Oil and Gas in the Capitals

	Vol. 232 No. 6
DR. A. F. ALHAJJI, CONTRIBUTING EDITOR, MIDDLE EAST

The ‘Arab Spring’ springs oil prices

Middle Eastern oil production at risk vs. OPEC spare capacity.

For the oil and gas industry and the global economy in general, the most significant news to come out of the Middle East in recent months is not about any of the events that took place, but rather what did not happen: None of the major oil producers experienced an Egypt-like revolution. Oil continued to flow normally, and the largest producers increased output to compensate for the loss of Libyan oil. Just imagine how the oil market would look if the Arab revolutions had extended to Saudi Arabia, the UAE and Kuwait.
 
So far, the impact of turmoil in the Arab world on oil and gas markets has been largely limited to the loss of Libyan oil and production declines in Egypt, Tunisia and Yemen. At the time of writing, pipeline bombings have reduced Yemeni oil production. Luckily, LNG exports have not been affected … yet.

These events, along with the possibility of reduced exports from other countries, have played a large role in the recent increase of oil prices by about 30%, affecting both fundamentals and the speculative component of prices. Most of the initial increase was related to the sudden loss of Libyan oil. Prices would have retreated quickly if OPEC were able to compensate, but the quantity of oil lost was too large and its quality was too high. After the initial reaction, oil prices continued to increase due to quality and distance differentials. Libya’s oil is light with low sulfur. The increased output from Saudi Arabia and other OPEC members has been heavier and sourer. Even the two new “manufactured” blends by Saudi Aramco to compensate for the Libyan crudes did not match the quality and the price. In addition, Saudi Arabia, unlike Libya, is far from European markets.

Demonstrations and turmoil are expected to continue in the foreseeable future, casting their shadow on global oil and gas markets. What we are witnessing is a “clash of generations.” The removal of a president or a regime will not bring back stability. Therefore, the risks that existed before the collapse of the regimes will continue for an extended period of time. In addition, this generational struggle will eventually surface in the larger oil producing countries, particularly Saudi Arabia, Iraq, Kuwait and Iran.

Oil at risk. The graph shows the amount of oil production at risk in the Arab world, including that which has already been lost in Libya and Yemen. The total risked production is almost equal to available spare capacity, which exists mostly within the same region. In the worst circumstances, if we lose all the oil from these countries, other OPEC members (mostly Saudi Arabia) can compensate, but the world will have no cushion. Luckily, the probability of losing the oil from all these countries at once is near zero. Therefore, the world has enough spare capacity to compensate for shortages.

Egypt. Despite oil and LNG traders’ nervousness during the massive protests against Hosni Mubarak and his government, the actual impact of the demonstrations and subsequent de facto military coup on the global oil and gas markets was limited. But the perceived risks still exist, and will remain with us for a long time.

These perceived risks are quite real with regard to the country’s own production, but are exaggerated with regard to Egypt as a transportation hub. Domestic events have never closed the Suez Canal or affected the flow of oil in the Sumed pipeline. The canal was closed only when other countries were involved, such as the events of 1956, 1967 and 1973. Egyptians across the political spectrum realize that revenues from the canal are badly needed and that Egypt’s reputation as a stable trade route hinges on the canal. This leaves only one scenario that could close the canal: an international terrorist attack on ships there. This possibility is remote since the canal is protected by its own police, and the Egyptian Army, the Israel Defense Forces and the US Navy are not far away. In the worst scenario, it would take the Canal Authority about two days to remove a disabled ship and clear the canal. The Sumed pipeline, meanwhile, is buried underground and well protected.

While Egypt’s midstream sector is relatively insensitive to political factors, the recent turmoil did take its toll on the upstream, reducing the country’s oil and gas production. However, impact on oil and gas markets was limited. Expatriates left, while Egyptian engineers and workers went on strike. Similarly, the biggest threat to oil and gas production in the future is not violence, but labor strikes.

In conclusion, while the impact of turmoil in the Middle East remains limited, the “clash of generations” in the region will increase the risk of supply interruptions for years to come. OPEC and market participants have already learned an important lesson: The quality of spare capacity matters just as much as the size. WO