Middle-East Crisis & Crude Oil

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Crude Oil Crude oil prices have recently spiked in the international markets on the back of the turmoil surrounding the Middle-East and other African nations. The geo-political concerns which erupted from Tunisia followed by Egypt and Libya led to concerns that oil supplies from the Middle-East and the African nations would be disrupted. After the Egyptian President, Hosni Mubarak had to step down from his President’s post after ruling around 30 years, the other countries in the Arab world started demanding an end to their autocratic rules. Crude oil prices, which were trading in a range of $80-$90 per barrel since December 2010, suddenly spiked since 21st February 2010. Oil prices on the Nymex touched their two-year highs of $103.41/bbl, whereas the London benchmark Brent touched a high of $119/bbl. Since February 21st, oil prices have gained more than 15% (till 3rd March 2011) on the Nymex, whereas on the MCX, oil prices gained around 14% during the same time. Gains in crude oil prices on the MCX were slightly tempered on the back of a stronger domestic currency. The Indian Rupee has gained around 0.5% in the last two weeks against its US counterpart and this capped gains in oil prices on the Indian bourses. Oil prices since December 2010 105 100 95 90 85

12 /1 /2 12 0 10 /8 12 /20 /1 10 5/ 12 2 01 /2 0 2/ 2 12 0 /2 10 9/ 20 1/ 10 5/ 2 1/ 01 12 1 /2 1/ 0 11 19 /2 1/ 0 1 26 1 /2 0 2/ 11 2/ 20 2/ 1 1 9/ 2 2/ 01 16 1 /2 2/ 0 11 23 /2 0 3/ 11 2/ 20 11

80

Nymex Crude Oil Prices $

Crude oil prices mainly rose sharply after protests in Libya emerged as the country is one of the largest producer and exporter of the commodity. There were news from media agencies later that Libya's Muammar Gaddafi agreed to proposals from Venezuelan President Hugo Chavez for an international panel to negotiate an end to the turmoil. This lead to further volatility as prices fell more than 2% immediately after this news, but later recovered and maintained its upward journey after news of clashes between the rulers and rebels of Libya continued to pour in.

What makes Libya an important cause of crude oil spike? Produces 2 percent of global oil consumption Libya, producing around 1.6 million barrels per day (mbd) of oil per day accounts for around 2% th of the total global oil consumption. In 2010, the country was the 9 largest crude oil producer in the Organization of Petroleum Exporting Countries (OPEC) group, after Nigeria and Angola which produced around 2.05 mbd and 1.85 mbd respectively. Libya’s production in crude oil has been on a constant rise since 2002, only with a marginal decline in 2008, when the global financial crisis emerged.

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Exports more than 75% of its total crude oil production th

Libya, the world’s 17 largest producer of crude oil, exports a major chunk of its crude oil production, accounting to more than 75% of its total produce. As per figures, crude oil exports from Libya totaled around 1.3 mbd in 2010. According to figures from the International Energy Agency (IEA), a vast majority (around 85 percent) of Libyan oil exports are sold to European countries namely Italy, Germany, France, and Spain. On the other hand, its domestic consumption is estimated at only around 270,000 barrels a day. Libya’s Exports in 2010 14%

Others 3%

United States

4%

United Kingdom

5%

Greece Spain

10%

Germany

10% 11%

China

15%

France

28%

Italy 0%

5%

10%

15%

20%

25%

30%

(Source: EIA)

Largest Crude Oil Reserves in Africa As per the Oil and Gas Journal (OGJ) statistics, Libya holds around 46.4 billion barrels of oil reserves, which is the largest in Africa. The country also holds close to 55 trillion cubic feet (Tcf) of natural gas reserves. Despite Libya’s production numbers in 2010 being slightly less than those of Nigeria and Algeria, the oil reserves are much higher when compared. This reiterates that the country has much more oil to be explored helping it to climb higher in the top producer’s list in the future. Top holders of Crude Oil Reserves in Africa 46.4 37.2

42 32 22

12.2

9.5

12

5

4.4

2 Libya

Nigeria

Algeria

Angola

Sudan

Egypt

African Oil Reserves (billion barrels)

(Source: Oil and Gas Journal)

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Libya’s Share in Global Crude Oil Reserves Global Crude Oil Reserves

3% 29% Libya OPEC Others 68%

(Source: Oil and Gas Journal)

Libya's oil industry is run by the state-owned National Oil Corporation (NOC). As per the latest st estimates from the NOC released on March 1 2011, Libya’s oil output had fallen by almost half due to the ongoing political issues. Outage estimates were around 800,000 barrels per day. Most of Libya's oil fields are located in and around the Sirte Basin, which contains around 80 percent of the country's proven reserves. As per media reports, the opposition parties of Libya had managed to take control of the Eastern part of the country, where these reserves are located.

How will the OPEC, US and the others act for controlling prices? 1. Organization of Petroleum Exporting Countries (OPEC) may use spare capacity: Currently, what everyone is looking out for is whether the OPEC, which is the largest oil cartel, would resort to pump in more oil to offset the shortfall arising from Libya. But, here it is to be noted that currently only Saudi Arabia, Kuwait, United Arab Emirates (UAE) and Libya itself have excess capacity. While Saudi has the maximum of around 3.5 mbd of capacity surplus, Kuwait and UAE each have around 0.3 mbd of excess capacity. Although this is much more to cover the supply gaps, what remains a major question is how far Saudi will succeed in bringing more oil into the markets, because there have been fears that political crisis may spread to Saudi as well. 2. Releasing oil from the Strategic Petroleum Reserve (SPR): The SPR was created by the US Congress in the mid 1970s after the Arab oil embargo. The motive behind the creation was to use this reserve during any national supply shortage. The US government has used these reserves in the past and this has helped the prices to come down substantially. The SPR currently holds 727 million barrels and is filled to capacity. The US Republicans have urged the US President to use the SPR to fill in the supply shortages that would be faced through disruptions in Libya. But, the International Energy Agency (IEA), which coordinates policy among the world's consumer nations, has said it would likely let OPEC move first to address any supply shortages.

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Effects of higher crude oil prices on Global Economy With oil prices soaring suddenly, a new threat to the global economy has emerged. With investors already continuing to fear the ongoing Euro zone crisis, such high crude oil prices would derail the economic growth. The developed economies have recently started to show signs of economic improvement, and hurdles in the form of higher oil prices would make things worse. The emerging economies, which were the major drivers that helped the world come out of the deepest recession, would also face the heat of these prices. Fiscal balances would be disturbed and inflationary pressures would make things worse for the global economic leaders.

What lies ahead for the Crude Oil? Are we Heading towards Another Oil Crisis…. Of course, a possibility of another oil crisis cannot be ruled out completely, though the risk of that is still lower. While Libya’s supplies can be covered up, things would really go wrong if situations in Saudi and Iran become worse. Both these countries are the top producers of OPEC and any disruptions in their production activities would see oil prices rocketing. Saudi supplies around 10 percent of the global oil and is the world’s largest country of oil reserves. In 2010, production of crude oil in Saudi Arabia amounted to 8.41 mbd and as per news sources it has currently enhanced production above 9 mbd in February 2011. The kingdom amounts to around 28% of the total OPEC production. King Abdullah of Saudi, who returned after 3 months absence for medical treatment, immediately announced a $36 billion package to be spent on welfare and public services. This move was to avoid the Middle-East protests to emerge in his own country. But, as per sources, there have been constant protests by the Shiite community which are expected to further escalate in the coming days. Coming to Iran, the country was the fifth largest producer of crude oil in the world in 2010. The country, which is the second largest in OPEC in terms of production, produced around 3.75 mbd in 2010. Iran is also amongst a top exporter of crude oil. In 2008, Iran exported around 2.6 mbd and has been increasing since then. As per news, clashes have been reported between antigovernment protestors and security forces in Iran. Another major factor still prevailing in India is the payment issues with Iran for its crude oil imports. Although India's oil minister recently said that overdue payments to Iran have began, and payments amounting to around 1.5 bn Euros ($2.1 bn) have been made to the National Iranian Oil Company through the Central Bank of Iran. But, the mode of payment used had not been declared and a permanent mechanism for making payments is still to be decided. India's payment issues with Iran erupted when Reserve Bank of India placed restrictions on transactions with Iran through Asian Clearing Union (ACU), a system that was created in the 1970s by central banks in South Asia and Iran to clear trade payments between them. But, the US is of the belief that Tehran has been using the ACU to bypass international sanctions. If the payment issues continue to persist for further elongated period, supplies from Iran may be disrupted which would affect the domestic consumers, thus pushing prices higher. India would be amongst the worst sufferers if the Middle-East tremors would be felt in Saudi Arabia and Iran. India is amongst the top consumers of crude oil, but has to rely on imports to fulfill its huge demand. More than one-third of the oil in India is imported from Iran and Saudi Arabia.

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Coming back to Libya, Gaddafi, himself has not yet announced any acceptance for a dialogue. Hence, it cannot be said that the crisis has come to an end. Hence, crude oil prices will continue to be supported on the upside on supply fears. Nymex crude oil prices are likely to touch levels of $110-115 per barrel in the coming days if these concerns continue to persist for another two to three weeks or rather a month. With such levels, prices on the MCX may well breach Rs 5000/bbl mark and trade around 5200-5300 levels. Another factor that could boost prices on the MCX would be the depreciating Indian Rupee. If oil prices in the international markets trade higher, equity markets are likely to take a hit and the domestic markets will also face the heat. This will lead to a weaker domestic currency as FII flows would be hurt. If the Rupee depreciates, crude oil prices will be additionally supported on the Indian bourses.

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