For oil market veterans, it has a familiar ring. Turmoil in the Middle East triggers a spike in crude prices. Cue panic in financial markets.
This, time, though, even as oil moves above $101 a barrel to trade at its highest in more than two years, the message from analysts and traders is “stay calm”. Prices are heading higher, but are unlikely to challenge the record high of July 2008. Nobody is panicking, yet.
Brent, the benchmark crude for Europe and Asia, has jumped after a week of unrest in Egypt, amid fears that the protests which have paralysed the country could disrupt oil flows from the Middle East, which accounts for almost a third of global supply.
Yet today’s oil market is very different from that of early 2008, when crude prices first hit triple digits. Now, almost every link of the supply chain is padded with spare capacity, making the market less vulnerable to supply shocks. Stocks, while falling, are still at comfortable levels.
“We see fundamental differences from the situation today and the situation in 2008,” says Richard Jones, deputy director-general of the International Energy Agency. Brent first hit $100 a barrel in late February 2008, reaching an all-time high above $146 in July. Some oil bulls, even, are predicting a pullback from current levels because of these differences. Goldman Sachs, which is forecasting $105 oil by the end of the year, says crude is at risk of a “near-term price correction”.
The biggest change is spare capacity, from production to shipping and refining. The amount of idled production inside the Opec producers’ cartel fell to a record low of 1m barrels a day in early 2006 as global demand surged. Then, the oil market panicked in reaction to unsettling headlines about Iran’s nuclear programme and militant attacks in Nigeria. Traders worried that spare capacity could not cover even a small disruption to supplies.
But as the global financial crisis depressed world oil demand, the cartel’s effective idle capacity surged to a peak of more than 6m b/d in early 2009, more than enough to respond to even the largest disruptions.
Since then, rising consumption in emerging markets has eroded Opec’s effective spare capacity to below 5m b/d, by the IEA’s estimate.
Traders and oil officials believe a worst case scenario in Egypt – a closure of the Suez Canal and the 200-mile-long Sumed pipeline linking the Red Sea to the Mediterranean – would divert but not halt oil flows.
The US Department of Energy estimates the two conduits handled 2.1m b/d in 2009, which Goldman Sachs says was well below their capacity. Greg Priddy, oil analyst at Eurasia Group, a consultant, says the Egyptian military knows how to run the canal in the event of a strike. A total shutdown would not mean lost production, but a more costly 15-day trip around the Cape of Good Hope.
“There’s clearly a fear factor in the market,” says a senior executive at a leading oil trading house. But he adds: “Having said that, the market is only $3 or $4 up.”
Between 2005 and 2008, when shipping capacity was limited, that kind of disruption could have caused problems. But now there are enough idle tankers to meet the potential extra demand for shipping.
Moreover, there has been a huge structural shift in oil demand since the last closure of the canal, in 1967 after the Arab-Israeli war. Almost half a century ago the centre of gravity for demand was in the US and Europe and the canal was therefore crucial. Nowadays it has shifted to Asia, which does not rely on the canal.
“The impact of the closure of the canal this time around would likely be far more limited than in the 1950s and 1960s,” says Amrita Sen, analyst at Barclays Capital.
Global oil stocks are also higher now, further cushioning the market against any disruption. According to the International Energy Agency, oil stocks in rich countries are currently adequate enough to cover about 61 days of forward demand, near the highest level in 10 years and well above the less than 52 days’ cover in early 2008.
“The available slack in the system suggests persistent tightness should not be a feature” of the market, even if strong economic growth boosts demand, says David Kirsch, market analyst at consultants PFC Energy.
Yet, some traders are still concerned that the unrest in Egypt – and to a lesser extent Tunisia, Algeria and Yemen – points to wider instability in the oil-rich Middle East. They fret especially about Saudi Arabia, the largest oil exporter.
John Sfakianakis, chief economist at Banque Saudi Fransi in Riyadh, says events in Egypt should serve as a sharp reminder to governments across the Middle East about the pressing need to address rising unemployment and income disparities.
For that, countries such as Saudi Arabia, Iran and Iraq will need bigger oil revenues. That, in turn. could lead them to support higher oil prices. If so, the $100 barrel may be here to stay.
Copyright The Financial Times Limited 2011