Who Blinks First?

Oil is back above $100 a barrel. That’s not good. Energy feeds into almost everything: transport, manufacturing, food, aviation and household spending. What’s worse is that we know what happens when prices stay this high for too long. They act like a tax on the global economy, pushing inflation higher while simultaneously taking money out of consumers’ pockets.

There are essentially three ways this adjusts. The first is more supply. Higher prices encourage producers elsewhere to pump more oil, governments can release strategic reserves, and previously uneconomic production becomes viable. The problem is that meaningful new supply takes time, while the world is paying higher prices today.

The second is lower demand. This is where central banks and higher interest rates come in. Consumers drive less, airlines cut capacity, companies postpone investment and economies slow. Markets have always been very effective at destroying demand when prices rise far enough. Unfortunately, the price to pay is often a recession.

Which leaves politics. In the US, $100 oil makes lowering the cost of living much harder to deliver as the midterm elections approach. In Iran, the blockade and damage to infrastructure are creating fuel shortages and increasing pressure on an already struggling population. Eventually something has to give. Producers pump more, consumers buy less, or politicians decide that the economic cost is too high. Ultimately, high oil prices will cure high oil prices. The question is who is forced to blink first.