Rising oil prices and their impact on inflation

Oil prices have hit a more than 7 years high this Tuesday. These worryingly high prices are illustrated by Brent and WTI (West Texas Intermediate), whose prices have risen by around 13% this year. As oil is a commodity, used by the majority of production processes, price rises will lead to cost-push inflation. Cost-push inflation is caused when the costs of the production increase (in this case caused by rising oil prices).

This leads to the short-run aggregate supply shifting inwards from AS to AS1. In turn, the shift results in the economy's output falling leading to a fall in real GDP, as well as a rise in the general price level.

This rise in the general price level is known as cost-push inflation as it was caused by costs rising. With the current high oil prices, inflation is already at 4.2%. Predictions forecast crude oil prices, and thus inflation, to rise even further. Oil prices are currently at around $88.13 per barrel, and some analysts predict that crude oil could trade at more than $100 per barrel.

These predictions originate from the belief that supply will struggle to keep up with demand as the global economy continues to rebound from the coronavirus-induced slowdown that began in early 2020. In response to this growing issue, the US called on OPEC to increase their supply to help control inflation.

OPEC is a group composed of the world's leading oil producers. Within the group, they agree on the levels of output to produce to ensure oil price does not drop to their disadvantage.

Although technically they are a cartel (an illegal group that agrees on prices and output levels for a good or service), OPEC has never been prohibited for their collusive behaviour.

In regards to the USAs plea for help, OPEC has decided to continue to stick to their plan agreed in July to only increase supply very gradually. This involves increasing oil production by just 400,000 barrels each day per month. Concern has been sparked as not all members of OPEC+ (which includes more countries like Russia than OPEC) have met their monthly targets. This suggests that there is limited spare capacity in the market.

These rumours have been backed up by the production figures released by OPEC on Tuesday. The figures show that monthly output, whilst increasing for Saudi Arabia and Angola, have declined for Nigeria and Libya.

Other forecasters have predicted that total spare capacity among OPEC+ members was forecast to reach “historically low levels” of about 1.2 million barrels per day by the summer.

In contrast, some believe that there may be enough spare capacity in Saudi Arabia and Iraq among other countries. This would help mitigate the effects of other countries with diminishing capacities and prevent a major geopolitical supply interruption.


Written by Charlotte Hurst


Top Stories