What does unrest in the Middle East and North Africa mean for oil prices? Suddenly, quite a bit.
Just a few weeks ago, in early January, with oil at $92/barrel, it appeared that, while the long-term bullish case for oil looked strong, the price of West Texas Intermediate crude (one of the main oil benchmarks) looked overdone in the near term. And when unrest began a few weeks ago in Tunisia and Egypt, it had only a short-lived impact on the price of oil, because the two countries are relatively small oil producers, and there was no disruption to supply through a closing of the Suez canal.
However, with unrest spreading to Libya and other more significant oil producing countries, further pull backs in crude are not likely in the near-term. Here are key points for investors to consider:
1) The situation in Libya is deteriorating quickly. Libya produces 1.8m barrels a day and has 41b barrels of proven reserves, three percent of global supplies.
2) Unlike Egypt, where a strong, established, and respected military can provide near-term stability and the potential for a peaceful transitional government, it is not clear what the exit strategy would be in Libya should the regime fall. Oil production would certainly be at risk.
3) In addition, further contagion appears to be intensifying in Bahrain, Yemen, and most importantly Iran.
In short, political instability in the Middle East has now reached a point where it is likely to add to the risk premium for crude (it is already impacting Brent Oil, the European benchmark). The broader impact of higher oil prices will be a marginally higher headline CPI in the near term, a negative environment for stocks (particularly consumer discretionary, but obviously not energy stocks), and a positive for volatility.
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