From crisis to catastrophe

THE market sells into headlines hastily and buys into reality at leisure and the price movement in the oil markets has followed much the same path. But a closer look at the dynamics of supply side provides a dose of reality – that fears of the 2008 price cycle being repeated are unfounded.
From crisis to catastrophe
From crisis to catastrophe
From crisis to catastrophe
From crisis to catastrophe
From crisis to catastrophe

US benchmark Western Texas Intermediate crude futures have been trading well below the $90 a barrel mark for more than two weeks. And while crude did stage a relief rally yesterday on the back of a sharply higher close on Wall Street, the broader market has been mostly bearish.

The economic and geopolitical events of the last two weeks that have grabbed headlines have lent further uncertainty to already shaky capital and commodities markets, making investors wonder if the crisis in the global economy is teetering on the edge of catastrophe.

But many analysts note the current turmoil is essentially one of a "crisis of confidence and not fundamentals" and much of the adjustments being made are in response to slower growth and not outright recession.

And the supply side in the oil markets support higher prices.

One example is the fall of the Gaddafi regime in Libya, which has demonstrated, once again, the institutional and power vacuum in a regime run by a dictator. While the power struggle continues, much of Libyan output remains offline.

"We believe that a resumption of about 250,000 to 500,000 barrels per day of production, on the assumption that Gaddafi actually falls, seems possible by year-end and into first quarter of 2012, but extrapolating Gaddafi's departure to the restoration of full output volume of 1.6 million barrels per day from Libya would be a mistake," analysts at Barclays Capital noted.

They further add that for any meaningful resumption of Libyan exports, aside from security of installations, the fragile oil infrastructure there, damaged by lack of investments, needed to be repaired.

Secondly, any new regime will have to renegotiate with foreign oil companies the terms of production sharing agreements for investments and operations.

Arabian Gulf Oil Company recently said there was no timeframe for Libyan oil output to resume, and it could take months. It added that about 700 Libyan oil wells needed workovers once security was restored.

"We would, however, expect the oil market to act with a sudden wave of market bearishness," Barclays said.

It might be too soon to draw parallels with Iraq, but the institutional and power vacuum there seems eerily similar to post-invasion events in Iraq, and readers will remember that it took eight years for Iraqi production to return to pre-invasion levels.

Analysts point out that while much of the geopolitical headline is dominated by events in Libya, the political discontent in both Nigeria and Syria and its impact on oil supply need to be factored in as well.

While Shell declared a force majeure on its Nigerian exports, which substitutes for Libyan supplies, until October, Western countries are mulling oil export sanctions against Syria, where the uprising has gone on for five months.

Any sanction, analysts say, will only serve to widen the gap between demand and supply.

But what is perhaps most important and arguably most overlooked in determining floor price for oil, is producer price aspirations, one that has had a sharp upward spiral.

Indeed, much of what the Arab Spring has demonstrated is the socio-economic discontent in these countries - one that Gulf countries, which are pumping in significant levels of money into social programs, are determined to keep from spreading.

Saudi Arabia, which is re-emerging as the swing OPEC supplier, has increased its fiscal package by 35% year-on-year compared with the positive impact of an 11% year-on-year increase in oil prices, which has led to a 29% year-on-year increase in breakeven prices to $86 a barrel compared to $68/bbl in 2010, Barclays said.

And any increase in social spending has to essentially come from higher oil exports revenue -all of which reinforces the need to maintain oil prices at an elevated level.

"The threshold for active producer involvement in the market is some $20 to $25 higher, lending support to an oil price at around $90 to $100 per barrel," Barclays said.

"This perhaps would be one of the biggest differences between 2011 and 2008 when it comes to determining a potential soft floor for price."

Barclays said any sustained move below $90/bbl would "entice some action on Saudi Arabia's part".

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