Geopolitical tensions weigh on oil market
Published:Friday | June 17, 2011 | 12:00 AM
It is still too early to forecast the direction of global oil markets in the coming months, following Saudi Arabia's unilateral decision to ramp up oil production starting next month.
Immediate reaction to this decision which will involve a 10 per cent increase in Saudi production to 10 million barrels per day, is that prices have dipped modestly, although all but one of the benchmark crude oil prices have remained over US$110 per barrel.
Oil markets are being influenced by uncertainty surrounding the pace of world economic growth in the wake of recent data showing a slowdown in the United States, while the threat of a default on Greece's sovereign debt could damage Europe's economic recovery.
There is, as well, the action of the Chinese authorities to further tighten monetary policy in their effort to rein in inflation.
China has been the major source of growth in demand for oil in the post-recession period and, in fact, Saudi Arabia has announced that its additional production will be geared to supplying that market.
At the start of 2011, crude prices stood at just above an average of US$90 per barrel. But political developments in North Africa and the Middle East increased volatility in the markets, sending prices to over US$100 per barrel by late February, and to nearly US$120 per barrel by late April.
As it became evident in early June that the US economy was slowing in key areas - manufacturing output, home sales, consumer goods sales, and new jobs - and news of the Greek debt crisis resurfaced, crude prices fell.
Speculative pressures also eased, as fears of spreading unrest from Egypt and Libya to oil producers in the Middle East lessened.
Energy analysts are, however, pointing to factors which it is felt will keep oil prices at elevated levels in the immediate term.
First, indications are that the tightening in Chinese monetary policy which has been underway since last year, has had limited impact on demand for oil, as industrial production has remained strong, rising at an annual rate of 13.3 per cent. And economic growth remains buoyant in other emerging economies that have been driving demand in global oil consumption.
Second, the struggle for power and influence in the Middle East between Iran and Saudi Arabia could, in the medium term, lead to political instability and destabilise oil production.
Iran's influence has grown in Iraq and is expected to become even stronger with the American military withdrawal. In response, Saudi Arabia has been wooing other countries in the region to join an informal Arab alliance against Iran, as it attempts to establish a countervailing force to Shiite Muslim radicalism.
The possibility of unrest in Middle-Eastern oil-producing countries has been a powerful factor influencing the psychology of oil markets, especially since the 1973 Arab-Israeli war, and 1979 Iranian revolution that overthrew the pro-Western Shah.
The chaotic events in Iran severely disrupted oil production, with output falling from six million barrels per day, prior to the revolution, to as low as 1.3 million barrels per day at the lowest point.
The subsequent Iran-Iraq war in 1980 scuttled Iraqi production which, at the lowest point, stood at one million barrels per day, falling from 3.5 million barrels per day before the war.
Three decades after those events, oil production from these two countries is still over 30 per cent below their peak levels, as they have lost a significant share of their producing capabilities with pipelines, wells, and other infrastructure having been permanently damaged.
Apart from the physical damage, they have also suffered loss of skilled workers with the disruption and political upheaval. In Libya, which is currently engulfed in civil war, production has collapsed from its pre-war level of 1.6 million barrels per day.
It is important to note that Saudi Arabia, Iran and Iraq account for over 17 million barrels per day, or 20 per cent of global oil production, and that nearby countries supply another five to six million barrels per day.
The rivalry for power and influence in this bloc over the medium term is, therefore, likely to be an even bigger factor in the psychology of oil markets.
Dennis Morrison, Columnist