clue. And now, on top of it all, the Oil hit. Big Interest Rate Drop, Stimulus!”
Unfortunately for President Trump, to battle inflation, regardless if it is cost-push or demand-pull, the suggested monetary policy is to raise interest rates. Obviously, the Fed isn’t going to panic and raise rates right now, but I also don’t think they are going to rush in and make major rate cuts.
The Fed started a two-day meeting on Tuesday and the rate decision will be announced on Wednesday. At this time, the Fed Fund futures are priced such that a 25-basis point cut is considered a 58.8% probability. Just last week that probability was at 80% and two weeks ago it was at 99%. That’s how much things have changed in the last two weeks.
Getting back to the oil discussion, President Trump has already approved the release of oil in the Strategic Petroleum Reserve (SPR). If there is a release and how much oil will be released has yet to be determined, but this type of situation is exactly why we have the SPR. The SPR was established late in 1975 after an oil embargo by OPEC crippled the United States economy. Over the years the SPR has been tapped in to on several occasions.
As of the September 13 report, the U.S. had approximately 645 million barrels in the reserve, giving it room to push oil into the world supply for a considerable amount of time. Such a release would certainly help stabilize prices as the geopolitical landscape is certain to heat up even more in the coming weeks.
Even though a Yemen-based terrorist network has taken credit for the drone strikes, the U.S. has claimed that the evidence points to Iran being behind the attacks. Regardless of what information comes out in the next few days and weeks, the tensions in the Middle East are heightened and will likely remain that way for the foreseeable future.
As long as these tensions are heightened, oil prices are likely to stay elevated. I would think the price will remain above the trend line I showed on the chart and above the 52-week moving average at the very least. Even if Saudi Arabia is able to get the production facilities back online quickly, the tensions alone will likely keep oil prices at a more volatile state.
Personally, I think the spike in oil prices was a bit of an overreaction. Sure I understand that a spike was bound to occur, but a 15% jump seems a little excessive given that we don’t know how quickly production will be restored or if production will be increased at other facilities, etc. Between these factors and the SPR of the U.S., the supply disruption should be minimalized. My bigger concern is the potential for a long-term shift in oil prices and the heightened tensions in the region.