One day, you turn on the television and see news about civil unrest or a terror attack somewhere overseas. Soon after, you notice diesel prices rising, and suddenly, you’re paying significantly more for the fuel that moves your goods to market.
Sometimes the reason for a rise in fuel prices is obvious. An attack that takes out a major pipeline in an oil-producing nation will certainly impact the global supply. Other times, it’s unclear. Why do oil prices start climbing when there are geopolitical events in non-oil-producing countries?
To gain a better understanding of geopolitical events and their effect on the oil market, we spoke with Daniel Cullen, Breakthrough®Fuel’s Vice President of Advisory Services. Cullen explains that even the possibility of geopolitical issues can lead to price hikes.
“Markets operate based on two things that seldom point the same direction,” he says. “That is perception versus reality – or expectations versus what the current data are showing.”
The potential for geopolitics to influence fuel prices comes down to the basic principles of supply and demand.
Geopolitics and the Supply of Oil
Cullen says global events usually cause a change in fuel prices when that occurrence has a certain probability of affecting the amount of oil available around the world.
“Whenever there’s a threat that exists to the oil supply, if it seems substantial enough to manifest and move the needle, that’s when you get a perception-based geopolitical risk factor that builds price into the market,” he says.
This is the reason why something could happen in an area that isn’t directly connected to oil production, yet that incident is still cited as the cause for rising prices. The fear of an event can impact prices almost as easily as the event itself.
The Arab Spring is an ideal example of this. In 2010, a civil uprising began in Tunisia during which the nation’s president was ousted. The movement at the center of the Tunisian Revolution spread to nearby nations, including Libya, Egypt, Yemen, and Syria. Plus, there were smaller protests and demonstrations in many other Middle Eastern countries. However, Tunisia and many of the countries where uprisings took place are not major producers of oil.
“The Arab Spring kept fuel prices really high for a long time, even though it never really took out any major oil production,” Cullen says. “The thing was, it presented an enormous risk to the oil supply.”
Cullen explains that the oil market started to price in a risk premium because an uprising in an oil-producing region could have halted production.
“If something similar to what happened to Tunisia had happened in Saudi Arabia, and civil resistance overthrew the kingdom, that would have been huge. Basically, the oil market said, ‘there’s a real likelihood this could happen and supply balance is close enough right now that if this does happen, it would be a catastrophe.’”
The balance between supply and demand is another factor in how much a geopolitical event moves oil and fuel prices. Cullen says supply and demand were fairly well-balanced during the Arab Spring.
“But, when the market is even close to balance today, that means it is under the persistent threat of not being in balance tomorrow,” Cullen says.
Conversely, the state of the global oil market in 2017 is heavier on the supply side. That means geopolitical events are somewhat less likely to influence price changes at the pump.
“Libya has been in civil war for years, and it’s knocked out most of the nation’s oil production,” Cullen says. “Years ago, that sort of thing would have had a big impact. However, there’s so much oil from everywhere else, it simply hasn’t made much of a difference.”
Geopolitics and Demand for Oil
Macroeconomic factors that influence demand for oil can also lead to changes in fuel prices.
“Historically, oil consumption is closely tied to economic activity,” says Cullen. “So, if a nation’s GDP is going up, consumption of oil products goes up at a corresponding rate. For the most part, what creates a geopolitical risk from a demand perspective is a serious economic crisis.”
The Great Recession and the corresponding 2008 global financial crisis are the most recent example of that situation.
“During this time, we saw a huge reduction in GDP throughout the world,” Cullen says. “That meant industrial activity was down, the freight market was down, consumers were consuming less fuel as well as fewer products that drive the need for fuel in the supply chain. All of that pulls the bottom out of demand.”
Global GDP Growth Rates in 2009
The crisis caused a steep decline in oil prices as the price for a barrel dropped from a high of $147 in July of 2008 to $33 per barrel by February of 2009. While that meant fuel prices were lower, it was a troubling sign for the global economy. Cullen notes that oil prices still have not returned to pre-recession levels.
It’s important to mention that economic growth or decline will affect regions of the world differently based on their current economic state.
“A unit of economic growth in the U.S. isn’t going to produce as much demand for oil as it would in China,” Cullen says. He explains how growth in the U.S. often comes from the service industry or less oil-intensive goods. While in China, economic growth results in demand for basic goods, which are more oil-intensive to produce and consume.
Why Supply is More Sensitive than Demand
A potential threat to the oil supply is much more likely to cause a rise in fuel prices than a threat to demand. Cullen says that’s because threats to supply are concentrated to fewer places while demand for oil comes from many places.
“If you want to knock out the world’s oil supply, there are a handful of countries, and frankly, a handful of locations in those countries you’d need to knock out. To make an impact on demand, you would need to take down entire economies, and major economies at that.”
Supply is a much more fragile part of the equation, which is why all that’s needed is the perception of a problem, and the market reacts.
How Breakthrough®Fuel Can Help
Even when the state of supply and demand in the oil market makes it less likely that geopolitical events will impact diesel prices, it’s still wise for shippers to keep an eye on world news. You never know when the situation will change.
“It’s something that can re-enter the market very quickly and without warning,” Cullen says.
That’s why Cullen and the Applied Knowledge Team at Breakthrough®Fuel often report on geopolitics in the monthly Breakthrough®Advisor publication, an exclusive resource for our clients. The content clients receive helps them make informed supply chain decisions. Find out how to get a condensed version of the Breakthrough®Advisor in our Knowledge Center or sign up by entering your email at the bottom of this page.
You can’t completely avoid the impact of geopolitical events on diesel prices. However, you can ensure you’re paying a fair and accurate price for fuel. Unlike traditional methods using the DOE Index, a Breakthrough®Fuel Fuel Recovery program allows shippers to reimburse carriers for diesel based on actuals not averages.
Plus, Breakthrough®Fuel clients taking advantage of our Fixed Fuel Price solution no longer need to worry about market volatility from world events and other factors. They’re achieving budget certainty for as long as three years, allowing them to focus on other matters.