Egypt’s crisis means $120 Brent price by October

The tragic events in Cairo last week have made the prospect of a protracted, violent conflict between the government and protesters the highest-probability scenario in Egypt. This means supply risk to Egypt gas fields in the Western Desert/Sinai and the Red Sea/Mediterranean LNG loading ports is now a factor in crude oil markets. If geopolitical risk in Egypt, Libya, Iraq and Yemen escalates, Brent could well rise to as high as $120-$125 a barrel.

By Sarie Khalid (MACRO IDEAS)

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Published: Tue 20 Aug 2013, 12:57 AM

Last updated: Tue 7 Apr 2015, 4:48 PM

The real Achilles’ heel of the world oil market is that Opec spare capacity has fallen from six million barrels a day in 2009 to less than three MBD now. While Egypt is not an oil exporter, 4.5 MBD of crude and refined product transit via the Suez Canal and the Suez Mediterranean pipeline. Egypt is also the most populist, politically-significant nation in the Arab world. No oil trader in London or New York dare be short West Texas or Brent crude futures as long as the historic heart of Cairo resembles a war zone.

Iraqi sectarian bloodshed is now the highest since the exit of US combat troops. The IEA has slashed its estimates of Iraqi production growth until 2018. Iraq is far more relevant than Syria or even Egypt to supply risk in the world oil market. If the Assad regime survives in Syria, an insurgency in Iraq is inevitable. The stability of the Kurdish regional state government in Erbil is irrelevant since three fourth of Iraqi production is in the south. The Niger Delta secessionist group Mend has also threatened to attack oil facilities and oil super majors now limit production to offshore fields. Nigeria also faces a terrorist campaign waged by Boko Haram in its northern Hausa-Fulani states.

The world has learnt the hard way in 2013 that the Strait of Hormuz is not the only source of supply risk in the oil market. There is also no evidence that Ayatollah Khamenei, the Supreme Leader of the Iranian Revolution, will back reapproachment between Iran and the West on the nuclear issue, through President Rouhani has used diplomatic language to send positive signals to Washington.

Macroeconomic logic dictates that a sharp fall in gold prices precedes a drop in crude oil. Gold dropped sharply from $1,600 last spring when the Federal Reserve hinted it would “taper” its quantitative easing programme. Any contraction in global liquidity is hugely bearish for gold prices. However, crude oil has been resilient to a selloff in commodities on China growth shocks due to supply shocks from Libya, Iraq, Iran and Nigeria as well as the promise of stronger economic growth in the US and Europe. The existence of the Opec, with Saudi Arabia as its swing producer and quota discipline enforcer, also keeps a floor under oil prices. However, all is not well in the universe of black gold.

Emerging markets are one-third of global GDP and oil demand in these countries is as anemic as it was in 2009, when the world money market were still traumatised by Lehman’s failure and economies were in recession. The auto booms in India and China is now over, at least for the short run. Emerging markets account for no less than 50 per cent of global oil demand. This is a bearish omen for oil prices, particularly since emerging-market currencies have plummeted against the US dollar, a double whammy burden for the emerging-market consumer

Political unrest in the Middle East represents a threat to regional crude oil and gas production and transport infrastructure. Syria’s crisis has spill over into Iraq and Lebanon. A spillover of the Libyan and Egyptian crisis into Algeria or other oil producing countries is not at all implausible. The recent bombing in South Beirut, an Al Qaeda attack on an LNG export complex in Yemen and renewed conflict between Khartoum and Juba in Sudan all contribute to raise the geopolitical risk premium in the oil market. US crude oil inventories are also falling and it is doubtful if Iraq can supply Chinese, Indian and South Korean refineries who face restrictions on Iranian oil imports. The path to $120 Brent is all too real.

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