Mid-East: Matters of Energy

Posted on March 3, 2011 by David Laidlaw 

The political uprisings which started with the self-immolation of a Tunisian fruit vendor continue to spread throughout the Mid-East.  The current scene is one of Colonel Moammar Gadhafi waging a bloody pitched battle against his own people to hold on to power. 
 
These events have caused the price of oil to spike and the equity markets have become more volatile.  We have no educated opinion regarding whether or not the political changes will lead to a more democratic Mid-East or represent the transformation from lands ruled by dictators to ones controlled by Islamacist Theocracies as in Iran.  However, our net opinion on the impact of these events on the world economy and the energy markets is that they may cause short-term disruptions, but the long-term impacts will be muted. 
 
The price for oil is rising due to the market participants’ concerns that oil supplies will be disrupted.  Libya produces about 2% of the world’s oil and its production has been halved.  Reports from Saudi Arabia have indicated that Saudi Arabia could increase its production to cover any shortfall from supply losses from Libya.  However, there is always the chance that political unrest could migrate to Saudi Arabia with its corrupt monarchy ruling a large population of under-employed and disenfranchised young people who feel its rulers are out of touch. 
 
Recently developed drilling technologies have opened up vast new oil and gas reserves that could be tapped if disruptions from the Mid-East look more permanent.  After BP’s oil spill last year, the Interior Department re-opened the Gulf of Mexico for offshore oil drilling in November of 2010.  However, the government’s response to applications has been extremely slow even though new safety precautions were implemented by the industry.  It was reported earlier in the week that the first new drilling permit was issued in the Gulf of Mexico since the BP spill to Noble Energy (a core holding).  Higher oil and refined gasoline prices will cause political pressure to ease domestic drilling restrictions and, in turn, reduce supply constraints. 
 
Similarly, Canada’s oil sands become far more attractive to exploit with oil trading for about $100 per barrel.  Higher prices increase production margins on this source of supply which is otherwise fairly expensive to extract.
 
Finally, while oil prices are surging, prices for natural gas are moving in the opposite direction.  At the beginning of the year, natural gas was trading for about $4.50 per Mbtu.  As of yesterday, it traded for a bargain rate of $3.75 per Mbtu.   Extraction technologies have expanded the supply for domestic natural gas dramatically.  While not a current substitute for oil, the means exist to increase natural gas’s role in home heating and transportation dramatically if the price of oil remains high for an extended period of time. 
 
This analysis is not meant to minimize the threat to energy supplies posed by political changes in the Mid-East.  However, with a longer range view,  these events should not prove calamitous and may even lead to a more stable energy supply.