G7 weighs using emergency oil reserves amid soaring prices driven by war

Policymakers started last week by calling for calm and not rushing to judgment on what the U.S.-Israeli campaign against Iran meant for the economy.  They started this week with the risk of the worst global energy crisis in 50 years staring them in the face.

The finance ministers of biggest advanced economies are to hold talks on Monday to coordinate a release of strategic oil reserves, to head off the prospect of an inflation shock rocking the world economy.

News of the talks helped take the edge off a potentially disastrous spike in crude oil prices on Monday, in which benchmark prices rose as high as $118 a barrel, nearly double what they were at the end of last year and the highest level since Russia launched its invasion of Ukraine in February 2022. 

By 2 p.m. CET, Brent crude futures had fallen back to $104.47 a barrel, some 15 percent off their overnight peak but still high enough, if sustained, to threaten a sharp economic slowdown.

“The use of strategic reserves is an option being considered,” one French official, granted anonymity because they are not authorized to speak publicly on the matter, said Monday. The virtual meeting of G7 finance ministers and central bankers was scheduled to start at 1:30 p.m. CET.

Talks on using oil reserves were first reported by the Financial Times, which added that the ⁠International Energy Agency would join the discussions. The G7’s reserves total between 300 and 400 million barrels — or less than two weeks of all G7 oil consumption.

Desperate times call for desperate measures

Strategic reserves have have only been released a handful of times in the past. The last time this drastic measure was taken before the war in Ukraine was to in 2011, to cushion the fallout of the Libyan Civil War. In 2022, a coordinated release by rich countries helped bring Brent prices down from $139 a barrel to around $105-$115 a barrel within two months. 

By 2 p.m. CET, Brent crude futures had fallen back to $104.47 a barrel, some 15 percent off their overnight peak but still high enough, if sustained, to threaten a sharp economic slowdown. | Dan Kitwood/Getty Images

But Russia’s invasion affected a far smaller part of world energy supplies than today’s  campaign against Iran. That’s mainly because of Iran has the ability to close off the exit from the Persian Gulf, through which around 20 percent of global oil supplies pass. Already, key exporters such as Saudi Arabia and Iraq are reported to be cutting oil production because storage capacities are full and no ships can arrive to take the oil to market.

Left unaddressed, the spike in oil prices could quickly translate into a sharp jump in consumer prices, as well as killing growth, creating the dreaded ‘stagflation’: a combination of economic stagnation and high inflation, forcing central banks to raise interest rates even at the cost of triggering a recession. 

Policymakers stress that the risk of inflation ripping is smaller now than in 2022, when world supply chains were still recovering from the pandemic, and when consumers had built up savings that allowed them to splash out. The economy today looks weaker: job growth in the U.S. has virtually ground to a halt and the European Central Bank is warning that the eurozone labor market is weaker than a record low jobless rate of 6.1 percent would suggest. In the U.K., unemployment has been rising for over a year.

Central banks “shouldn’t be too worried about wage-price spirals, despite the endless overshoot” in inflation, said TS Lombard analyst Dario Perkins on X. “But my worry is that it tips labor markets over — and that risk is bigger than in 2022.”

Either way, financial markets are quickly losing hope for a swift resolution. They are now pricing in a bigger and longer supply shock, after a weekend that saw massive attacks on energy installations, reports suggesting that President Donald Trump has softened his opposition to ‘U.S. boots on the ground’ in Iran, and signals of defiance from the Islamic Republic with the nomination of Mojtaba Khamenei to take over as Supreme Leader from his assassinated father.

The economy today looks weaker: job growth in the U.S. has virtually ground to a halt and the European Central Bank is warning that the eurozone labor market is weaker than a record low jobless rate of 6.1 percent would suggest. | Spencer Platt/Getty Images

Interest rate futures now suggest about a 70 percent probability of the ECB having to raise its key interest rates by half a percent this year, having expected no change at all in 2025 on the eve of the conflict. A first hike is expected by July. Meanwhile, money markets assign roughly a 50 percent chance of a Bank of England rate increase by year‑end. Last week, investors still had their money on a cut.

As recently as Friday, ECB board member Isabel Schnabel said that while geopolitical volatility posed upside risks to ⁠inflation and ​warranted vigilance from policymakers, the ECB could ‘look through’ short-term volatility in inflation stemming from the war. 

However, she also warned that it “must carefully monitor the persistence of the energy price shock, its impact on inflation expectations and any indication that firms start passing through higher input costs to their customers.”

No escaping the fallout

Europe, a net importer of energy, is likely to be hit exceptionally hard. However, the U.S. is not immune either: domestic gasoline prices are up 20 percent from a month ago at nearly $3.50 a gallon, leaving Trump, who had campaigned on bringing prices down, exposed to a severe political backlash as mid-term elections approach.

In a social media post, Trump said prices would “drop rapidly when the destruction of the Iran nuclear threat is over” and added that more expensive oil was “a very small price to pay for U.S.A., and World, Safety and Peace.”

ECB board member Isabel Schnabel said that while geopolitical volatility posed upside risks to ⁠inflation and ​warranted vigilance from policymakers, the ECB could ‘look through’ short-term volatility in inflation stemming from the war. | Horacio Villalobos/Corbis via Getty Images

Iran’s Revolutionary Guard Corps (IRGC) on Sunday, meanwhile threatened to target energy facilities across the region in retaliation, and warned that prices could hit $200 a barrel if the U.S. and Israel “continue this game”.

For now, analysts think the truth may be somewhere in-between. “Uncertainty is high and rising” said Barclays analyst Amarpreet Singh.  “But, based on all the available information at hand, it doesn’t look like the worst is behind us yet.” 

Nobel-winning economist Paul Krugman said in a Substack post it’s still “premature to predict a global economic crisis,” noting that the oil price shock following Russia’s invasion of Ukraine “was ugly” but didn’t trigger recessions in the U.S. or Europe. “But the situation is scary.”