According to analysts' forecasts, Libya's oil production is expected to reach 1.6 million b/d in 2011 or approximately 1.80 per cent of global oil supply. Many of the foreign oil producers have already suspended operations for safety reasons. In fact, the International Energy Agency (IEA) estimated that 500,000 to 750,000 b/d (less than 1.0 per cent of global daily consumption) had been lost due to protests. Thus far, OPEC, of which Libya is a member, has resisted calls to increase output, however, Saudi Arabia is reported to have stepped up its production to meet the majority of the estimated 1.3 million b/d shortfall by Libya.
Benchmark Oil Prices
The West Texas Intermediate (WTI) and Brent are the benchmark oil prices used globally. WTI crude is the benchmark used for the Americas, while Brent is affiliated with the European, African and Middle East regions. WTI normally gets discounted to compete in its own markets in the US. This would typically be worth only a few dollars to account for quality. But, because of current events, the Brent premium is being exacerbated by current physical conditions in the WTI and Brent markets. Figure 2 shows the two benchmarks price movements over the four-year period 2007 to present. Over the period, the WTI-Brent spread averaged -$0.52/bbl. Since the Middle East crisis, this discount reached an all-time high of -$19.54/bbl (based on Generic futures price). When Brent is higher than WTI, it strengthens the value of US grades that compete with West African and European oils that are priced against Brent. Two things are worth noting. First is that the trajectory of the price ascent is similar to that of the pre-crisis price hike.
Second is that the WTI discount to Brent prices was partly attributable to recent logistical issues in the US midcontinent. Refinery outages led to price dislocation in that region. This has since reversed to some extent as refineries are reported to be increasing production once again. Based on these new developments, various houses have revised their WTI price projections upwards. Table 1 shows the forecasts for a sample of three houses. There is an average US$10 differential among the three-, six- and 12-month pricing. The average however is US$92.17/bbl over the next six months and an even higher $98.00/bbl in one year's time. Year to date, oil is up close to 5.0 per cent.
Any Effect Locally?
The current fiscal year, 2010/2011, has been pegged against a budgeted oil price of US$65/bbl.
Over the five months of the FY, the WTI price has averaged US$86.59/bbl or approximately 33.2 per cent above the budget price. Intuitively, this should improve our revenue position for the period, though there are reasons why this may not materialise. One reason is that many of our contracts would already be set at a fixed price and another is that the majority of our revenue stems from natural gas sales than crude oil. As a result, there may only be a noticeable positive revenue effect if the price appreciation persists over the next few months.
Opportunities
Aggressive investors can take indirect positions to profit from the oil price volatility. With fundamental conditions having a minimal effect on the price movements, close observation of the geopolitical events would give investors an indication of the direction of their positions. To take a position, investors can utilise many of the oil-only ETFs and oil and gas ETFs in which investments can be made. In addition, equity investors can consider acquiring the shares of oil and energy sector companies.
Conclusion
The ongoing events represent a clear upside risk to oil prices in the near-term. However, the risk of further contagion to some of the larger neighboring countries seems limited for the while. Therefore, despite the uncertain situation, it is not necessarily the case that oil supplies may be significantly disrupted over an extended period. The events can still have a lasting impact on the region's oil sector and even Brent pricing. On a macroeconomic level, the possibility of high oil prices hampering the global recovery becomes more critical if high prices are sustained. For oil investors, therefore, the key is continued monitoring of the events at hand and adequate due diligence before any investments are taken. As always, we recommend seeking the advice of a qualified investment advisor before making any investment decision.