Rapidly developing events in the Middle East, especially the threat of chaos and an escalation of armed conflict in Libya (which is the world’s 12th largest oil-exporting nation), have driven the price of crude oil up sharply in recent days. The Eurasian benchmark ICE Brent price has shot up about 9% to around $114 a barrel (at one point hitting more than $119 a barrel in intraday trading Thursday). Meanwhile, the North American West Texas Intermediate (WTI) benchmark rose about 10%, to about $100 a barrel.
Fears that rapidly increasing oil prices could set back the nascent global economic recovery has sent stocks tumbling, with the Dow Jones Industrial Average down a little less than 3% from last week, and the Standard & Poor’s 500 Index off a little more than 3%. Particularly hard hit were industries in which oil is a major cost factor, such as the airline industry. The NYSE airline index was down about 15%, while the Dow Jones Transportation Index has suffered outsized declines. Analysts estimate that at a per-barrel price of $120, most companies would have to start reckoning with materially higher energy costs, forcing such users to raise prices, which would likely slow overall economic activity.
The question then, is whether the current price run-up will continue. Prolonged unrest in Libya, especially if it should spread to other major oil-exporting nations, would unquestionably disrupt global oil supplies, sending prices up further. Indeed, unconfirmed reports out of Libya already estimate that the country’s daily output has fallen by anywhere from a quarter to three-quarters as a result of the conflict. With the situation in that country as fluid as it appears to be, it is impossible to rule out further rises in the price of oil, just as it is impossible to discount a sudden reversal of the price run-up. Investors should be cautious of an energy market in such fear-induced disorder.
One indication of the disruption of global oil markets is the fact that the ICE Brent and WTI benchmarks have shot up in almost perfect tandem since the beginning of the crisis. The WTI benchmark has been trading at a historically large discount to the Brent price during the last six months, or so, due to large new supplies of shale oil coming out of North Dakota, increased oil sands imports from Canada, and a pipeline infrastructure not designed for growing production north of the U.S. Gulf Coast region. The amount of this discount has remained almost exactly the same since the beginning of the Libyan meltdown, despite the fact that the U.S. is the destination for less than 0.5% of Libyan exported oil. In other words, given the indirect effect of a reduction in Libyan exports on U.S. supplies (and thus the WTI price), the gap between WTI and Brent should have widened more.
One thing investors should watch for is an indication from the U.S. government that it is considering releasing oil from the Strategic Petroleum Reserve (SPR); even a small release would likely calm the markets, especially for forward prices connected to the WTI. Similarly, signals from OPEC or IEA of production increases (in the case of the former) or reserve releases (in the case of the latter), would serve to reverse the run-up in the ICE Brent price. Lastly, it is worth noting that most of Libya’s hydrocarbon reserves and export facilities are located in the east of the country, which is the part already under the control of anti-Qaddafi rebels. If these forces can show that they can keep the oil flowing from these facilities, it would go a long way toward restoring calm to the energy markets.
At the time of this article’s writing, the author did not have positions in any of the companies mentioned.