The price of fear: Oil Markets and Arab Unrest

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A complex chain of cause and effect links the Arab world's turmoil to the health of the world economy

TWO factors determine the price of a barrel of oil: the fundamental laws of supply and demand, and naked fear. Both are being tested by the violence that is tearing through Libya, the world's 13th-largest oil exporter. The price of a barrel of Brent crude now hovers around $115. On February 24th, however, it rose to almost $120, as traders realised that they might have to do for a while without some or all of Libya's exports: some 1.4m barrels a day (b/d), or about 2% of the world's needs.

The situation in Libya is grim, as the rebels and the forces of Muammar Qaddafi battle for control of the country's only resource. Brega, the seat of the Sirte Oil Company in the east of the country, has changed hands three times in recent days. Most of the oil workers have fled, and production has fallen by two-thirds. The ports of As Sidra, Brega, Ras Lanuf, Tobruk and Zuetina, which together handle almost 80% of Libya's oil exports, were all seized by the rebels; two have now been retaken by Colonel Qaddafi's forces. The rebels remain in control of Africa's largest oilfield, Sarir, pumping some 400,000 barrels on a normal day. But for how long?

The history of oil is marked by Middle Eastern strife, supply shocks and global recession, with the Arab oil embargo in 1972, the Iranian revolution in 1978 and Saddam Hussein's invasion of Kuwait in 1990. To gauge the risks today you need to answer three questions. How vulnerable is the oil market to an interruption in supply? How sensitive is the world economy to oil-price spikes? And how well can policymakers cope with a shock if the worst happens? Take each in turn.

The troubles in Libya are only the most serious example of the impact of Arab unrest on global oil markets. Prices jumped as Egypt's citizens took to the streets to oust President Hosni Mubarak. Egypt is an oil importer, but acts as a vital conduit between the huge oilfields in the Persian Gulf and markets in Europe, via the Suez Canal and through the SUMED pipeline. Although it seemed unlikely that protesters would or could disrupt oil shipments, events in Cairo were enough to add more than $5 to a barrel.

The spread of unrest to Bahrain, Oman and the Gulf has created a whole new dimension of anxiety. North Africa produces 5% of the world's oil, but the Middle East produces 30%. Moreover, Bahrain's problems are on Saudi Arabia's doorstep. These bear on the situation in the eastern Saudi provinces, from which a huge quantity of oil is pumped into global markets.

Saudi Arabia is therefore the traders' chief worry. But it is also, in oil terms, the world's chief hope. It is the only producer with significant spare capacity that could quickly be released if the oil price rose too high. Although OPEC, in which Saudi Arabia is the biggest force, exists to keep oil prices buoyant, it does not want to see them reach a point where the world economy is damaged and demand for oil falls. When prices spiked in 2008, the Saudis said they had capacity to spare. Terrified oil markets doubted its existence, and prices rose anyway, to reach $145. Yet the subsequent collapse in the oil price in the second half of 2008 was only partly caused by the credit crisis and the rich-world recession that resulted. Saudi Arabia also pumped extra oil: nearly 2.5m b/d on top of the 8.5m it was already providing.

OPEC's spare capacity now is put at anything between 6m b/d (by OPEC) and 4m-5m b/d (by industry analysts); Saudi Arabia's share of that excess is perhaps 3m-3.5m b/d. The oil price has retreated from its peak in the past ten days largely because Saudi Arabia says it is pumping up to 600,000 b/d to replace the shortfall in Libyan exports. It has invested heavily in expanding capacity, with plans to spend perhaps $100 billion on wells and infrastructure by 2015. It has also been far more open about letting the world see what it has done. OPEC's stated aim of stabilising oil prices relies on traders believing that the Saudis really do have the capacity to pump more when prices rise.

Why, then, are traders still so nervous? The answer is that the long-term trends of supply and demand were already unfavourable when the Arab shoe-throwers intervened. Before the uprisings, a barrel of Brent crude was commanding close to $100 a barrel. World demand grew by an extraordinary 2.7m b/d in 2010, according to the International Energy Agency. It will probably keep growing by another 1.5m b/d this year and the same again next, as the rich world recovers and demand surges in China and the rest of Asia. Net expansion of non-OPEC supplies is likely to be negligible in the coming years. Though the rich world's inventories are high, with cover of around 50 days, it is not clear that Saudi Arabia can pump much more than it did in 2008; and the speed of oil released from government reserves, such as America's Strategic Petroleum Reserve, also has upper limits.

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http://www.economist...r%2Fpriceoffear

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TWO factors determine the price of a barrel of oil: the fundamental laws of supply and demand, and naked fear.

No. Demand has very little to do with the price of oil anymore. A small percentage of investors judge demand, but most investment in oil is on pure speculation and a direct result of a weak US Dollar.

Speculators aren't placing money out of fear at all. They are placing their investments out of 'hope' that things do continue to go wrong and the supply line is cut off and that the price will continue to go up and therefore yield them some nice gains.