The market has just been hit with a reality check. Oil prices have plummeted after reports emerged of a breakthrough in US-Iran negotiations, a development that threatens to dismantle the geopolitical risk premium that has kept crude elevated for months. Brent crude plunged by over 5% in early trading, falling below $75 a barrel, while West Texas Intermediate dropped to around $70. This is the kind of move that reminds everyone in the City that speculative froth can evaporate faster than a pint in a pub at lunchtime.
For months, the oil market has been sustained by two factors: genuine supply constraints from OPEC+ cuts and a hefty dose of fear over potential supply disruptions from the Middle East. The latter has been a particularly lucrative trade for hedge funds piling into long positions. But now, with news that US and Iranian diplomats have made significant progress on a new framework for nuclear talks, the market is repricing that risk. If sanctions on Iranian oil are lifted, we could see upwards of 1 million barrels per day flood back onto the global market. That is not a trivial amount, especially with demand growth slowing in China and Europe.
The immediate question is whether this is a negotiating tactic or a genuine breakthrough. I have seen enough phoney peace deals to be sceptical. But the market does not care about nuance. It trades on headlines. And this headline is a monster. The volatility index for oil options has spiked, suggesting traders are bracing for more swings. For the UK economy, this is a mixed blessing. Lower oil prices will ease inflationary pressures in the near term, taking some heat off the Bank of England. Petrol at the pump could fall below 130p a litre, a welcome relief for hard-pressed consumers. But for the Treasury, lower oil prices mean lower revenues from the North Sea windfall tax. That is the kind of fiscal twist that keeps Chancellors awake at night.
In the broader context, this crash also exposes the fragility of the recent equity rally. If oil prices continue to slide, it could signal weakening global demand, which would hit the FTSE 100 hard, given its heavy weighting in energy and mining stocks. The gilt market has already priced in a dovish turn from the Bank, but if oil stays lower, we might see the 10-year yield drift below 4%. That would be a boon for mortgage holders but a headache for pension funds.
My take: do not get lulled into a false sense of stability. Iran talks have a history of collapsing. I would not be surprised if we see a sharp reversal if the negotiations hit a snag. For now, though, the bulls are running for cover, and the smart money is watching the next round of US inventory data. If storage builds, the sell-off could accelerate. Keep your eye on the fiscal ball, because lower oil prices are not unequivocally good news for a nation that is still addicted to hydrocarbon revenues.
