EGYPT CRISIS: An Imminent Oil Contagion effect?

Why Are Oil Markets So Nervous about Egypt?

By GLG Expert Contributor

The uprisings in Egypt will put upward pressure on oil and gas prices in the short run as traders will worry about similar revolts in oil-exporting Arab countries. The risk of physical threats to oil facilities in the region remains small but slow down or production stoppage in is a possibility if popular uprisings spread to Algeria or Saudi Arabia. The probability of such developments however remains small. Inside Egypt there is a small risk that flow of oil through Suez canal might be disrupted as a result of chaos and lack of authority. 

Egypt produces about 600,000 barrels of oil per day and it consumes almost every barrel of domestic production. Yet the oil markets reacted nervously to the Friday unrest in Egypt and price of crude rose despite indications of rising supply in the US. What has contributed to this increased demand for oil by investors and speculators is partly a general flight to safety in reaction to political uncertainty. Worried about the regional and global ramifications of the growing Middle East protests, investors are turning to safe assets such as gold and commodities. The price of gold was also up on Friday.

However an even more important concern for the oil markets is that the Egyptian unrest can spread to some oil exporting Arab countries. Large protests have already been reported in Yemen, and Algeria has experienced sporadic political violence since early December. In both of these countries news of the Egyptian uprising will further energize the protestors and bring larger crowds into the streets.  As a result there is a growing uncertainty about political stability of these countries and their oil exports.

Even before an actual regime change the supply of oil exports might be interrupted if the oil sector employees decide to go on strike or engage in work slowdown in solidarity with the protestors. Yemen’s crude oil production is relatively small but even a partial disruption in Algeria’s oil exports can have an impact on Global markets. Crude oil production in Algeria and Yemen averaged 1.8 and 0.262 million barrels per day respectively during the first ten months of 2010 according to the US Energy Information Agency (EIA).

Down the road there is also a possibility that anti-regime political protests might spread to other oil exporting Arab countries. Moammar Ghaddafi’s regime in Libya is considered stable by outsiders but even in that country some segments of the population live in relative poverty and unemployment among the youth remains high. A similar situation prevails in Saudi Arabia where there is a large income disparity. In both of these countries, as in several other oil exporters, extreme poverty, at levels similar to Egypt, is not an issue because of large price and income subsidies. However, large segments of the population are alienated from the political process and feel powerless and marginalized. If there are any mass protests in these oil rich countries they are most likely to be motivated by political demands rather than economic ones.

Prior to the January 28 Friday protests in Egypt most analysts were predicting that the Mubarak regime would be able to contain the unrest in that country. What has happened in Friday has changed that equation. Not only the risk of a regime collapse in Egypt has increased sharply but the likelihood of a contagion effect throughout the Arab world has also increased. This contagion effect depends on how the situation evolves in Egypt within the next few days. If the mass protests force President Mubarak to leave the country or offer substantial political concessions no Arab capital will remain immune from rising public demand for an end to authoritarian rule. Under such a scenario the oil markets are right to be nervous about the supply of oil and gas from the region.

However, any disruptions to the oil supply of Arab countries will be a short-term phenomena. If any oil exporting country experiences mass uprisings and a regime change, any future regime is likely to continue the oil exports since the oil revenues will be badly needed (take for example the experience of Iran after the 1979 revolution). It is during the political unrest and early stages of the transition of power that the supply might be interrupted or reduced. This temporary interruption or production slowdown can be caused by worker strike in solidarity with the protestors or exodus of professional and foreign workers for safety reasons. Risk of physical damage and sabotage by the protestors will be small since these oil assets will be closely guarded. In the case of Saudi Arabia and its neighboring oil sheikhdoms the United States will also directly intervene to protect the oil assets if necessary.

What was described in the previous paragraph (mass uprising and political instability in oil exporting Arab countries) might be an extreme scenario. Another more optimistic possible development is that after a potential regime change in Egypt some rulers in oil exporting Arab countries will proactively take steps toward political reform to address public grievances and prevent a regime collapse. Such a scenario cannot be ruled out in Saudi Arabia and smaller oil sheikdoms. Under this scenario the risk to oil supply of these countries will be minimal.

*Professor of economics, Crown Center for Middle East Studies, Brandeis University

Source: http://www.glgroup.com/News/Why-Are-Oil-Markets-So-Nervous-about-Egypt--52410.html

NUTSHELL:

Figures may vary but about 3 to 8 percent of world oil supplies (up to 3million bopd) flow through the Suez canal- which is in Egypt. This is significant if we imagine the implications for oil price and its attendant negative economic implications for the world's recovering or stuttering economies. Even more of a danger is the possibility that the crisis will spread across the rest of the Arab world. This remains to be seen, however analysts are optimistic that whatever disruptions and their consequences will only be short lived.  Let us hope so.