Oil at $119: The 'devil's excrement' hits the fan
Brent Crude today has reached $119 a barrel. It is of scant concern to those fighting for their lives in Libya, or to maintain and extend democracy in the rest of the Arab world, but there are now clear economic risks arising from this power-shift in the Middle East, and they're starting to filter through to investment decisions.
Here's the main danger:
> the conflict spreads, temporarily choking off supplies
> speculators pile in (there are 2.5x the number of call options to put options on oil futures markets right now)
> this drives the price up towards where it ended up in 2008 - around the $150 mark
> and this chokes off the recovery leading to an oil price slump and a commodity price slump
Nouriel Roubini says that the oil price rise was a major transmitter of negative growth out from the financial crash in 2008.
An oil price spike, however temporary, could again reduce the world's spending power, turning recovery into stagflation.
For this reason some investment analysts are now hedging their bets towards a second downturn: Religiare Capital Markets just issued a note saying that a point may soon be reached where "demand destruction" takes place - ie the oil price tanks the real economy.
Most analysts don't think the social unrest will spread to Saudi Arabia - however the risks arising from the commodity Venezuelans call "the devil's excrement" are more longterm and complex.
One of the reasons the West bent over backwards to get Gaddafi on board in the mid-2000s is because Libya's oil represented the last major source of fresh, high-quality, cheap to produce oil that was not being tapped by the oil majors. If you buy the Peak Oil scenario, the tendency in future would be to go to more expensive, hard to get, lower-quality venues, such as offshore in the Gulf of Mexico (with all the political risk that now involves), or the tar sands of Canada.
In addition there is the political factor for the oil majors: most decent onshore reserves are now controlled by national oil companies, who have changed the term of trade with the big oil companies to their own advantage.
Libya was - in theory - a chance to decrease the strategic risk. Unlike Saudi oil it does not have to go through three pinch points: the straits of Hormuz, the Mandab Strait and the Suez canal. It can, and does, go mainly straight to Europe (only 14% of Libyan oil goes in the "wrong" direction, through the Suez canal to Asia).
So Libyan oil - once Gaddafi was squared and Megrahi returned to Tripoli - was seen as "out of the chaos zone".
On the terms of the oil contracts things are complex: we don't know the full details - hopefully somebody will be obliging enough not to destroy the documents should Gaddafi's last day in power arrive.
However the general trend in Libya had not been great for the oil majors: Libya's cut reportedly moving from the traditional 60/40 split between Libya and the oil company to, in one case, 92%. Oil analysts believed that in the past year a "conservative faction" had gained control of oil policy and was squeezing ever more revenue for the regime out of oil contracts. (See this article by Fawzia Sheik of oilprice.com)
But the suspicion is that for BP, the numerous political contacts, back-slapping sessions, LSE donations etc. may have been worth it on a strategic level - however large a cut the Libyan state was taking - because any new source of cheap supply is better than none, and the exploration deals alone were, for BP, pretty huge at the time.
This is what is thrown into confusion as the Libyan people take control of their destiny.
It looks now like enough of the regime has defected to make a smooth transition possible, whereby the existing oil contracts are honoured and production not massively affected. (This would be thrown into doubt if Robert Baer's report in Time, of alleged sabotage plans by Gaddafi, were to come to pass).
If the supposedly "conservative" oil faction goes down fighting with Gaddafi, and a stable replacement is established, then the opportunity is there for the oil companies finally to deal with a new government which respects the international rule of law.
If however the whole thing ends in chaos, the net political risk to Middle East oil is strategically hiked - because the rest of the oil - in Saudi, Kuwait, the Gulf Monarchies - lies within range of Iran's Fajr-3 missiles, and indeed the Iranian production would be vulnerable to any social revolution there.
Across the region it is likely that increased democracy will mean increased distribution of oil wealth - and other economic rent income, such as with the Suez canal and various pipeline transit fees - to the people. Even without the revolution, as the surviving despots dole out free cash, this is starting to happen. What that means is oil prices will be, tendentially, higher than they would have been where wealth is simply hoarded and then spent in the boudoirs of Park Lane hotels.
In the long-term the economic outcomes of these revolutions will affect all the other outcomes - and Europe has begun to realise this means stability here too.
The obvious answer is for Libya - with massive foreign exchange reserves and healthy economic growth even under Gaddafi - to create the kind of country that people might want to live in rather than to leave.
This now looks possible. It will be a major challenge for the State Department, the FCO and the Quai d'Orsay to start summoning the kind of will to help it happen that has eluded them previously.