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Change is on the way in the Arab world, with Egypt the latest focal point. Here I review recent events and their implications for world oil markets.
I begin with a timeline, if not to connect the dots, at least to collect the dots in a single list.
• Sudan, Jan 9-15: Country holds a referendum whose apparent outcome will be a split of South Sudan into its own a separate country.
• Lebanon, Jan 12: Key cabinet ministers resign in protest against impending indictments from a U.N.-backed investigation into the 2005 assassination of former prime minister Rafiq al-Hariri, toppling the governing coalition. U.S. Secretary of State Hillary Clinton offered this assessment:
We view what happened today as a transparent effort by those forces inside Lebanon, as well as interests outside Lebanon, to subvert justice and undermine Lebanon's stability and progress.
• Tunisia, Jan 14: President Ben Ali flees the country in response to widespread protests.
• Iraq, Jan 17-27: Over 200 people killed in a spate of recent bombings, a sharp and tragic increase from the recent norm.
• Egypt, Jan 29: Cairo appears to be near anarchy as a result of an uprising against President Mubarak.
• Yemen, Jan 29: Demonstrations and rallies have resulted in clashes with police, with unclear implications at this point for the stability of the regime.
An optimist might see the common thread in many of these developments to be the realization across parts of the Arab world of the power of popular will to overthrow dictators, the first step toward democracy and a better life for the people. A pessimist might see in at least some of these situations deliberately orchestrated chaos for purposes of seizing power by a new group of would-be ruthless leaders. A realist might acknowledge the possibility of both factors in play at once, and worry that ideologically motivated uprisings have often turned out to be usurped by groups with their own highly anti-democratic agenda. In the event that some of the transitions of power prove to be more chaotic than peaceful, let me comment on their potential to disrupt world oil markets.
The table at the right reports the recent levels of oil production in the countries mentioned above and some of their neighbors. For the most part, the popular uprisings so far have been in the "have-nots" of the Arab world, with modest levels of oil production relative to the members of OPEC. Of the countries facing a likely immediate transition of power, the most important in terms of oil markets is Egypt, with 2/3 mb/d of its own production and another million barrels of oil being transported each day through the Suez Canal plus 1.1 mb/d crossing Egypt via the SUMED pipeline.
In my recent paper surveying historical oil shocks I discuss the Suez Crisis of 1956-57 in detail. In that episode, sunken ships blocked traffic through the canal for a considerable period. Pumping stations for the Iraq Petroleum Company's pipeline through Syria were also sabotaged. At its peak, the episode removed about 10% of global oil production, a bigger percentage disruption than any subsequent oil shock. It took half a year for production from the Middle East to get back to normal, though there was enough excess capacity elsewhere in the world to bring global production back up to the levels at which it had been before the crisis within 3 months.
My paper notes this description of what the original Suez Crisis meant for Europe at the time, taken from the New York Times on December 1, 1956:
LONDON, December 1-- Europe's oil shortage resulting from the Suez Canal crisis was being felt more fully this week-end.... Dwindling gasoline supplies brought sharp cuts in motoring, reductions in work weeks and the threat of layoffs in automobile factories.
There was no heat in some buildings; radiators were only tepid in others. Hotels closed off blocks of rooms to save fuel oil.... [T]he Netherlands, Switzerland, and Belgium have banned [Sunday driving]. Britain, Denmark, and France have imposed rationing.
Nearly all British automobile manufacturers have reduced production and put their employees on a 4-day instead of a 5-day workweek.... Volvo, a leading Swedish car manufacturer, has cut production 30%.
In both London and Paris, long lines have formed outside stations selling gasoline.... Last Sunday, the Automobile Association reported that 70% of the service stations in Britain were closed.
Dutch hotel-keepers estimated that the ban on Sunday driving had cost them up to 85% of the business they normally would have expected.
A closure of the Suez Canal at the present time would not be as economically damaging as the original. For one thing, there is less oil going through the canal today (1 mb/d in 2009 compared with 1.5 mb/d in 1956), and that flow is a significantly smaller fraction of the world total (1.1% today versus 8.8% then).
I think the bigger worry for oil markets would be that the process may yet spill over into other key oil-producing countries. Iraq will be a huge factor in determining medium-term growth in world oil production, and Iran is twice as important as Iraq in terms of current production. And should we see the temporary cessation of Saudi production, it would be an event without historical parallel.
I do not know where current developments will lead. But I am quite confident in the conclusion from my survey of historical oil shocks:
given the record of geopolitical instability in the Middle East, and the projected phenomenal surge in demand from the newly industrialized countries, it seems quite reasonable to expect that within the next decade we will have [an additional observation] with which to inform our understanding of the economic consequences of oil shocks.
Posted by James Hamilton at January 29, 2011 02:15 PM
We see the next oil shock most likely in the next 18-36 months.
Much depends on Saudi Arabia. The EIA current lists global spare production capacity as 4.65 mbpd. Of this, 3.75 mbpd is attributed to Saudi Arabia. However, many observers feel that Saudi is unlikely to ever produce more than 10 mbpd in sustained fashion. As Saudi is currently pumping 8.5 mbpd, this would imply global spare production capacity of 2.4 mbpd all in.
The IEA has reported that oil demand increased by 2.75 mbpd last year; the EIA STEO shows this number as 1.8 mbpd. Thus, were demand to grow as fast in 2011 as in 2010, and if production failed to grow, then global spare production capacity could be consumed this year.
The EIA, and we at Douglas-Westwood, see non-OPEC liquids production essentially flat in 2011. Thus, all incremental production is assumed to come from OPEC. As noted above, spare production capacity is 2.4 mbpd there, with Saudi assumed to be operating at max long-term production rates when this capacity is drawn. No material increases in OPEC oil production are anticipated in other OPEC countries--with the exception of Iraq.
It is generally felt that Iraq should be able to increase production at the rate of 0.5 mbpd per year for the next several years. In addition, OPEC NGL's did very well last year--up 874 kbpd. We might expect some expansion this year as well, let's say, 0.5 mbpd.
So, the world would appear to have 2.4 mbpd of one-time spare capacity + 1.0 mpbd / year, primarily Iraq and OPEC NGLs.
The IEA/EIA see demand rising at the pace of 1.4 mbpd in 2011; OPEC anticipates 1.8 mbpd. I personally doubt demand growth will be less in 2011 than 2010, which puts our forecast growth in the 2.25-2.50 mbpd range. This is consistent with anticipated long-term growth rates (primarily from China) and recoveries from the 1976 and 2001 recessions.
Put all the math together, and we might expect a draw of 1 mpbd on spare capacity this year, a similar amount next year, and after that, we're quite likely out of spare capacity, as a practical matter. Once spare capacity is exhausted, we might expect an oil shock in short order.
Therefore, we could see an oil shock as soon as around election time next year. Or it could occur later, but it is hard to see how we make it to the end of 2014 without an oil shock somewhere along the line.
Posted by: Steven Kopits at January 29, 2011 05:01 PM
Professor I'm counting on you to let me know--ahead of time--when I should grab a shot gun, canned foods and run for the hills. I'm planning my victory graden right now as a contingency plan.
Posted by: David at January 29, 2011 05:09 PM
Anybody else think the Fed is partially responsible for this by devaluing the dollar, exporting inflation, and creating commodity speculation?
But you have to break a few eggs to make a Wall Street bailout omelet, right?
Posted by: W.C. Varones at January 29, 2011 05:14 PM
Oil is the sideshow.
Liberty and self determination are rights that we take for granted in the U.S.
Appreciate the fact that 250 years ago, America began experimenting with the idea that the only obstacle between self, and self determination, is an autocratic government.
We are an outlier. Historically, the common man has traded self determination for government protection.
However, our founders created a framework for a system of self rule. They created an example for the world. America demonstrated that liberty creates prosperity for the common man.
America's belief in self determination is so strong that our sons/daughters, brothers/sisters, fathers/mothers offered their lives fighting tyrannical rulers that promise death to those who seek liberty.
Ignore those who seek to force their will on others. Ignore borders and wake up to the fact that our fellow human beings deserve no less than the liberty that we take for granted.
Posted by: tj at January 29, 2011 09:56 PM
What is most interesting is:
1) history in making 2) The process Egypt revolution following Tunisia is a model, step by step, how these informed middle class Internet coordinated revolutions will occur everywhere with minor deviations-unrest, denial, clashes, blackout of SMS, mobile and Internet, cosmetic changes by regime, police and secrete service going rogue and trying to destabilize the situation so that people look back for "good" old days and rulers , people establishing militias for self protection, army not interfering or taking the side of the people, and finally, the dictator being ousted in one way or another, new popular transitional government, euphoria, reality of governing, splits , start of embryonic democracy with all the faults, old rulers partly returning to power under new guises after first 5 years of democracy bring disillusionment and some fatique( as happened in Russia in 2000) etc. 3) reaction of Israel-Arabs not ready for democracy- sure they are not, but they have to start one day, as we started after the collapse of the Soviet Union- there is no other way to get "ready" for democracy other than starting one., and it takes tens of years, generation before it becomes a true democracy. You will never get "ready " sitting under a totalitarian regime. 4) USA completely taken by surprise and struggling to express any definite opinion ... Damaging to the USA image as advocate of democracy and human rights completely, e.g. in my eyes definitely. This is a moment someone clever in the USA can catch to play loudly against the USA elites ( and taking the risk of becoming a target for Mossad or even CIA) 5) China communists again scared out of their wits and suppressing coverage of events in Egypt - they do not want their middle class (100 million) or students ( 36 million) get any idea which they anyway already harbor. 6) spreading of unrest via the Middle East and problems it creates for oil supply and Israel and, consequently the West. The local war in Middle East with Israel involvement is coming closer in leaps... But I still think not before Iran develops a credible nuke, say in 2014. Oil is on rise now for at least 2-3 years with spikes and drops, but the average will never again be below what we see today.
Exceptionally interesting, though scary as any change of such scale.
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