Libya's Ripples for Energy Markets

The unrest that began in Tunisia and Egypt has now destabilized a country that exports important quantities of petroleum, and the oil market is reacting in earnest. With Libya in violent turmoil, UK Brent crude traded above $108 per barrel today, and even West Texas Intermediate (WTI), which has been massively discounted due to excessive inventory at its Cushing, OK delivery point, hit $98 in early trading before falling back to the mid-$90s. Unless events in Libya resolve quickly and positively, oil's price moves will shortly translate into higher gasoline prices. As I considered these events over breakfast, it also struck me that GM and Nissan could turn out to be very lucky indeed in launching their electric vehicles now, instead of a year or two ago when gas prices were lower and less volatile.

The media commentary I've seen so far concerning Libya's oil production has missed some key details that explain why a disruption of exports that in theory can be covered by OPEC's ample spare capacity--currently at a multiple of Libya's output--could be disproportionately large. Instead of focusing on Libya having Africa's largest oil reserves--a fact that is important for the long run but essentially irrelevant in the current situation--what matters is production and exports, and especially the location and quality of the latter. Libya produces around 1.7 million bbl/day of crude oil and exports much of that, due to its small domestic market. As oil companies evacuate personnel, that output will drop, and exports from Libya's ports are at risk of disruption by the chaos unfolding there. The majority of those exports stay in the Mediterranean, where they are key inputs for Italian, French and Spanish refiners. Very little of it comes to the US, for which Libyan oil made up less than 1% of our imports in 2009. So any effect on US markets will be indirect, but no less dramatic for that.

On the surface, OPEC is more than capable of making up for the loss of a bit over 1 million bbl/day from the market, if it wished. However, most of the cartel's roughly 5 million bbl/day spare capacity is on the Arabian peninsula--near another focus of instability in Bahrain, which is no longer an oil exporter. Nor is most of OPEC's remaining capacity of a quality comparable to the typically light, sweet crude types that constitute most of Libya's output. These crudes are well-suited for making the diesel favored in Europe, and it would be difficult for many European refiners to switch on short notice to a diet richer in Saudi grades that are higher in sulfur.

Various analysts have noted that US gas prices were already reflecting higher world oil prices, rather than the lagging WTI indicator. With April gasoline futures trading above $2.75/gal. on the NYMEX this morning, that would yield an effective average US retail unleaded regular price of around $3.45/gal, after factoring in excise and sales taxes and typical dealer margin. That's well above the $3.18/gal. average that the Lundberg Survey reported for last week. It would also be the highest average at the pump since October 2008, when prices were unraveling from their $4-plus peak of that summer.

It's too soon to predict an imminent return to those heights, although no one can gauge what will happen next in Libya, where it's not even clear who's in charge at the moment. (It does seem safe to predict that the US will not lead a NATO invasion of Libya, as Fidel Castro has apparently warned.) Still, it is worth thinking about how consumers might react if the current chaos persisted. The last time gas prices rose sharply, we saw significant drops in both US vehicle miles traveled and gasoline consumption. We also observed a noticeable increase in the sales of hybrid cars, which have lagged recently. There were no mass-market electric vehicles available at the time, but it doesn't require a leap of faith to envision a healthy boost in EV sales from their low initial levels, too. That would be good for both GM and Nissan, which have invested enormous sums--and their corporate reputations--bringing their Volt and Leaf models to market. It might not be so positive for sales of clean diesels, despite their high efficiency, if constraints on Libyan oil tighten European diesel supplies and drive up world diesel prices.

Events in North Africa and the Middle East will determine how high oil and gasoline prices rise in the weeks ahead. If Libya's dictator departs as readily as President Mubarak did, things could settle down quickly, unless the unrest spreads to another major oil producer. It's still too early to call this a new oil crisis, but it's not too soon to consider our options if it proved to be one. Although that would be a very unwelcome shock to an economy just regaining some momentum, we have many more options than in 1979, when the Iranian Revolution sent oil prices to levels that it took nearly three decades to exceed, in real terms.