Where Are Oil Prices Heading?

The security environment for global energy has been flipped on its head because drones and real-time tracking allow even agrarian forces to shut down critical shipping channels and strike deep into Saudi Arabia.

China is the most exposed major economy because it depends on Middle Eastern oil but relies on the U.S. to protect the shipping, a paradox China now wants to change. Chinese transport fuel demand will drop in 2026 for the first time since 2001, driven by an exponential increase in electric vehicle uptake far in excess of what most analysts thought.

The U.S. declined to help Saudi Arabia after the 2019 Abqaiq attack, triggering a dramatic response in Riyadh regarding the unwritten Carter Doctrine guarantee. The U.S. is stretched at the moment, and this conflict has exposed vulnerabilities of conventional militaries like the U.S. in their ability to take on nations like Iran.

A City analyst report forecasting the Strait of Hormuz will reopen in Q4 supported by regional diplomacy is likely wrong because giving a date for an oil forecast breaks a fundamental rule.

For much of his career he heard the Strait of Hormuz was a red herring and the U.S. would always protect it, but that assumption has proven false.

Inflation is hovering around 3.5% and would likely be around 2.5% without the war, with rising prices concentrated in gas, diesel, airfare, and heating oil. The impact is highly targeted, creating a disaster for drivers and agricultural states while barely affecting subway commuters in cities like New York.

Airlines can pass on higher fuel costs because consumers are financially healthy, with rising wages and higher stock portfolios sustaining travel demand. Energy inflation has not yet seeped into core inflation categories like food or packaging, which is great news for the Fed.

Oil executives are making a lot of money but are concerned because higher prices tend to slow the economy down.

Mechanisms that helped mitigate price and supply risk have largely played out, leaving few options to cap prices.

The oil and gas industry is desperate to avoid a diesel export ban, which the administration has repeatedly rejected but recently said all options are on the table. A diesel export ban could cause refiners to produce less overall, raising U.S. prices and damaging reliability for allies.

Price caps are a flawed solution because they don't fix supply shortages or change behavior, and historically lead to a surge of inflation once lifted. Giving people cash to offset energy costs doesn't fix inflation and can make it worse, which is why economists dislike both options.

Raising interest rates is the most straightforward way to deal with energy inflation turning into a broader problem by reducing the money supply available to businesses.

If energy inflation seeps into other categories or surveys show rising inflation worry, the Fed will likely be more aggressive in raising rates.