Oil Shocks and Middle East Politics - January 30th, 2011

The London Brief

Oil Shocks and Middle East Politics

January 30th, 2011

The week started well for markets. Ali al-Naimi, the Saudi oil minister, commented early in the week that OPEC would boost supply if necessary. He said OPEC has 6 million barrels per day (b/d) of spare capacity (versus the market data I cited last week of less than 5 million b/d). He believes demand will increase by 2% this year versus my extrapolation of 2.6% (see last week's LB). "The market will be in equilibrium. I expect stability to continue at last year's rates". The UAE's oil minister said, "Demand is growing but for the time being we do have the spare capacity to meet it if necessary."

OPEC's actions suggest a range of $90 to $100 Brent prices (WTI is about $10 lower). As a result of OPEC's comments and perhaps some signs of economic weakness in the UK and worries about a China "hard landing", oil prices dipped as low as $95 Brent and $85 WTI. This is market bullish as higher oil prices are the chief mechanism of halting the recovery.

OPEC has always been a bit murky about its statistics, so it is difficult to know whether al-Naimi is accurate about the spare capacity. If true, the news was certainly oil bearish and economic recovery bullish in the short-term. And therefore prices declined. However, al-Naimi seems too low on demand. This week's Economist reports that miles driven in America are back to 2007 levels with a new high this year. Americans returned to purchasing light trucks and SUVs in 2010, comprising a large part of the 13% increase in car sales. SUV sales were up 41% from the end of 2009. Petrol electric-hybrid sales are down slightly. The IEA's demand predictions are predicated on U.S. oil demand declining.

Our Oil Supply

By the end of the week, oil prices jumped on concerns that the unrest in Egypt could disrupt oil shipping through the Suez Canal. About 4.5% of the world's oil supply is shipped through this channel and the pipe beside it. So far, the canal has not been disrupted.

But regime change is looking probable in Egypt. Groups of looters with semi-automatic weapons were roaming the streets of Heliopolis, the Cairo suburb where President Mubarak lives. Every major city in the country has demonstrators. Saudi Arabia has sent eight planes to evacuate its citizens. Across Egypt, vigilantes are patrolling the streets with sticks and knives protecting shops and houses from looters. One activist says they picked up five looters carrying Interior Ministry identification cards, home of Egypt's infamous police. Tahrir Square in Cairo has tens of thousands of demonstrators violating the curfew. Several gangs fought police at the prisons and released thousands of prisoners, including members of the Muslim Brotherhood. The military is attempting to stay neutral for the time being.

OPEC has twelve members: Algeria, Angola, Ecuador, Iran, Iraq, Kuwait, Libya, Nigeria, Qatar, Saudi Arabia, the United Arab Emirates, and Venezuela. They provide 41% of the world's daily oil supply and possess most of the oil reserves. Let's look at the stability of each of these countries to see if our oil supply is secure.

Algeria (1.8 million barrels per day) (2% of global oil supply)

President Abdelaziz Bouteflika is now considering a high level cabinet reshuffle after five days of violent protests in January. Four people were killed and 800, including 736 policemen, were injured from protests over rising food prices before the Tunisian revolution. The army is said to have moved away from politics and has allowed Bouteflika to rule. A retired general thought it was unlikely the Tunisian situation would carry through to Algeria because there is no socio-political organization to rally the protesters like the union movement did in Tunisia. However, the public is angry over rising prices and unemployment. There is a secular protest movement called the Rally for Culture and Democracy, which waged a protest last week but it was broken up. However, they led another protest on Friday with 5,000 people in the city of Bejaia demanding a regime change.

Angola (1.8 million barrels per day) (2% of global oil supply)

The president rules the country in Caesar-like fashion after a 26 year civil war. There is a rebel movement trying to secede from the northern provinces. At the current time the president rules with an iron fist and fall-out from Egypt should be minimal. However, the opposition has been stifled and there is concern of a future civil war.

Ecuador (0.5 million barrels per day; 0.7% of daily supply)

Revolution risk is low. But because of budget constraints and a crazy President, there is a constant risk of nationalism which contributes to lower foreign investment. Ecuador is depending on the Chinese to ignore precedents and help them through it. Otherwise oil supplies may decline precipitously in the future.

Iran (4.2 million barrels per day; 5.3% of daily supply)

The people's revolution from a year ago has fizzled. But high unemployment and rising prices make Iran a volatile place. There were support protests in front of the Egypt embassy. Mir Hossein Mousavi, an opposition candidate, compared the protest movements in Tunisia and Egypt as similar to the Iranian protests in 2009. Iran is supporting regime change in Egypt (diplomatic ties were broken in 1980 when Mubarak reconciled with Israel).

Iraq (2.4 million barrels per day; 3.2% of daily supply)

There is a U.S. presence and a democratically elected government. But there are many factions: Islamist, Iranian, ex-Bath, Shiite that are all vying for power. There is a danger of terrorist activity and civil war after U.S. soldiers leave.

Kuwait (2.5 million barrels per day; 3.2% of daily supply)

The country has democratic institutions in place. Debate is quite rigorous with tribal sheikhs having more military power than the emir. Women can vote and several are members of Parliament. The emir may be toppled one day (and perhaps soon), but it won't affect the oil supply because there is a real parliament that can fill the leadership vacuum.

Libya (1.6 million barrels per day; 2.0% of daily supply)

Nestled between Egypt and Tunisia, Libya is not immune from the aftermath of the protests. A Wikileaks cable says Gaddafi's sons had "provided enough dirt for a Libyan soap opera" and could endanger the country's stability. On January 14th and 15th, hundreds of people raided South Korean construction sites looting and creating fires. Libya says it was because of an official's miscommunication.

Nigeria (2.0 million barrels per day; 2.6% of daily supply)

There were protests over the weekend in the northern city of Jos over a lack of jobs. Sectarian divisions between Christians and Muslims made this turn into violence. Things flared further after a political candidate was killed and gunmen opened up at police at a check-point. There have been frequent raids from the south on oil infrastructure from secessionist groups. This is under control for now. But at least a few times a year, the issue disrupts oil supply.

Qatar (1.3 million barrels per day; 1.3% of daily supply)

Home of al-Jazeera, it seemed the network censored itself when reporting on Egypt and Tunisia in the early days, but has since come back to form. It's now considered the media focal point for Arab frustration; Egypt shut down its office. Given how the people are allowed to say almost anything they want and the oil revenue goes a long way to supporting social services, it's unlikely the people try to topple their benevolent dictator.

Saudi Arabia (9.7 million barrels per day; 12% of daily supply)

The Saudis called Mubarak to pledge their support to him. The king phoned Obama and told him that there can be "no compromise" over the "stability" of Egypt. Saudi Arabia sports a 20% unemployment rate and has many bin-Laden and secular type figures frustrated by the ruling family. The oil revenue does not carry as far as in Qatar, the UAE or Kuwait (although recent food price increases have hit low oil producing states like Tunisia and Egypt the hardest). There are no major reports of protests, but if there was no threat of Egypt spilling over into the streets of Riyadh and Jeddah, then why would the king care so much? Saudi Arabia will be interesting to watch the next few days.

UAE (2.6 million barrels per day; 3.2% of daily supply)

They seemed to be more worried about Dubai's property situation and trying to buy football teams. The oil revenue goes a long way to help make everyone complacent.

Venezuela (2.4 million barrels per day; 3.3% of daily supply)

President Chavez passed the "decree law" in late December and is busy expropriating banks and creating high inflation. He then blames America for the problems. How long can he keep up this cycle? While imminent political problems may not be an issue,

Venezuela has a high depletion rate in its existing fields. They require foreign investment. But how can you invest if he has decree powers to seize your assets and there are many precedents of him using such power?

To Summarize

Algeria, Libya and Iran have Tunisia/Egypt revolution risk, which could disrupt oil supplies. Saudi Arabia has all the necessary catalysts in place for a revolution to occur but they have the wherewithal to provide social services from oil revenue. Let's see how things go the next few days.

Venezuela and Ecuador's economic policies eliminate investment which could contribute to larger than expected declines in their production.

Angola and Nigeria suffer from chronic instability and secession movements. Iraq may have secessionist movements in times to come and is likely to join these two in this category.

If you count Qatar, Kuwait and the UAE as calm, 33% of our daily oil supply is somewhat unstable. Assuming Saudi Arabia is stable, 21% of our OPEC oil supply is at risk.

This figure does not include marginal states. For instance, Egypt produces 0.9% of the world's oil supply. But it's quite likely that some of that will be disrupted by the protests. The Congo is 0.4% of the world's oil supply. The Sudan is 0.6%.

If Egypt calms down, oil prices may re-test the low 80s level. But it looks like a promising investment level to capture higher than expected demand and supply shock risks.

Some Other Notes From Emerging Markets

India’s central bank has raised interest rates seven successive times and has not been able to tame inflation. Industrialists are worried that the rate hikes could slacken industrial production. There is a shortage of liquidity in the banking system. Indian officials are in a box. The increase in interest rates slowed industrial production, yet food prices still elevated. Now many within the government are murmuring that raising interest rates won’t solve the inflation problem and it may be better to do nothing. Jahangir Aziz, the chief economist of JP Morgan said, “We are entering dangerous territory where both the RBI and the government are willing to tolerate inflation. Things can go out of hand.”

Meanwhile there were reports that emerging market economies' growth rates could be slowing as food prices rise to a record. BRIC nations spend 19% of their income on groceries compared with 6% in the U.S. (Euromonitor International) (however, the bottom 20% of Americans spend something like 60% of their after-tax income on food and energy according to JP Morgan).

Ending Note

Here is an interesting factoid: Pollster IFOP in La Croix newspaper showed that 33% of French people believe it is time to abandon capitalism. Only 3% in communist China thought the market system was working badly.

Someone also forwarded this news to me:

Explosion at a pie factory in Huddersfield 3.14159265 dead

Good luck at the gas station.

Omar Sayed

London, January 30th, 2011