Oil and Energy Shocks: How Energy Prices Move the Economy

Oil is traded worldwide, mostly in dollars, and priced off a few benchmark grades. Brent, from the North Sea, is the reference for roughly two-thirds of internationally traded oil. WTI (West Texas Intermediate) is the US benchmark, delivered at Cushing, Oklahoma. They usually trade within a few dollars of each other. When the news says "oil is at $80", it means the price of a barrel (159 litres) in the futures market for the next month.

Natural gas is more regional, because it is harder to ship. Europe's benchmark is the Dutch TTF price; the UK's is the NBP. That is why Europe's 2022 gas crisis barely touched US gas prices.

OPEC+

OPEC, founded in 1960 and led by Saudi Arabia, has worked since 2016 with other producers led by Russia as OPEC+. Together they produce around 40% of the world's oil. When they agree to cut output, prices tend to rise; when they fight for market share, prices can collapse, as in 2014–16 and briefly in 2020.

US shale

Since about 2010, US shale producers have made the US the world's largest oil producer. Shale wells can be drilled quickly when prices are high, which tends to cap rallies over time.

Chokepoints

About a fifth of the world's oil consumption, plus a large share of its liquefied natural gas, passes through the Strait of Hormuz between Iran and Oman. Any threat to shipping there adds a risk premium to the oil price. Other chokepoints include the Suez Canal and the Bab el-Mandeb strait at the mouth of the Red Sea.

• Straight into inflation: petrol, diesel and household energy bills rise within weeks. A rough rule of thumb: each $10 rise in the oil price adds a few tenths of a percentage point to US headline inflation.
• Then into other prices: transport, food (fertiliser and farm fuel) and manufactured goods follow over months.
• Squeezes spending: money spent on energy can't be spent elsewhere, so demand for other goods falls.
• Shifts income: from energy importers to exporters, and from consumers to energy companies.
• Tests the central bank: it can "look through" a one-off jump in prices, but if inflation expectations start to rise it may have to raise rates into a slowdown.

1973 oil embargo

×4

Oil from about $3 to $12 a barrel

2008 peak

$147

WTI in July, then $33 by December

April 2020

−$37

WTI futures briefly below zero

• 1973–74: Arab producers embargoed the US and others; oil quadrupled. Followed by the 1973–75 recession and double-digit inflation.
• 1979–80: the Iranian revolution more than doubled the price again, feeding the inflation Paul Volcker's Fed fought with 20% interest rates.
• 1990: Iraq's invasion of Kuwait doubled the oil price in three months; the US was already slipping into recession.
• 2008: oil hit $147 in July on strong demand from emerging markets, then collapsed to about $33 as the financial crisis hit.
• 2014–16: a supply glut from US shale and an OPEC price war took Brent from about $115 to under $30, causing losses for energy companies and a wave of defaults in high-yield bonds.
• April 2020: lockdowns cut demand so far that storage ran out, and one WTI futures contract briefly traded at minus $37.
• 2022: Russia's invasion of Ukraine sent Brent above $130 and European gas prices to more than ten times normal levels. The UK government capped typical household bills at £2,500 a year.

• Energy shares have tended to rise with the oil price; airlines, chemicals and other heavy energy users have tended to fall.
• Bonds: market measures of expected inflation (breakevens) rise, and yields can rise if markets expect central banks to respond.
• Currencies: exporters' currencies (Canadian dollar, Norwegian krone) have tended to strengthen against importers' (euro, yen).
• Broader shares: a demand-driven rise in oil (a strong global economy) has often coincided with rising shares; a supply-driven spike has more often hurt them.