The international oil markets are in disarray following the revolt in Libya, where the oil-rich eastern half of the country is in the hands of rebels trying to overthrow the crazy Colonel Muammar Gaddafi. The Nymex front-month price settled at $97.88, but is up to $98.23 in afterhours trading. Nymex WTI stands alone below $100/barrel. Brent sells for $112.39, Bonny Light (Nigeria) is at $115.04, and so on. It's time to raise the alarm level (green, yellow, orange, red).
Oil Alarm Level — Red
Earlier this week, I wrote Oil And The Revolt In Libya — What If? I am not going to rehash that material, so read it separately for background.
Here is the situation as I understand it from current reports. Estimates for the daily flows of crude currently shut-in range from 500,000-700,000 barrels (IEA, Goldman Sachs) to 1 million barrels (Barclays) to 1.2 million barrels (Paolo Scaroni, Eni SPA chief executive officer) as reported in the Oil & Gas Journal. This information is a day or two old, and various operators (Repsol, Inpex, Total, CNPC, etc.) are still evacuating their workers from troubled areas. If the higher estimates overstate the situation now, they'll surely be accurate after this weekend.
Saudi Arabia has reportedly raised production by 700,000 barrels per day to meet the crisis.
The International Energy Agency confirmed on Friday that Saudi Arabia was stepping in to cover the fact that many platforms producing high-grade oil from Libya have been completely shut down because of the unrest.
A source told Reuters that the Saudi state oil company increased its production to more than 9 million barrels per day – a rise of more than 700,000 barrels.
The worsening situation in Libya has seen about 1.2 million barrels of production out of Libya's 1.6 million barrels daily output lost.
European refineries have been particularly worried about a shortage of high-grade crude, of which Libya is a key supplier...
IEA figures show that Saudi Arabia has 3.5 million barrels a day of spare capacity, while the United Arab Emirates could add 330,000 barrels, Qatar could put on 180,000, and Kuwait 230,000. While not all of this would be likely to come on stream at once, Middle East production is still 1.7 million barrels per day lower than it was at the height oil price spike in mid-2008.
The IEA says Saudi Arabia has 3.5 million barrels of spare capacity, but an anonymous Saudi source puts the number lower.
A Saudi oil ministry official said the kingdom, in coordination with OPEC members, was ready to cover cuts from Libya. "We have a surplus of 2.5 million barrels a day," the official said on condition of anonymity in line with regulations.
I am not going to argue about Saudi spare capacity today—this is a lot like Thomas Aquinas arguing about how many angels can dance on the point of a needle. The "point" right now is that the Saudis have got plenty of spare capacity at the moment, but raising output 700,000 barrels is probably not enough to replace all the lost Libyan crude in the international markets. And to those like economist Jeff Rubin (or Kevin Drum) who claim that the Saudis do not have any spare capacity, I suggest that you stop trying to sell your book and try growing up.
As James Hamilton observes, the Libyan shortfall is relatively small as supply shocks go. As long as any further geopolitical contagion is contained, that will remain true. However, the national average gasoline price is now $3.333 per gallon, and prices won't be going down anytime soon. Gas at these prices in February makes one wonder what gas might cost in May. In any case, these high gas prices are bound to curtail spending on other goods & services (like rent or food) in poor and lower middle-income households.
The longer prices remain elevated, the greater the impact on households will be. Various economists have argued that the current price spike is not much of shock to households because their models tell them that relative to the 2008 price shock, the current rise is small potatoes. Here's Hamilton—
Next let's take a look at the likely economic consequences for the U.S. Americans consume about 140 billion gallons of gasoline each year. I use the rough rule of thumb that a $10/barrel increase in the price of crude oil translates into a 25 cents per gallon increase in the price consumers will eventually pay for gasoline at the pump. Thus $10 more per barrel for crude will leave consumers with about $35 billion less to spend each year on other items, consistent with a decline in consumption spending on the order of 0.2% of GDP in a $15 trillion economy. The recent turmoil in North Africa has been associated with perhaps a $20/barrel increase in the price of crude and so might be expected to shave half a percent off GDP from this rough calculation...
Having recently seen $4 gasoline, I don't think creeping back above $3 has the same psychological shock value. That suggests to me that the erosion of consumer confidence should be less severe. The gains in employment that I believe are underway are another important offsetting plus in terms of what's going to happen to consumer sentiment.
The particular dynamic model from which the above Brookings figure came builds in quite strong nonlinearities and threshold effects. Interestingly, according to that specification, one wouldn't begin to anticipate significant effects on U.S. GDP until the price of oil got above about $130 a barrel, or until the second half of this year. Prior to that, according to that specification, we're still ok.
I don't want to make too strong a claim about those particular details. It's very hard to claim precise statistical evidence in support of one choice of a threshold over another. But, this particular model has held up fairly well since its original publication in 2003. So I'm not about to abandon it just yet.
My bottom line is that events as they have unfolded so far are not in the same ballpark as the major historical oil supply disruptions, and are unlikely to produce big enough economic multipliers that they could precipitate a new economic downturn. 4
They might shave a half percent off annual GDP growth, but I don't anticipate a whole lot worse than that.
What a crock! The 77% of Americans living paycheck-to-paycheck and the 29% who find it difficult to afford food will no doubt be comforted that Hamilton's model says we're all "ok" so far. One really does wonder why the outcomes such models are meant to capture are important to anyone other than their creators or government propagandists extolling the virtues of GDP growth. These absurdities arise when one talks about "the economy" as a monolithic entity instead of acknowledging that America has two economies, one where the well-off or rich folks reside, and another where everyone else tries to eke out a living.
My next Saturday oil report is due in two weeks. Lots can happen between now and then. There's no way of knowing how events will unfold. Since the current oil price is always the best predictor of the future oil price in the very short-term, I predict that Nymex WTI will be priced in the $95-$100 range on March 12th.
I can understand why prices would go up in Europe and Asia, but I don't get why gas in Minnesota is jumping when our heavy oil is coming from Canada and North Dakota. It's not like the products refined in my state of Minnesota are suddenly going to Europe or Asia.
Posted by: ZZwcck | 02/26/2011 at 03:46 PM