Last Updated: Mon Feb 07, 2011 10:35 am (KSA) 07:35 am (GMT)

Egypt, OPEC and rising oil prices

Walid Khadduri

There are two essential questions haunting oil markets these days. First of all, there is the question regarding the repercussions of the unrest in Egypt on these markets. As is customary during major geopolitical shifts, and as fears surface regarding the emerging situation, speculators become more active in the futures markets, in anticipation of any disruptions in oil supplies, thereby pushing prices higher.

The second question involves OPEC’s stance vis-à-vis rising prices. The price of Brent Crude exceeded the one hundred dollar per barrel mark recently, so the question is, can OPEC continue asserting that the desired price range is 70 to 80 dollars per barrel, while maintaining the same production rate, given the inherent contradiction in this stance?

We shall first deal with the second question, on account of its far reaching significance. Oil prices have been following an upward trend for months now, driven by improved global economic performance, which helped increase demand in Western industrialized nations, as well as emerging countries. Prices also rose as a result of the cold snap in the northern hemisphere, while improved dollar value prompted investors to increase their purchases of commodities such as gold and oil.

In fact, the price of one barrel of Brent Crude rose by nearly 29 percent last year, averaging 80 dollars throughout, before exceeding 90 dollars at the end of that year. This rise in prices reflects increased demand for oil. But despite that, OPEC has kept the agreement over production rates, which was reached in Oran in the autumn of 2008 – i.e. at the start of the global financial crisis- unchanged. Back then, the organization cut production to avoid dramatic falls in demand and to safeguard oil prices, which shrank to nearly 30 dollars per barrel at the time.

Naturally, there is a different reality in place now, and remarkably so, in comparison to the one prevalent back in those days. However, OPEC has yet to change its policies and production agreement in order to curb the rapid increase in oil prices. OPEC ministers and the organization’s general secretariat, meanwhile, have asserted that the desired price range is 70 to 80 dollars per barrel.

At first glance, there seems to be a fundamental contradiction between the two positions. Upon examining the bigger picture of the markets, however, different explanations emerge. On the one hand, we find that some price increases are temporary, like the ones driven by the cold snap in Europe and the United States, or as a result of temporary shutdowns in Alaska, Norway, and Great Britain for technical or natural causes.

OPEC’s basic data indicate the existence of a very high level of surplus production capacity in OPEC member states, which would allow supplies to be rapidly dispatched to the markets in the event of emergency additional demand. The surplus production capacity of the organization amounts to approximately six million barrels per day (four million in Saudi Arabia and two million in the UAE and Kuwait combined). There also is an excess refining capacity of nearly 15 million barrels per day worldwide, and large commercial oil inventories in several primary consuming nations.

These data mean that there is no actual shortage in the markets, or any fears regarding supply shortages in emergency contingencies. However, they also reflect a real risk of price deterioration at the issuance of any misleading signal, such as pumping additional quantities of oil, as additional supplies will go to storage instead of going to consumption markets.

This may highlight OPEC’s keenness to maintain reasonable production levels, while ensuring that hikes in oil prices do not aggravate global inflation levels or jeopardize global economic growth. These calculations gain extreme importance in light of the developments in Egypt. The fact that prices rose above one hundred dollar is symbolic, because the price of Brent Crude was hovering around this level even before protests erupted in Egypt.

There is no question regarding the importance of Egypt’s role in the oil transit trade through the Suez Canal, the SUMED line, and also the liquefied gas from exporting nations to Europe. Egypt also plays a key role in oil storage across continents. Therefore, any shutdown or suspension affecting either sector will lead to increased prices. Meanwhile, the voices that raise concern regarding the impact of the closure on Suez Canal on prices, know that the canal is operating normally at present. Hence, fear is not of seeing the canal closed, but instead, it is of the continued closure of banks in Egypt, where transit fees are transferred to the Egyptian authorities.

It is plausible to imagine that oil can be transported to Europe for a short while via Cape Town in South Africa, even though it is a longer journey naturally. The same applies to the scenario where some of the Western African oil is diverted to European markets while Gulf countries compensate for African oil in Asian markets. Finally, it is also plausible that oil inventories in Europe itself will be tapped. Even if the Suez Canal is to be closed down, which is something difficult to imagine at present, production would continue, and there are readily available alternatives to provide Europe with the necessary supplies.

*Published in the London-based AL-HAYAT on Feb. 6, 2011.

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