Oil prices are likely to extend last week's gains despite assurances from de facto OPEC leader Saudi Arabia that it's willing and able to meet any supply shortfalls from Libya, according to the latest CNBC market sentiment survey.
Production shutdowns in OPEC member Libya and fears that the contagion may spread to neighboring oil-rich countries in the region, drove Brent crude oil last Thursday to a two-and-a-half year high of nearly $120 a barrel and U.S. crude to more than $103. Nymex crude futures jumped by nearly $2 towards $100 a barrel during Asian trade Monday.
The sharp and disorderly rise in oil prices may further stoke inflationary pressures that have already been building as food costs surge. A prolonged rally in oil prices will impose a hefty burden on consumers, particularly in the U.S., where consumer spending accounts for two-thirds of the overall economy.
Last week's turbulence has raised the specter of the 1970s style oil crisis. PIMCO chief executive Mohamed El-Erian told CNBC last Wednesday that the mounting unrest throughout the Middle East and North Africa is fueling a period of oil-price shock for the global economy.
It may be a cliché but the Jasmine Revolution is nothing short of a fluid situation. Armed rebels who have seized control of Zawiyah, close to the capital Tripoli, were preparing for a counter-attack on Sunday as Libyan leader Muammar Gaddafi vowed to cling on to his 41-year-old rule.
In Oman, police fired rubber bullets at stone-throwing protesters demanding political reform on Sunday, killing two people, and demonstrators set government buildings and cars ablaze, witnesses said. Meanwhile, in Bahrain the king reshuffled the cabinet in a further attempt to appease the Shi'ite opposition that has staged days of protests against the Sunni-led government.
More importantly, Saudi Arabia's stock index slumped to a nine-month low on Sunday and most Gulf Arab markets also slid on fears unrest was spreading in the region. The kingdom's benchmark fell 5 percent to its lowest level since June 6, with investors unmoved by a $37 billion social spending plan announced by the country's monarch last week.
Against such a rapidly evolving background,investors may need to brace for another round of oil-induced volatility this week. This week, 7 out of 12 respondents, or more than 58 percent, expect oil prices to rise, two predict prices remain around current levels while just 3 respondents said prices would ease, the survey showed.
"I can't see the market being anything but jittery over the next few weeks.""
"I can't see the market being anything but jittery over the next few weeks," said Ben Westmore, Economist, Australia & Commodities at National Australia Bank. "Indeed, if instability in the region does settle and there is a supply response from the Saudi's, it will take some time for the market to fully process and transmit to prices."
The International Energy Agency reported late last Friday that Libya is probably still producing about 850,000 barrels of oil daily, down from its normal capacity of 1.6 million barrels but acknowledged the estimate is based on "incomplete, conflicting information." Libya produces just under 2 percent of the world's oil, most of which flows to Europe.
Saudi Arabia, the world's top crude oil exporter, has attempted to calm markets by saying it will step in and offset any shortages with extra crudeif customers ask for it.
Saudi Arabia has increased its oil production by more than 700,000 barrels daily to more than 9 million bpd to compensate for disruption to Libyan output, an industry source familiar with the kingdom's production told Reuters last Friday.
"It is less likely that the current high oil price prices will last," said Michael Langford, Proprietary Trader at StreamTrading.com. "Particularly as there is no actual shortage of oil, coupled with other producing countries such as Saudi Arabia willing and able to make up for any lost Libyan production. As long as the situation in the Middle East does not escalate then the oil price should fall back."
As the 'swing producer' holding the bulk of OPEC's spare capacity, Saudi Arabia may have acted unilaterally as it has done in the past, circumventing OPEC process, according to a report out of Washington by industry publication Energy Intelligence. "The Saudi move has not been announced publicly, most likely because of the political sensitivities in the region and the internal dynamics of OPEC," Energy Intelligence wrote.
Linda Rafield, Senior Oil Analyst at Platts, said the Saudis are ready and have the spare capacity to replace lost Libyan volumes. "Naimi reiterated that $70-$80 a barrel was good for producers and consumers so the Saudis probably are concerned about a price spike."
Sweet Versus Sour
Still, some have pointed out that the Saudi moves, as decisive as they are haven't, cooled overheated prices appreciably. The reason: Saudi crude is mainly heavy and sour and cannot directly replace the light sweet grade produced by Libya.
The Saudis have disputed this. A Saudi source informed Platts that the Kingdom would be able to ramp up production of lighter grades to make up for the loss of Libyan high quality light grades to Europe. "Saudi Arabia is willing and capable of replacing all missing oil and by the same quality of oil, Arab Extra Light."
Furthermore, Olivier Jakob of Petromatix says that "the global refining system is not as stretched as in 2008 and that should allow for a greater flexibility in the composition of the crude slates."
"Valero Energy has restarted over the last few weeks its 235,000 barrel a day refinery in Aruba that was shut in July 2009 and that is a refinery that runs on heavy and sour crude oil. Likewise the mega-refinery in Jamnagar India that started in 2009 is able to process all sorts of crude oil including heavy and sour crude oil," Jakob continued
From the perspective of the major consumers, supplies are sufficient enough to cope with a shortfall from Libya. The Energy Department said Thursday that the United States' commercial oil inventories were 2.7 percent higher than a year ago. Plus, the International Energy Agency, which represents the major industrialized consumers, said it could release emergency stocks if needed.
Despite the calls for calm, upgraded price forecasts and worst-case scenarios for supply from the North African producers are grabbing the headlines and bolstering the position of the bulls. One of the most aggressive calls came from Nomura's Michael Lo who forecast crude futures prices could peak above $220 a barrel if Libya and neighboring Algeria "were to halt oil production together."
J.P. Morgan meanwhile revised its average forecast for Brent crude up by nearly 14 percent in 2011 as the supply-demand situation is expected to tighten on Libyan output losses.
"While we envisage spot Brent prices easing over the balance of the year toward $95 per barrel as refinery maintenance season progresses and producers maneuver to offset supply losses, there remains a smaller but significant chance that prices move toward $180 per barrel if supply disruptions increase," J.P. Morgan analysts led by Lawrence Eagles said in a note late on Feb. 25.
Eurasia Group Middle East analyst Mohammed El-Katiri offered a bleak assessment of the Libyan unrest and its impact on oil production.
"We are headed to a scenario of sustained domestic unrest and violence over the next 4-6 months as Qadhafi tries to retain his hold on power," El-Katiri wrote. "Such a scenario bodes poorly from an oil production point of view on two counts: not only will it compromise production with Qadahfi still in power, but ongoing violence could further complicate the ability of a post-Qadhafi political order to emerge in a manner that creates a stable domestic security environment."
"We are headed to a scenario of sustained domestic unrest and violence over the next 4-6 months as Qadhafi tries to retain his hold on power.""
Even if there is a swift resolution to the Libya crisis, inter-tribal tensions may mean uninterrupted oil flows out of Libya are not necessarily guaranteed, Eurasia's El-Katiri noted.
"The immediate post-Qadhafi era would be characterized by a deep divide among tribes, particularly inherited resentment against tribes that supported Qadhafi," he said. "The divide could also be triggered by disagreement over the share of political power and wealth, which more likely will be based on the size and location of tribes. This prolonged political instability could limit the likelihood of resuming full-capacity production, particularly that oil production requires a renewed inflow of skilled hydrocarbon sector workers."
Leaving the fundamentals aside, Daryl Guppy, chief executive of Guppytraders.com expects prices to continue their bull run from a chart perspective. He characterizes last week's gains on Brent crude futures as a "rally on top of an existing uptrend" that started around September-October. Expect another break above $100 a barrel this week for U.S. crude futures with resistance at $112 then $123 and technical support at $98, Guppy said.