Four decades of crises have taught us that conflict in the Middle East means two things: higher oil prices, and possible trouble for the U.S. economy.
True to form, crude oil prices jumped more than $4 a barrel last week as Sunni militants captured the Iraqi city of Mosul and threatened to advance toward Baghdad. That will add a few cents a gallon to the price motorists pay for gasoline, fueling familiar worries about the effect on cash-strapped consumers.
So far, however, the problems in Iraq don’t appear to be a big threat to the U.S. economy. Ken Matheny, an economist at Macroeconomic Advisers, says his firm hasn’t changed its forecast based on the events of last week.
“If the impact of what’s going on in Iraq is small and it doesn’t last very long, the impact on our forecast is minimal,” he said. “But that is a very big ‘if.’”
Even a $10-a-barrel increase in oil prices would shave just two- or three-tenths of a percentage point off the U.S. growth rate, Matheny said. “It would be just a little more gradual economic expansion, and a little slower decrease in the unemployment rate,” he explained.
A couple of facts can help put this oil-price spike in perspective. First, prices are just back to where they were last summer, and they didn’t cause any noticeable slowdown then. Second, because U.S. oil production has risen, price increases are less of an economic drag than they used to be.
Still, the fall of Mosul is a reminder that much of the world’s oil comes from unstable places. Iraq is the world’s sixth-biggest oil exporter, and forecasters had been expecting a steady increase in its 3 million barrels of daily production.
“If it goes to the extreme and you shut down Iraqi exports, then we have a real crisis on our hands,” says James Williams, an energy economist with WTRG Economics in London, Ark. He estimates that if the insurgents take Baghdad and move on toward the country’s southern oil region, Brent crude could jump $20 from today’s $112 a barrel. That would add about 50 cents a gallon to gasoline prices.
More likely is a long, bloody conflict that doesn’t cut off oil exports. “I do think these initial fears on oil prices are probably overdone,” says William O’Grady, chief market strategist at Confluence Investment Management in Webster Groves. “If the markets figure out that Baghdad is going to be OK, then oil prices will probably back down a little bit.”
Again, though, there’s that big word “if.” After watching Libya struggle to get production back up after its 2011 civil war, oil traders know that supply disruptions can last a long time.
A big oil-price spike also can affect the world economy in unpredictable ways. “You could get a lot of fear, an increase in uncertainty, and maybe risk spreads widen in financial markets,” Matheny said. “Could you get all that ignited by a flare-up in the Middle East? That would be one channel by which you could get a negative outcome.”
So when you fuel up the jalopy for summer vacation, try to contain your anger about the latest increase in oil prices. It could be a lot worse.