Oil markets are on edge, surpassing once again the psychological three digit barrier. With eyes glued on Tahrir Square over the last few days, crude continues to hover on or above the $100 mark. Brent is flexing muscle at its highest level in more than 2 years. From $95.25 a barrel on Jan. 25, the first day of mass protests in Egypt, Brent has been on up.
Markets seem rocked by the political protests in Egypt, raising serious concerns about the security of energy supplies. The turmoil is reverberating, battering stock markets all around, driving up oil prices and raising questions about whether the rising cost of crude would begin impacting adversely the state of the global economy.
Egypt is not a major crude producer, yet it is home to Suez Canal. And about a million barrels a day of crude and refined products are shipped northward on the Suez Canal, according to the US Department of Energy. A separate pipeline across Egypt carries 1.1 million barrels a day between the Red Sea and the Mediterranean. Together, that is roughly 2-2.5 percent of global oil production.
Bypassing the canal means vessel carrying crude from the region would have to go around the Horn of Africa, adding time and expense. Any closure of the Suez Canal would thus force shipments to seek alternative routes, adding about 10 days to the time it takes for Middle East oil to reach the US and 18 days for the trip to Northern Europe. That alone would push up crude prices, even if supplies were adequate, in the wake of emergency reserves around the world.
Yet the jitters about Suez closure, while understandable, appear misplaced. “The possibility of a halt in shipping on the Suez Canal is remote, to say the least,” said economist Travis Tullos of TXP, an Austin-based consulting firm. “It would not and should not be tolerated.”
The prospects of the Suez closing down due to the continuing flux in Egypt appear overblown. “We think the canal will remain open,” says Helima Croft, analyst at Barclays Capital in New York. “Closing the canal like we saw in the six-day war would require a decision by the Egyptian military. There’s no indication they would do anything like that. It’s a major source of revenue for the (Egyptian) government and they wouldn’t want to tarnish their international reputation by closing it.”
And thus despite protests spreading to the city of Suez over the last few days, oil transit through the Suez Canal and the Sumed pipeline, both guarded by the military, remain unaffected.
And then even in the extreme, rather improbable case of, the Canal and Sumed pipeline closing down, this could not be eternal. At best this would be for a few days, before powers that matter would intervene to reopen it. And for the few days of that remote possibility of closure, the flow through Suez could easily be replaced by the spare capacity with the OPEC. And currently there is no shortage of oil in the market. Russian crude oil production in January, at 10.2 million bpd a day, is 1.6 percent more than a year ago, says Commerzbank and as per the API, the US inventories of crude oil increased last week by 3.8 million barrels.
And the other factor contributing to the current price imbroglio is the increasing concerns about the wider ramifications of the events in Egypt on the politically volatile Middle East. Growing unrest in North Africa, and its significance for the wider Arab region, has brought political risk back to the fore for an industry, which interestingly is in rude health. “The principal concern remains that the Egyptian civil unrest could spread to Middle Eastern and North African oil producers, and this is generating significant reverberations in financial asset prices and confidence,” J.P. Morgan said in a research note.
Large protests in recent days have been reported from Yemen and Algeria. Crude oil production in these countries is not that significant. Algeria and Yemen averaged 1.8 and 0.262 million barrels per day respectively during the first ten months of 2010 according to the US Energy Information Agency (EIA).
A consensus however, seems building that markets are over reacting to the doomsday scenario. “We believe that markets have over-reacted to the Egyptian concerns,” says Scott Darling, Nomura’s Middle East energy and power analyst. “In terms of oil price movement it seems more sentiment driven rather than actual significant supply constraints.”
And most pundits are skeptical of the notion that the protests could spread to other countries, in the region, with globally significant oil production. Ground realities in the wider oil rich, Gulf Arab states are significantly different from Egypt, most agree. “The markets may have over-reacted to this political upheaval which we doubt can spread beyond Egypt and Tunisia,” underlines Angelos Damaskos, the CEO of London-based Junior Oils Trust.
However, these perceptions have led investors to increase their bets in recent days, that oil prices may surge to as much as $250 a barrel. Open interest in the $250 call option for December, which give the buyer the right to purchase oil futures on the New York Mercantile Exchange at that price, climbed to 242 from 142 on February 1 and stayed at that level until Thursday.
Yet, the current blip on the markets is simply an overreaction. It seems a phase in passing. Once things begin to cool down in Egypt, markets should get back to basics. The political tsunami in Egypt may indeed change the political landscape in the region, one cannot deny, yet in all probability it would not impact the crude demand — supply fundamentals in a rather significant manner in the short to medium term — one could say with some degree of confidence.
