Sunday, February 27, 2011

Oil and the specter of revolution

The uprisings in the Middle East and North Africa have caused prices surges in global commodity markets. Now the revolt in oil-rich Libya has brought oil prices to a level unseen since 2008.

The IMF has already revised its forecast of the average price per barrel of oil from $89.5 up to $94.75. Widespread unease and speculation are what's driving oil prices up for now. But if the riots spill over from North Africa to the Arabian Peninsula, there could be a physical shortage of oil in the world economy, sending prices as high as $150 per barrel.

Specter of revolution

The price of oil continues to rise. April futures on WTI oil have gone up $0.15 to reach $97.43 per barrel (as of 8:58 a.m. Moscow time). The price of April futures for North Sea Brent Crude has gone up by $1.29 to reach $112.65 per barrel.

Fears that the popular revolts in the Middle East could push up prices on hydrocarbons began to surface immediately after protests began in Egypt. While not a major oil-producing country, Egypt controls the Suez Canal, one of the world's key shipping routes.

The threat of shipping disruptions on the canal was enough to drive up March futures for WTI and Brent by 0.31% and 0.76% respectively in early February. But the prices subsided before long, as shipping through the Suez Canal continued seamlessly and Egypt appeared not to be the beginning of a domino effect that could destroy or at least shake up other regimes in the region. But this is exactly what happened. First the regime fell in Tunisia, then Egypt; now oil-rich Libya is in the grips of a bloody revolt. And the specter of revolution (albeit very faint) is already hovering over Iran and Saudi Arabia.

Gaddafi doubles down

The instability in Libya has contributed greatly to the soaring oil prices. The market was sent into a panic when Libyan strongman Muammar Gaddafi vowed to sabotage oil and gas pipelines and oil refineries in the country. In the several days since, the price of major oil brands has gone up by about 7%. Analysts are predicting that the price of oil could reach $120 per barrel as early as March.

For the time being, the price increases are the result of speculators sowing panic on markets. It is unclear how much Libya has actually reduced oil production. Some experts claim the production has declined by about 400-500 barrels per day, while others think it's double that amount. Regardless, Libya only produces about 1.6 million barrels of oil per day, or roughly 2% of global output.

If oil production falls by about one third in Libya, global output will go down by about 0.6%. Moreover, OPEC has already promised to increase production to offset the shortage from Libya, and the cartel, with its vast resources, will have no trouble making good on this promise. In other words, there is no threat of a physical shortage of oil, nor of a realignment in the oil market.

Real trouble will begin only if the chain reaction of revolt reaches the oil-rich countries of the Arabian Peninsula, primarily Saudi Arabia, which accounts for 10% of the world's oil. If oil production was to be disrupted in Saudi Arabia, this would deal a serious - though far from fatal - blow to the world economy.

A lose-lose situation

Oil prices are determined by a host of other factors, for instance, global and U.S. economic growth, and the level of oil reserves in America. Gaddafi's threat to destroy his own oil infrastructure happened to coincide with the news last week that oil reserves in the United States grew three times slower than projected, on top of an overall decline in oil reserves of late. On the other hand, forecasts of U.S. economic growth have become more optimistic.

True, we may have to revise down these sunny forecasts very soon, at least if the trend of sharply rising oil prices continues. Economic growth has always depended greatly on oil prices. For the time being, experts do not see a direct threat to the global economy, but let's not forget that speculation-fueled spikes in fuel prices in 2007-2008 was a direct cause of the global economic downturn.

As Prime Minister Vladimir Putin noted at a news conference in Brussels yesterday (, the Russian economy would not benefit from the further growth of prices on hydrocarbons: "We realize that if global economic growth slows down, this will have a negative impact on our economy as well."

True, higher prices on hydrocarbons will increase Russia's export revenues. But oil is less a blessing for our country than "the devil's excrement," as Juan Pablo Perez Alfonso, one of the founders of OPEC, called it. The discovery of deposits in Western Siberia and steadily rising oil prices in the early 1970s lulled the U.S.S.R. into abandoning much-needed economic reforms.

Today, the fuel and energy sector is both the engine of the Russia economy and its anchor. Russia's abundance of oil has allowed the government to carry out social programs. It has helped finance Russia's recovery from the economic crisis, and much, much more. But Russia's oil-based economy is one of the main causes of its technological backwardness, the enormous disparity between rich and poor, and corruption.

There is also a factor of addition. Just as a sick person gets addicted to medicine, our raw materials-based economy becomes addicted to high oil prices. Even if oil prices reach pre-crisis levels, we still won't be able to patch the hole in the budget and achieve pre-crisis economic growth rates.

23:42 25/02/2011