The Quiet Before the Storm?
The unrest in the Arab World and in the Middle East continues to spread.
The Egypt-style demonstrations in Bahrain turned deadly and on Thursday in Libya protestors are holding "a day of anger/" Similar protests were also staged in Algeria as well as in Iran, where at least 50 people were reported hurt.
Iran, Algeria and Libya are some of the world’s largest oil producers. I decided to catch back up with Richard Soultanian Co-President of the utility cost management firm, NUS Consulting, to get his outlook on the protests and what it could mean for oil.
LL: Are you worried about the Egypt liberation spreading?
RS: Yes, we are very concerned about the risk of contagion in the region. Former President Mubarak’s resignation appears to have created an odd calm in the equities and energy markets despite the fact Egypt now finds itself in the hands of the military, which was highly vested in the old regime, and with no clear successor to the Presidency, due to years of the Mubarak regime eliminating any potential rivals.
Moreover, the recent success in both Tunisia and Egypt has sparked demonstrations in Iran, Algeria, Jordan, Bahrain, Libya and Yemen. It is clear that the events in Tunisia and Egypt have not been fully contained. Although, the demonstrations in these countries, at present, do not appear to be as widespread or well organized as those in Tunisia and Egypt, their governments appear to be taking a much more forceful approach in dealing with protestors.
LL: Is this the quiet before the storm?
RS: This is one of our fears and would certain represent a worst case scenario. In viewing the current landscape in the Mideast we do not share the confidence and calm being exhibited by the equities and energy markets that the recent unrest will remain largely contained or resolved in a constructive manner.
In our view, the path from authoritarianism to democracy normally does not proceed in a straight line. In many instances this journey is high-jacked by those with long-standing interests and the final destination is not reached.
As such, we believe that repercussions from Tunisia and Egypt have yet to be fully felt or understood and we expect that in the coming months, events emanating from the Mideast will create increased volatility in the energy markets.
There is no doubt that further repression or token gestures will not put out the fire which started in Tunisia and Egypt. Recent demonstrations in Algeria, Iran, Yemen, Libya and Bahrain are just the immediate and visible repercussions of the recent events, there will undoubtedly be many more less visible and unforeseeable consequences in the future.
LL: What does all of this mean for the global oil supply?
RS: Recent events do not bode well for supply security and undoubtedly will add to risk premium/price volatility. Unlike Egypt and Tunisia, the countries in which we have seen recent demonstrations are important suppliers into the global oil system. Specifically, Iran, Algeria and Libya are the world’s 4th, 15th and 17th largest oil producers, pumping roughly 4.2 million, 2.2 million and 1.8 million barrels per day respectively.
Together, these three countries represent approximately 9 percent of the world’s daily oil supply/demand and sit atop considerable reserves.
Despite being a tinder box, the Middle East over the recent years had developed an uneasy equilibrium—the ouster of longstanding authoritarian regimes in Tunisian and Egyptian will most likely upend this equilibrium for a period of time as various actors attempt to gain advantage. The likelihood of potential supply disruptions has definitely increased as a result of recent events just as the supply and demand balance has been tightening due to the economic recovery.
LL: With the unrest in the Middle East and the Arab world where do you see the price of oil going?
RS: In early January NUS Consulting Group issued its oil price forecast for 2011. Our forecast called for oil prices to increase above $100 per barrel in the first quarter and then begin to decline into the $80-$85 per barrel range. Our analysis was based primarily upon the following factors:
(1) underlying fundamental economic activity around the globe has improved – particularly in the emerging markets, but the developed markets (i.e., the US, Europe and Japan) remain sluggish;
(2) supplies, at present, remain more than adequate to satisfy global demand; and
(3) a significant amount of pricing momentum seen in the past months was being driven by the US Federal Reserve’s overly accommodative monetary policy. At NUS Consulting Group we continue to believe that the Fed will not follow QE2 with QE3 and as this reality becomes clearer to the market, most likely in late April or May, some of the pricing pressure/momentum created by Fed policy on commodities will begin to ease.
At present, we see no reason to modify our forecast but note that the recent events in the Mideast will not only add significant additional volatility to the market but also have the potential to destabilize the current supply/demand balance—should the later occur oil prices will rise to precipitously to levels seen in 2008 which will most likely endanger the health of the global economy.
LL: Why is there a significantly large gap between WTI and crude oil?
RS: As most industry followers know, the WTI and Brent benchmarks reflect the price of a certain blend of oil located/delivered in the US (at Cushing, Oklahoma) or Europe respectively.
Both benchmarks represent pricing for light sweet crude (WTI being slightly lighter or containing less sulfur than Brent) and thus the difference in composition cannot provide the full rationale for the increased pricing spread.
In the recent past WTI was typically somewhere between $1 to $3 more expensive than Brent. However, over the past months this spread has reversed and grown to historically wide levels.
It seems that the growing price differential is a result of increasing stockpiles of oil available in the US. Although consumption in the US has increased in the past year—US production has remained fairly level, while imports from Canada have expanded considerably.
Consequently, US stockpiles which stood above 350 million barrels (excluding the SPR) for most of 2010—levels which had not been seen since the early/mid 90s—have effectively suppressed WTI pricing and made it less susceptible to exogenous factors. Brent, on the other hand, is used on an international basis and thus been more susceptible to geopolitical pricing risk as well as strong demand emanating from Asia/emerging markets.
LL: When will that gap close?
RS: At NUS Consulting Group, we are of the view that the gap between Brent and WTI will close when one of the two following events occurs:
US economic activity accelerates to keep pace with the emerging markets (thus reducing stockpiles) or the emerging markets succumb to increased inflation or tightening local monetary policy.
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A Senior Talent Producer at CNBC, and author of "Thriving in the New Economy:Lessons from Today's Top Business Minds."