Violence in Libya has caused talks of a double-dip recession to once again gain steam. The story goes that Gaddafi's forces will destroy oil infrastructure as they flee, or that different tribal groups will come to control the oil fields, then go to war with each other. Who destroys the oil infrastructure of Libya does not really matter for the story, so long as it gets destroyed. The interruption in the flow of Libyan oil will drive up oil prices, crimping a fragile American consumer, and crushing economic growth. At the same time, doomsayers insist violence will engulf Saudi Arabia, and as that regime is toppled oil flow from Saudi Arabia will also stop. This will cause oil prices to rocket to $220 a barrel, crushing economic growth and crippling the world. While not quite an M Night Shyamalan story, media pundits and stock market bears have painted quite a scary tale. Here's why it won't come true, and how to profit off of it.
1. Libyan Oil Flows Will Return
The Libyan economy, stifled by years of sanctions and embargos, is fully reliant on the continued flow of oil. Oil accounts for 95% of Libyan export earnings, 25% of GDP, and 80% of the Gaddafi government's revenues, according to the CIA World Factbook. Gaddafi would not order infrastructure destroyed unless he was sure he had lost control, since destroying the country's oil infrastructure would cripple his ability to run a government, in the unlikely event he remained in power. If Gaddafi refuses to leave Libya, which seems likely, it seems there is a rather high probability he will be captured or killed there. Either way as the noose tightens around Tripoli, more and more of the country's oil fields and infrastructure falls outside Gaddafi's sphere of control and into the hands of pro-democracy rebels.
Rebels who take control of the oil fields will more likely than not refrain from destroying the oil infrastructure, as this is the first time in decades they can take advantage of the country's oil wealth. The Wall Street Journal is reporting as of Sunday morning that Libya's largest oil producer, the Arabian Gulf Oil Company, will be resuming shipments of oil via tanker Sunday. According to officials at the company, 700,000 barrels of oil will depart Tobruk, a port in eastern corner Libya which is in rebel hands. The Arabia Gulf Oil Company, which is headquartered in eastern Libya, has cut production to 40% of its 420,000 bpd production rate due to the turmoil in the country. This cut is due to the company reducing flows due to worker shortages and delivery interruptions, not due to destruction of facilities or infrastructure. This means production can be increased rather quickly, once the political climate stabilizes.
2. Oil Prices Will Not Spike
The Nomura prediction for $220 oil is based on Libya and Algeria halting oil production completely, which is a very low risk probability. As events in Libya continue to look less dire than the first reports claiming the world would relive the burning oil fields seen in Iraq in the Gulf War, the threat of a super spike looks less and less likely. Several other factors also speak against a prolonged spike in oil prices. First, the US currently has a glut of supply at the Cushing, Oklahoma, the delivery point for US West Texas Crude. The price difference between the WTI crude in Cushing and the Brent Crude is about $15, give or take. Lower US oil prices give the US a competitive advantage over Europe, where most of Libyan oil flows to. Increased US production, as well as Canadian imports into the US are helping to dampen the impact of Libya's supply disruptions on the US consumer.
Second, being that this is the 3rd year of President Obama's presidency, the President and the Democrats will not allow an oil price shock to plunge the country back into a recession. While the President will most likely not release oil from the Strategic Petroleum Reserves, the threat of Mr. Obama doing so should keep a lid on prices. Obama can effectively talk the market down, just by saying the release of reserves is on the table. Third, Saudi Arabia has pledged to bring spare capacity online to more than make up for lost Libyan production. If the supply of oil remains unchanged, headline premium should continue to come out of oil markets, leading to lower prices.
3. The Saudi King Will Remain King.
As monarchs and dictators face popular uprisings all across the Mid East and North Africa, all eyes have turned to Saudi Arabia. The Saudi government, long seen as the de facto head of OPEC due both to the Kingdom's massive oil reserves and large spare capacity, is the linchpin of the world oil market. A disruption to Saudi oil flows would undoubtedly push the world into a recession. The US is not unaware of this situation, and has been supporting Saudi's efforts to remain a regional powerhouse for decades. Besides assisting Saudi Security Forces on cracking down on Al-Qaeda, the US has been selling the Kingdom tens of billions of dollars in weapons and supplying missile defense systems for key infrastructure. The Saudi's in turn are in the process of tripling the size of its oil protection forces to 35,000, from 10,000. The force was formed in 2007 after AL-Qaeda plots to attack key facilities were uncovered.
Saudi Arabia also have a few things Tunisia, Egypt and Libya didn't have, namely a popular monarch and massive wealth. Last week Saudi King Abdullah returned to the Kingdom, after seeking medical attention outside the country. His return was greeted with an outpouring of support by the populace. The King was quick to add to the jubilation, promising $36 billion in new spending to help the impoverished Saudi people. That is the equivalent of 10% of the Kingdom's 2009 GDP, and should keep the King in the public's favor, and in power, for a few more years.
Without a serious threat of a double-dip, US equities still appear to be a good place for investors to park money. Oil companies like Exxon (NYSE:XOM) and ConocoPhillips (NYSE:COP) are benefiting from the higher oil prices, while oil companies with Libyan exposure, such as Eni (NYSE:E) and Total (NYSE:TOT) are suffering. Petrobras (NYSE:PBR), with its huge deepwater discoveries off the Brazilian coast, is also a long term winner. US natural gas producers like Chesapeake (NYSE:CHK), Williams Companies (NYSE:WMB), Range Resources (NYSE:RRC), EOG (NYSE:EOG), and Petrohawk (NYSE:HK) should command higher valuations based not only on higher energy prices, but also on the stability of their operations. Oil drillers and oil service companies like Schlumberger (NYSE:SLB), Baker Hughes (BHI), Transocean (NYSE:RIG), Halliburton (NYSE:HAL), and National Oilwell Varco (NYSE:NOV) will benefit from a lifting of the drilling slowdown in the Gulf of Mexico, as well as an increased hunt for oil in more stable regions of the world. Pump making companies like Flowserve (NYSE:FLS) and Colfax (NYSE:CFX) are also long term winners from more oil exploration and production activity.
Disclosure: I am long CHK, CFX.