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Trouble at Trouble at the Top of the Pyramid – Brent Tops $100 on Supply Concerns

Thinkng points:

    • Oil prices have moderated from two year highs despite the fact that a disruption to supply seems unlikely

    • OPEC spare capacity and high inventories provide flexibility in the global system and a ceiling for potential price spikes

    • Geopolitical turmoil in other less democratic, oil producing states could add further volatility to oil prices in 2011

The latest geopolitical turmoil and protests in Egypt, along with volatility in the oil markets, have shifted the world’s attention to North Africa and the Middle East. As a result, Brent traded last week above $100 per barrel for the first time since 2008, and WTI flirted with a new high for 2011 before moving back below $90 per barrel. While Hart Energy does not expect a disruption in crude oil production
or transportation of crude and refined products through the country, the situation does appear to highlight a longer-term geopolitical price premium which could once again raise its head in the market. As demand forecasts remain bullish for 2011, much of the attention has been focused on the supply side, so potential threats to it will put upward pressure on prices.

Political turmoil has spread to Yemen and Egypt, after president Zine El Abine Ben Ali from Tunisia stepped down, making this the first time in generations that an autocratic North African leader has done so, due to political pressure. Many oil producing nations in Africa and the Middle East have similar political structures in place that reduce the ability of its citizenry to express themselves politically in an era where technology allows for increased openness. Consequently, there is major concern that we could see a domino effect in the region, amplifying the potential for a disruption to crude oil flows. The table on the following page illustrates the longevity of current leaders in the region in oil-producing countries.

In particular, Tunisia, Jordan, and Yemen appear to be the most at risk, while Algeria and Libya, which together account for approximately 2.6 million barrels of daily crude oil production, are close neighbors in North Africa. While OPEC would more than likely increase production if there was a disruption to the region’s crude oil supply ̶ Saudi Arabia is sitting on 4 million barrels of spare production capacity ̶ it would still take time for short-term markets to react and for this oil to get into the market. Any action by OPEC would put a ceiling as to how high prices could potentially go.

OPEC Quotas and Production (thousands of barrels per day)

OPEC Quotas and Production (thousands of barrels per day) - click for larger view

When compared to some of its North African and Middle East neighbors, Egypt is a marginal producer of crude oil and is actually a net importer. According to the EIA, production stood at roughly 675,000 barrels per day in 2009. However, the country does conduct significant transit of crude oil and refined product flow. An EIA report has identified the Suez as one of the seven major choke points through which vessels carry high volumes of oil. Concerns have been heavily weighted toward a potential disruption of flows through the Suez Canal or Suez-Mediterranean (Sumed) pipeline which, combined, account for approximately 3 million barrels per day of crude and products. A disruption to either route would increase transportation costs, as cargoes headed for the Atlantic or Mediterranean would be forced around Africa’s Cape of Good Hope, pushing prices even higher. However, both routes will be protected at all cost and Hart Energy does not expect any disruption.

The ability of the United States to help manage a potential spike in oil prices is somewhat limited. While President Obama could release some additional oil from the Strategic Petroleum Reserve, it would be more of a political statement to calm the markets since crude imports to the U.S. would be marginally affected. Brent’s current premium over WTI is highlighted by the current demand vs. supply factors as inventories at Cushing are already well above average, while Asian markets are driving demand for African and Asian crude. Brent prices have also been supported by the unexpected closure of several platforms with no announcement as to when production will resume.

Geopolitical tension more often than not leads investors to bid up commodity prices because of their physical nature, and oil is a prime example. However, when the threat is close to the source (i.e., the Middle East), the market is even more sensitive to price escalations. While incremental supply disruptions played a role in pushing prices up to an all-time high in 2008, the psychological impact of events in Iraq, Nigeria and Iran all played roles as well. In 2006, when Israel invaded Lebanon, we saw a similar reaction to prices even though crude supplies were not impacted. The longer the situation in Egypt
lingers, or if political turmoil continues to spread to other countries, the more likely a price premium will remain in the market.

For more information please contact:
Hart Energy Research | | 1616 S. Voss Ste. 1000, Houston TX 77057 | +1.713.260.6400

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