The black stuff is back in the doldrums. Oil prices have cratered to levels not seen since before the Iran strike rattled markets earlier this year. Brent crude, the global benchmark, slumped to $68.40 a barrel overnight, a 12% drop from the post-strike peak of $78. That’s a market signal that screams one thing: the risk premium is evaporating faster than a puddle on a London summer day.
For UK motorists, this is a rare moment of respite at the pumps. The AA reports that average petrol prices have fallen 4p to 136.5p per litre since the peak, with diesel sliding to 140.2p. That’s still a painful premium over the pre-conflict levels of 130p, but the trend is your friend. ‘We’re seeing the fastest weekly decline in pump prices since the 2020 lockdown,’ said Luke Bosdet, the AA’s fuel price spokesman. ‘The oil markets are pricing in a return to normality.’
But what does ‘normal’ mean in this febrile geopolitical environment? The Iran strike, which sent Brent above $75 temporarily, was a classic ‘buy the rumour, sell the fact’ moment. The market had priced in a major disruption to supply through the Strait of Hormuz, but the subsequent lack of escalation from Tehran has drained the froth. ‘The market was expecting a supply shock that never materialised,’ noted Caroline Bain, chief economist at Capital Economics. ‘Now it’s back to worrying about demand, not supply.’
Demand concerns are indeed the elephant in the room. The International Energy Agency (IEA) cut its oil demand growth forecast for this year to 1.2 million barrels per day, down from 1.3 million, citing a ‘sluggish’ global economy. That’s code for the slowdown in China, where industrial output is sputtering, and the eurozone, which is teetering on recession. ‘The demand picture is soft,’ said Bain. ‘Even without the Iran noise, oil would be struggling to hold above $70.’
Meanwhile, the supply side is abundant. US shale output continues to hum along at record levels of 13.4 million barrels per day, and OPEC+ is sitting on 6 million barrels per day of spare capacity. The cartel’s decision to maintain its supply cuts until June is the only thing preventing a freefall. But even that looks fragile: reports suggest internal tensions are rising, with Iraq and the UAE chafing at their quotas. If the discipline breaks, we could see a stampede to the exit.
For the UK economy, this oil price collapse is a double-edged sword. Lower pump prices boost consumer spending power, which is desperately needed given the persistent cost of living crisis. But it also puts pressure on the government’s fiscal arithmetic, since North Sea oil revenues have been a key pillar of the Treasury’s forecasts. The Office for Budget Responsibility assumed an average Brent price of $75 for this year, making the current $68 a source of anxiety in Whitehall. ‘Every $1 drop in oil prices reduces North Sea revenues by about £80 million over the next two years,’ said Robert Wood, an economist at Bank of America. ‘That’s a hit the Chancellor can ill afford.’
And let’s not forget the pound’s vulnerability. Lower oil prices typically drag on the UK’s terms of trade, which can weigh on sterling. The pound has already shed 2 cents against the dollar since the oil rout began, touching $1.24. That makes imported goods, including food, more expensive, offsetting some of the pump relief for motorists. ‘It’s a zero-sum game,’ said Kit Juckes, a currency strategist at Societe Generale. ‘Cheaper fuel means cheaper exports for our oil sector, and that’s a drag on the currency.’
The broader market reaction has been telling. Bond yields are slipping, with the 10-year gilt yield falling 8 basis points to 3.82%, as traders price in lower inflation expectations. That’s good news for the Bank of England, which has been battling to bring inflation back to 2%. But it also raises the spectre of deflation if the oil rout gathers pace. ‘If oil stays below $70, we could see headline inflation dip below 2% by autumn,’ said Paul Dales, chief UK economist at Capital Economics. ‘That would be a win for the Bank, but it also means they might have to cut rates sooner than they’d like to stimulate growth.’
So what’s the bottom line? Oil has overshot to the downside, driven by demand fear and a disappearing geopolitical risk premium. But with OPEC+ holding its nerve and the US economy still humming, there’s a floor somewhere around $65. For UK motorists, enjoy the relief while it lasts. The markets are fickle, and the next shock is never far away.
