Against the tide: Political premium on energy
Continuing political instability in North Africa and the Middle East, together with oil-supply constraints, will increase energy risks and therefore prices.
The political upheaval in North Africa and the Middle East is another example of how fat-tail risks now abound. Volatility is the name of the game for financial assets, including oil and other energy commodities.
The outcome of the struggle for power in Libya is still uncertain. Whatever happens, though, a political risk premium for oil and energy is here to stay. Oil supply from Opec members has been disrupted and will be difficult to restore. Spare capacity has shrunk and there is little room to cover any other supply losses from disruption elsewhere in the region. New populist governments in the region will demand tougher terms for foreign oil exploration and production as well as higher prices. Governments such as Saudi Arabia and Kuwait will spend more domestically to placate unrest, forcing them to support higher prices for dwindling exports.
While the coalition forces claim not to be targeting Libya’s leader directly, Muammar Gaddafi’s removal from power would be their most desired outcome. Although Gaddafi’s removal remains the ideal objective, it is by no means certain. Libya might be divided permanently between two camps; once such a division took place it would be difficult to recreate the country. Libya’s oil production would collapse, leaving both halves of the country in poverty. And disputes about the ownership of Libya’s overseas financial assets would begin. The result would be a proxy war that sucked in other Arab nations, as well as a failed Libyan state.
The long-term implications for energy prices and political risk are even bigger. The turmoil in the Middle East has added too much unpredictability and this is likely to endure for years, regardless of how quickly the Libyan conflict is resolved.
Opec’s spare capacity is shrinking; it is less than 4 million barrels a day – well below the peak of more than 7 million b/d in 2009, although still well above the 500,000 b/d of 2004 after Iraq went offline during the US invasion. The cumulative effect of various disruptions in the Middle East could use up all that capacity.
Top oil consumers
Consumption in barrels per day
Another concern is when production will recover. In the case of Libya, and to a lesser extent Yemen, violence needs to end to allow the return of domestic and international workers to the oil fields. But even when staff come back, the task of restarting oil production will not be easy. For example, Iraqi production has still not returned to pre-2003 levels.
According to the International Energy Agency, the Middle East and North Africa needs to spend $20 billion a year in new investment for oil production up to 2030. And an Opec production increase is crucial to meeting global oil demand over the next few years as non-Opec production will be pretty static. If foreign investment is not forthcoming, oil supply growth in the region might falter. That’s especially so if governments in the region have to spend oil revenues on placating their people with subsidies and handouts.
Saudi Arabia has announced new public spending of $129 billion – equal to more than half the country’s oil revenues last year. Higher social spending will not only put upward pressure on oil prices, it will also reduce the funds available for state-owned oil companies to invest in future production capacity. In Saudi Arabia, domestic oil demand has doubled over the past 15 years, transforming the country into one of the world’s top 10 consumers, using more oil than countries such as the UK or France. If that trend continues, it will have less and less oil for export every year.
And there are wider global risks thrown up. Immigration pressures on Europe – and particularly on Italy and Malta – will greatly increase. Gaddafi stopped the illegal flow of migrants from Africa, but no new Libyan government will be able to do the same.
The military-led government in Algeria is unlikely to survive for long. Islamist fundamentalists could become important players inside Libya after the overthrow of Gaddafi. It is usually forgotten that in Iraq Libyan citizens contributed the biggest share of terrorists after the citizens of Saudi Arabia. And most of those who volunteered for terrorism in Iraq came from Benghazi, now the seat of the rebellion against Gaddafi. Volatility is the name of the game.
David Roche is president of Independent Strategy Ltd, a London-based research firm. www.instrategy.com