There is the possibility of a global crude oil price shock arising from the current unrest in the MENA (Middle East, North Africa) region — and the impact on a sluggishly rebounding global economy could be devastating. The precise outcome of events may be currently unclear but crude oil price projections have been wide-ranging. For example, while some analysts expect a gradual retreat of crude oil prices for 2011 to an average of US$95 per barrel after the recent peaks, others see a peak of US$300 and an average price of US$200 per barrel for the year. World Oil reports that a company recently slashed odds on a US$200 per barrel crude oil to just 3/1.
Global markets in their aversion to uncertainties have been restive even in spite of ameliorative efforts ... and perhaps rightfully so:
Spare Production Capacity
Marginal crude oil supply, crucial to moderation of global crude oil prices, is widely considered to reside with the petroleum grouping, Organization of the Petroleum Exporting Countries (OPEC). OPEC had just prior to the Middle East/North Africa (MENA) unrest put its spare production capacity at about 5 million barrels per day (Mbpd), though independent estimates had it at between 3 and 4 Mbpd. A report by Financial Times, however, indicates that Saudi Arabia’s recently-announced production increase of 700,000 barrels per day may have actually commenced prior to the MENA unrest; and that OPEC, with its rather poor record of quota compliance, may have been producing above its official production figures by as much as 1 Mbpd. The implication then, is that OPEC spare production capacity is up to 1 Mbpd less than estimated. When this figure is added to the Libyan production outage, the effective spare production capacity may become ominously challenged in the event of further production outages.
Spare production capacity as an absolute number may not always convey a desired level of confidence in the markets. For example, a spare production capacity of say 2 Mbpd in a 100 Mbpd global consumption scenario may carry higher levels of supply concerns than for the same 2 Mbpd spare production capacity when the consumption is only 10 Mbpd. A spare production capacity ratio (See Chart 1 below) is often used as a more realistic measure of supply reliability. The year 2008 is often remembered for that much-reviled oil price shock, but OPEC’s spare production capacity with regard to total global consumption was actually lower in 2005 than in 2008. Such is often cited in arguments absolving crude oil market fundamentals of any significant role in the 2008 crude oil price shock.
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The substantial regional variation in crude oil demand currently in place has further beclouded the issue of spare production capacity. Saudi Arabia recently introduced significant price differentials on its Asian and North American crude oil supplies and price differentials on Nigeria’s Bonny Light have ticked upwards.
The Tunisia Syndrome — still unresolved
In terms of global reserves, the MENA region holds about 60% for crude oil and about 45% for natural gas. In addition, the region accounted for 45% of global crude oil exports in 2009. The wave of events in Tunisia which led to a swift overthrow of that country’s sit-tight ruler have blown into countries such as Egypt and Libya, previously-deemed too "safe" or "tightly-ruled" to be affected; it has now crossed seas and deserts, morphing into a tense and still-awaited "Day of Rage" in Saudi Arabia. The concern is not so much about who controls the oil, for whoever does would most likely sustain production and even the Libyan revolutionaries have vowed to honor contracts, but it is more about appreciable damage to oil and gas installations, perhaps in the heat of conflict. There have been media reports about some damage to Libyan installations in Ras Lanuf and the port of Sidra but due to restricted access. The extent of damage has not been ascertained. Any substantial damage, especially in a country such as Saudi Arabia, would cause production outages far beyond the scope of remediation by any available spare capacity for the months or years which may be necessary for reconstruction or rehabilitation. Now, that would most likely result in an oil price shock, possibly the "mother of all."
Current concerns about potential supply shortfalls are driving stakeholders to strategic product storage. In the year 2009, when very weak global demand wreaked havoc on markets, total crude oil volume in floating storages alone reached an estimated 125 million barrels; other estimates were even significantly higher. Some oil storage tank operators are currently reporting rapidly exhausting capacities while others are racing to bring new ones on-stream. According to Business and Economy Digest, the Netherlands-based Vopak for example, reports that its 48 storage tanks in Fujairah on the east coast of the United Arab Emirates are fully engaged while additional capacities expected to come on-stream by year’s end have also been completely leased out.
Finally, the effect of spiraling crude oil prices would probably be different for developed and developing economies. Among the developed economies, the impact would be more severe for the energy-intensive ones such as the United States. Gasoline prices in some states of that country have already reached $4 per gallon.
Member countries of the Organization for Economic Co-operation and Development (OECD), as a group, have over the past few years seen marked reduction in energy use per unit of GDP. Chart 2 below shows GDP and energy use values for OECD countries between 1980 and 2009. While GDP for the group doubled between 1980 and 2007 for example, its energy use per unit of GDP reduced by a third for the same period. At such rates, the impact of an energy price increase on productivity for the group would be relatively less.
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Emerging economies, while more energy-intensive, have also seen reduced energy use ratios as more efficient industries come on-stream. Energy subsidies as well as price controls would also provide cushion for any short- or medium-term impact, even if inflation worries are kindled. Energy subsidies are politically and socially explosive issues in these economies and are unlikely to be eradicated anytime soon. Among many emerging economies, the last recession was not as deep as in the developed economies and recovery was faster.
An oil price shock however, particularly one that endures, would be quite devastating to just about all economies, but more so where recovery is still inchoate.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.