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Energy Insights: Energy News: Iran's oil could help Mark Carney win interest rates battle

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Iran's oil could help Mark Carney win interest rates battle


Sir Winston Churchill turned to Iran's oil to fuel Britain's dreadnoughts. Now the Governor of the Bank of England hopes it will soften the blow of higher interest rates

Dreadnought...July 1909:   

Dreadnought...July 1909:

Iranian oil helped Churchill ensure Britain's naval power Photo: Getty Creative
By  Andrew Critchlow, Commodities editor

Not for the first time in history, Iran’s oil is about to help Britain’s leaders navigate turbulent waters.

In the weeks leading up to the First World War, it was the promise of Persian oil powering the Royal Navy’s new dreadnought battleships that offered our best hope of defeating the Kaiser. Sir Winston Churchill, who in 1911 was made First Sea Lord, saw the war with Germany coming and convinced the Government to convert the fuel behind Britain’s powerful naval fleet from coal to oil.

The decision was a masterstroke. Oil would burn more fiercely in a ship’s boiler, allowing Britain to jump ahead in the race to build a new generation of heavily armoured battleships, mounted with giant guns. These ships were the most powerful of their day and, fuelled by oil, were capable of steaming faster than 25 knots, which was deemed critical to their effectiveness and destructive power.

The only problem with the plan was that Britain at that time produced no oil. It would be another 60 years before rigs would appear in the North Sea and at the turn of the last century the country was dependent on the coal dug from Welsh and Yorkshire pits. For Churchill the key to his plan was to secure an abundant and secure supply of crude from overseas, preferably from a friendly dominion.

Just weeks before the start of the conflict that would see millions die in Europe, Churchill secured a controlling stake in the Anglo-Persian Oil Company for £2.2m, which in today’s money would be worth almost £250m.

At the same time, Anglo-Persian – the great-grandfather of today’s BP – struck a deal with the Admiralty to supply the British navy with oil for 30 years at fixed prices.

Years earlier the company’s founder, William Knox D’Arcy, and his partners had struck oil in the Iranian desert and by 1913 they were producing commercial quantities of crude from the region. The oil would prove vital for Britain’s war effort and arguably helped to ensure that Britannia would continue to rule the waves for decades to come.

William Knox D'Arcy's first well, built in Chiah Surkh, Persia in 1902

Which brings us to Iran’s historic nuclear agreement to lift economic sanctions, followed just days later by Mark Carney giving his strongest signal yet that interest rates will rise from historic lows during the next six months.

Firstly, the Iranian nuclear deal agreed this week has guaranteed that oil prices will remain lower for the foreseeable future provided that terrorists don’t start blowing up tankers and pipelines in the Middle East, or that open warfare doesn’t break out between Tehran and Riyadh. Brent crude, a global benchmark, closed the week at around $56 per barrel, which is almost 10pc lower than where it was trading a month ago.

The reason for the decline in the price of the world’s most important fuel source is the expectation of a flood of Iranian crude hitting an already oversupplied market. Prior to the historic nuclear deal in Vienna, Iran’s oil minister, Bijan Zanganeh, had signalled that the country could easily pump another 1m barrels per day (bpd) of crude once freed from sanctions that have restricted its access to investment and vital technology. According to Bank of America Merrill Lynch, Iran opening its spigots could lop a further $10 off the price of a barrel over the next 12 months.

Before Iran’s deal with the so called P5+1 powers – the US, UK, China, Russia, France plus Germany – oil prices had looked like they could once again march back to $100 per barrel in the near future. Although the market remains hopelessly oversupplied, lower prices had stimulated demand in key markets such as the US and Europe. By May oil prices had crept back up to almost $68 per barrel, an increase of 40pc from the beginning of the year, partly due to rising hopes for stronger demand.

With lower prices closer to $40 per barrel now expected to last for some time, the real benefits of cheaper energy costs for everyone will become amplified, especially in industrialised and developed nations such as the UK. That is good news for the Governor of the Bank of England as he readies the country for the biggest shift in monetary policy since the global financial crisis.

Mr Carney has said the base rate of 0.5pc could rise by the turn of the year as the economy picks up momentum. Once triggered, interest rates will rise slowly over the next three years and peak at around 2.5pc, he has said. As with all things, this historic shift in policy will produce winners and losers. Borrowers will of course have less money to spend as the cost of their loans increases but for savers higher rates will finally reward years of prudence.

Carney knows cheap energy will help to ease the impact of higher rates

House price growth will probably ease as a consequence of higher borrowing costs but the financial services sector – a key area for the economy and jobs – will gain. However, the most immediate impact of higher interest rates, or even a change in sentiment towards monetary policy within Threadneedle Street, will be felt by the pound.

Sterling was already on a strong run against the US dollar and especially the euro before Mr Carney dropped his interest rates bombshell. The pound has surged to an eight-year high against the euro and that trajectory is expected to continue as the date for the first rate rise draws nearer. A higher pound is good for British holidaymakers and the country’s banks but terrible news for exporters, especially those focused on European markets.

That is why the cheaper oil prices that Iran can help to provide are vital at a time of transition when countries like the UK will shift out of a prolonged period of emergency monetary policy and back to normalisation. Lower wholesale energy costs for both oil and gas – Iran holds the world’s second largest natural gas supplies – will help to water down the negative impact that a strengthening pound will have on the wider economy.

Rates may be going up but Iran’s oil will help to ease the pain.

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