Middle East: Middle East Energy Profile

Middle East Energy Profile

International oil prices have risen of late to levels not seen for two and a half years. The immediate cause is concern over political unrest in the Middle East and its effect or potential effect on the supply of crude oil from Middle East sources. In practice, however, that price effect is superimposed on a more fundamental influence on the current level of prices.

The existing uncertainties, exacerbated by the potential loss of Libyan oil production and exports already being experienced from the conflict or through sanctions, have stimulated sharp price increases. Those uncertainties started with the flow-on of disturbances from Tunisia to Egypt and Libya with protests also in Yemen, Oman, Qatar, Bahrain, Iran and Algeria. Those nine countries constitute over 13 per cent of global oil production. A blockage of any significant part of that production would have important impacts. Added uncertainties arise over possible transport interruptions: in Egypt leading to blockages of the Suez Canal, a crucial transit route for Middle East oil to Europe, and the Sumed pipeline, which links the Red Sea to the Mediterranean; in Bahrain, the US naval base that provides protection to Gulf shipping.

A much more substantial concern among oil importers is the possibility of major disturbances moving into Saudi Arabia and Kuwait. That this is not fanciful is reflected in Saudi Arabia’s provision of $35 billion in increased welfare payments to reduce the possibility of disturbances, with Kuwait acting similarly.

Libya recently accounted for a little over 2 per cent of global oil production, most of which is exported. Even a complete block on Libya’s production would not be large in terms of the the historical experience of supply disruptions in the oil industry and would probably, in due course, be offset from elsewhere. Libya, however, provides a wide range of European countries — Italy, France, Germany and Spain being the main importers — with a light sweet grade of crude that fits European refineries. While oil is ultimately fungible, qualities vary widely and refineries are usually configured for particular grades and types. While Algeria produces similar grades of oil, disturbances in that country pose further uncertainties about its capacity to provide substitute sources for European refineries. So the disturbance to European customers is significant.

That prices have increased rapidly in part reflects particular shortages in Europe, where the Brent price is the relevant price marker — going from $79 in September 2010 to $116 in March 2011. Yet, that oil prices have been rising since September 2010 suggests that much of the price rise has been demand stimulated rather than reflecting supply constraints or fears of such constraints from the disturbances. Brent crude oil supplies were already tending to tighten as demand strengthened and expectations were that prices would continue to rise gradually towards the $100 in early 2011 as the International Energy Agency (IEA) revised upwards its forecasts of demand growth. Well before the Tunisian unrest, which started the regional protest movement, the IEA had expressed concerns about the impact on the global economic recovery of the high oil prices, and there were discussions between IEA and the Organisation of Petroleum Exporting Countries (OPEC) about augmenting production.

Saudi Arabia has said that it would be able to increase production to offset any loss from the shut off of Libyan production. Saudi spare capacity is mainly in the heavier sourer grades and does not provide a full answer to the problem of substituting for Libyan oil. Many analysts, however, believe the Saudis had already been increasing production to bring international prices back down to levels closer to their preferred $70-80 a barrel, or perhaps a little higher. Not all OPEC members, however, support the Saudi desire to hold the price below $100 a barrel.

It is clear that oil price increases of the kind being experienced at present are bound to disadvantage oil importers, developed or developing and increased petrol prices at the bowser will take increased spending out of the hands of consumers with consequently less to spend elsewhere. The extent of the impact of oil prices on economic growth is much debated with a lot depending on whether the price rise comes from supply reductions or from growing demand.

Various estimates have been made of the impact of the oil price increases on economic growth and global economic recovery. Australia’s Reserve Bank estimated that a 10 per cent rise in oil prices, if sustained, would cut GDP growth by -0.22 per %. This appears consistent with the view of the US economist James Hamilton in the case of the US. He estimates that a $20 or so oil price rise would cut US GDP by around half of 1 per %. How long ‘sustained’ is can be debated, but since September 2010 the oil price has increased by substantially over 20 per cent. In practice, rising demand accounts for much of that. Nevertheless, if sustained, we could perhaps expect an impact of at least half of 1 per cent of GDP growth.

Provided Saudi Arabia and Kuwait manage to avoid undue disruption, and other disturbances are held in check, oil prices will likely fall back from their current peaks. But given the current strong economic pressures leading to increased demand for oil, particularly in Asia and notably in China, it is likely that the underlying upward pressure on oil prices will resume reflecting, among other things, a longer term perception of emerging scarcity.