Thursday, March 10, 2011

Oil And The Economy

This essay by Ambrose Evans-Pritchard of the Daily Telegraph brings out into the open what has been obvious ever since Tunisia started to go up in smoke a few weeks ago. Oil prices dictate our future and if they go too high they kill of our already ailing economy. If they go too low they kill off Saudi Arabia's ability to pay off it's malcontents with payouts. The price of oil must be seen to be stable and affordable. Now there is no stability and Saudi Arabia is scheduled to start going up in smoke this week. Our future hangs in the balance and no one seems ready to discuss our vulnerable position. Except Evans-Pritchard and even though I dispute the commonly held assertion that the world economy is in recovery I like the way he lays out the inevitability of disruption. It's all by numbers not be guesswork. We face the mother of all oil crunches apparently.
Goldman Sachs suspects that OPEC has been pumping far above its agreed quota since November and therefore cannot easily raise output much without cutting deep into global spare capacity.

Jeff Currie, the bank's oil guru, said Saudi output had quietly crept up by 700,000 barrels a day (bpd) even before the Libyan supply shock.

Assumptions that OPEC has added 1.9m bpd over the last two years are wishful thinking. These new fields have been "largely offset" by attrition in old fields.

"We believe that OPEC spare capacity has already dropped below 2m bpd. The question therefore arises how much spare capacity is left to absorb potential supply disruptions in other countries," he said.

If this picture is broadly correct, spare capacity is already close to the wafer-thin levels that led to wild price moves in mid-2008.


Beyond a certain point, the price spiral can kick in with explosive force until the economic damage crushes demand.

Libya's conflict has already cut spare capacity by a third. Hopes for a quick solution are fading as the country succumbs to civil war along ancient lines of tribal cleavage. A raft of new projects planned for the Sirte Basin by mid-decade will be mothballed.

Chris Skrebowski, editor of Petroleum Review, said the long-denied oil crunch is starting to bite. "We cling to the comfort blanket that spare capacity exists, but it is mostly fictional, or inoperable. If you take 2m bpd off the figure, the whole dynamic of global oil supply changes," he said.

A Wikileaks cable cited a Saudi geologist claiming that the kingdom's reserves had been overstated by 40pc. A second cable questioned whether the Saudis "any longer have the power to drive prices down for a prolonged period".

Some investors see trouble. They are buying oil options contracts for $150 and $200 a barrel with expiry dates late this year, either as a bet or as an insurance against Mid-East mayhem. Barclays Capital said the options "call skew" is more stretched now that it was during the 2008 spike.

The implication is that markets are less sure this time that the crisis will blow over quickly, perhaps because the events the last month amount a strategic rupture.

The entire political order of the Middle East has effectively disintegrated, risking of years upheaval in a region that provides 36pc of global oil supply and holds 61pc of proven reserves.

Mass protest by Bahrain's Shi'ite majority against the ruling Sunni dynasty has been a rude awakening for investors who thought oil wealth would shield the Gulf against turmoil.

"We in the West have been listening to the wrong people," said Mr Skrebowski. "We have not been talking to the young: we missed what was happening underneath."

Bahrain sits at the epicentre of the world's energy system. It is a hop to Saudi Arabia's Eastern Province, home to an equally aggrieved Shi'ite population and the kingdom's giant oil fields.

Bahrain's Al Khalifa family has sought to defuse the island's crisis since the original crack-down, when seven people died. Yet protesters have refused to drift away, digging in at the financial hub and staging rallies outside the interior ministry. Sectarian violence between Sunni and Shia has been escalating.

What happens on the tiny island is being watched with alarm across the Gulf. The "demonstration effect" has already led to Shia protests in the Saudi oil region. Saudi police have released a Shia cleric arrested last week for demanding a constitutional monarchy.

Yet the country's Wahabi clerics also warned against "sedition" and violations of Islamic law, while the interior ministry said all rallies were banned and warned that police would use "all measures to prevent any attempt to disrupt public order."

The threats aim to quash a "Day or Rage" planned by cyber-protesters for Friday, allegedy swollen to 17,000. A similar event in Syria was nipped in the bud by secret police.

The world's economic fate now hangs on the success of Wahabi repression. Any sign that the Saudis are losing their grip risks an oil shock large enough to derail the global recovery.

Nobody knows where the "inflexion point" is. Bank of America says we are already in the danger zone since energy costs as a share of global GDP have reached 8.5pc, near historic peaks.

Deutsche Bank said the outcome differs depending on whether spikes are driven by booming demand or a supply crunch. It warns that a sudden jump to $150 will abort world recovery.

Former Fed chief Alan Greenspan said economists have been "bedevilled by over the years" trying to quantity the effect of oil shocks. "We don't know fully where all the channels are. My view is that when oil prices get up to this area and start to move up even higher, you do have to start to worry."

No comments: