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IHS™ CERA Alert®
HIGH ANXIETY: OIL MARKETS RESPOND TO MIDEAST TURMOIL WITH NERVOUSNESS, RESTRAINT

(02/03/2011)


HIGH ANXIETY: OIL MARKETS RESPOND TO MIDEAST TURMOIL WITH NERVOUSNESS, RESTRAINT

by Jeff Meyer, Bhushan Bahree, and Ruchir Kadakia

KEY IMPLICATIONS

The political upheaval in Egypt has provoked anxiety in oil markets, which are always fearful of any threat to big energy exporters in North Africa and to even bigger ones clustered in the Gulf. Yet market reaction has been restrained, a notable response because there is continuing nervousness about unrest spreading in the region. Since protests erupted in Egypt on January 25, West Texas Intermediate crude has risen to $90.97 per barrel from $86.19, and Brent to $102.34 from $95.25. Egypt’s President Hosni Mubarak says he will not seek another term, but protests seeking to unseat him immediately continue.

• To an extent, the risk for oil prices is to the upside. It is almost impossible for Egypt to return to the status quo that existed before January 25. It is difficult to imagine a scenario, at least in the near term, that would fully address oil market concerns. Anxiety and fear will continue to be priced in to varying degrees.

• A sharp price spike is likely to trigger formal or informal opeC action, which could act as a brake. The big Arab exporters in the Gulf with almost all of OPEC’s spare capacity are uneasy at the prospect of oil prices above $100 per barrel and are likely to counter it through increased output.

• Egypt’s military is protecting the oil and gas infrastructure and transit routes. There is also some redundancy in the system. For instance the military has deployed troops to enhance security along the Suez-Mediterranean (Sumed) pipeline, which alone has enough theoretical spare capacity to accommodate the tanker-borne oil that has lately transited the Suez Canal.


TURMOIL IN EGYPT GENERATES ANXIETY, RESTRAINED REACTION IN OIL MARKETS

The political upheaval in Egypt has caused tension and anxiety in global oil markets. Yet oil markets have reacted in a restrained manner to the crisis despite fears about the spread of unrest in oil- and gas-rich North Africa and the Middle East. Since protests erupted in Egypt on January 25, oil prices have increased, but not spiked. West Texas Intermediate (WTI) is up $4.78 at $90.97 per barrel on February 2. Brent is up $7.09 at $102.34 (see Figure 1). The market appears to be taking a wait-and-see approach to a fluid situation. Egypt President Hosni Mubarak’s vow not to seek another term in September has not ended the protests, which seek his immediate removal. On February 2 pro- and antigovernment demonstrators clashed violently on the streets of Cairo.

OIL MARKET RISK IS TO THE UPSIDE

One typical response to security-of-supply fears is to buy oil or future rights to it. Another is to cover short positions. Noncommercial investors in particular find it difficult to justify the converse, which would be to sell oil short at a time when there is significant political unrest in at least four countries in North Africa and the Middle East. These countries are Tunisia, where popular protests last month forced out the country’s long-time president; Egypt; Jordan, where Jordan’s King Abdullah II on February 1 dismissed his cabinet; and Yemen, where protestors have marched against the government in recent days and the president has promised to step down in 2013. Protests could spread further. Underlying the market’s anxiety is the potential—however


modest at this point—for an unknown event or events to suddenly and significantly change the region’s political and economic landscape.

IHS CERA believes that the risk for oil prices is to the upside currently. It is almost impossible for Egypt’s political system to return to the status quo (i.e., conditions before the protests began last month). In short it is difficult to imagine a quick resolution to the situation that would relieve anxiety in oil markets. Of the many scenarios that may play out, almost all leave the market anxious and uncertain.

On the low-anxiety side of the spectrum would be an orderly transition of power orchestrated by Egypt’s military, which is generally well respected by the protesters. On the high-anxiety side would be a disorderly transition of power over time, possibly to a fundamentalist Islamist regime, and/or the spread of political unrest to large oil-producing countries in North Africa and the Middle East. Indeed most alternative scenarios are likely to keep investors nervous.

WTI ABOVE $100 MAY PROMPT OPEC ACTION

The tension in Egypt and beyond has added to the upward momentum for oil prices. Last year registered the second largest annual gain in world oil demand in more than 30 years—and fourth quarter 2010 demand was particularly strong. Also, expectations of global economic growth for 2011 have shifted upward recently. Other existing tailwinds include bullish sentiment in the equities market and loose monetary policy, especially in OECD countries, that has led to high levels of liquidity, with investors seeking potentially high-return assets, including commodities. Unrest in the Middle East thus coincides with what has been a strengthening of fundamental economic factors driving markets.

Still, too sharp an oil price increase over $100 per barrel is likely to trigger OPEC reaction to counter it. There is no consensus yet in OPEC on an oil price level that should trigger an easing or even removal of formal output restraints. Yet the big Arab members from the Gulf are known to be uneasy about prices spiking above $100 per barrel to levels that threaten global economic recovery and oil demand growth. The “oil cost” to the global economy is rising, but for now at least it is still below the 2008 level.* These Gulf countries also have almost all of the operational spare capacity of OPEC, which IHS CERA estimates to be some 5 million barrels per day (mbd) at this time. Under a rising price scenario, these countries are likely to push for OPEC action or even to increase their output ahead of a formal decision by the group’s ministers. The next OPEC meeting is scheduled for June 2 in Vienna, but an emergency meeting can be called anytime at short notice.

Yet OPEC faces a problem. Inventories of oil are high, and there is no evident shortage of oil in the marketplace. Announcing an increase in production could have a psychological impact on markets, but pushing more oil into physical markets that are flush will be difficult. This was reflected in comments on Monday by Saudi Arabia’s Oil Minister Ali Al-Naimi, who maintained that the appropriate price for oil was $70 to $80 per barrel. Then he underlined the dilemma, saying “We cannot put oil in markets that don’t need it.”

In consumer markets the prospect of triple-digit prices for WTI crude has put the issue back on political radar screens. One manifestation of this concern is that on February 3 the US Senate Committee on Energy and Natural Resources will hold a hearing on the outlook for energy and oil markets.

EGYPT’S MILITARY SECURES VITAL OIL, GAS, AND TRANSPORT FACILITIES

So far, there has been no disruption in the production of oil and gas in Egypt. More importantly for global oil markets, there has been no hindrance to oil and gas transit through Egypt, whether by pipelines or through the Suez Canal.

The Sumed pipeline, a key facility transporting mainly Gulf oil to the Mediterranean via the Red Sea, is among key infrastructure that has received additional protection from the military since the troubles started. About 1.1 mbd, less than half its capacity of 2.3 mbd, flowed through the Sumed in 2009. A smaller amount, 585,000 barrels per day, was transported through the Suez Canal in 2009.* Extrapolating from these numbers, the Sumed pipeline theoretically has enough spare capacity to accommodate all the oil passing through the Suez Canal in tankers. The alternate route for tankers—around South Africa’s Cape of Good Hope—can add as much as 6,000 miles to a voyage, depending on destination, inflating transport costs and requiring additional time to reach markets.





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