Grupo de Economia da Energia

The crisis in the Arab world and price of oil

In oil on 28/02/2011 at 00:30

By Helder Queiroz

The current political crisis in the Arab world is already causing upheavals in the international oil market. After the worsening crisis in Libya, an OPEC member with production around 1.5 million barrels, the international prices of crude oil have risen significantly in recent days, reaching the level of US$ 108 per barrel for Brent crude.

The degree of uncertainty in the markets and the resulting volatility of prices tend to increase in the coming days, due to unpredictability for the political and economic consequences in Libya, but especially on possible developments in other OPEC countries.

Thus, the greatest fear of the agents operating in that market is about the possibility of disruption of supply. Under these conditions of uncertainty, the oil futures market is more active, multiplying significantly the number of transactions, causing an upward trend. This aspect is not particularly recent. In mid-2008, prices reached the level of US$ 145 and dropped to almost half that value at the end of that year.

How much are similar 2008 high prices and 2011 high prices? In fact, from the standpoint of explanatory factors, both movements are quite different: In the latter, a strong predominance of the structural component, and, in the current one, we find geopolitical determinants. We have to remember that in 2008 the too low excess production capacity worldwide, around 1 million barrels, raised strong concerns about the inadequacy of supply to meet demand in a context of global economic growth. Somehow, the international financial crisis has contributed to “solve” this problem, due to the strong economic downturn occurred in the second half of 2008.

Concerning current price increase, the geopolitical variable causes the main factor of uncertainty, leading economic agents to anticipate a possible spreading of the crisis to other oil producing countries. However, it is important to note that the excess oil production capacity worldwide is now significantly higher (around 5 million barrels/day). Nevertheless, the severity of the crisis in the Arab world increased significantly price of oil.

In common, the recent increases in international prices registered the importance of a financial component, which results the growing number of futures contracts traded. In a context of uncertainty, either structural or geopolitical, the short-term speculative movements enlarge the volume of transactions in the futures market, which feeds back the upward trend.

Despite the speculative nature of prices, it is important to emphasize that such crisis comes at a bad time for oil-importing countries, especially for those towards economic recovery after the 2008 crisis. The higher cost of oil tends to generate more inflation and slow down economy recovery. In many European countries, for example, governments prefer to reduce the taxes on fuel prices as a tool, by reducing the impacts on final prices of byproducts. The fiscal adjustment programs are not yet completed, so it is hard to imagine that governments at this time are using traditional tools to restrain price of oil, by reducing a portion of taxes on oil byproducts

If prices keep rising and hindering world economic recovery, Brazil, on the one hand, will reduce perhaps its exports to the industrialized countries. On the other hand, we have to remember that the country now benefits from energy independence in relation to imports of oil and is about to become a net exporter over the next decade.

Furthermore, in a scenario of high prices, the oil industry contributes more significantly for increasing the budget of the Brazilian states and municipalities beneficiaries of royalties and other government oil interests. The methodology for calculating the minimum price of oil produced in Brazilian fields, which is considered as reference for the calculation of royalties, uses a parametric formula using price of Brent crude as reference.

Finally, significant changes to this picture will emerge from reversal of some factors that have unbalanced the structure of supply and demand for oil over the past years, as well as the reduction of geopolitical instability in OPEC countries. But, in the short term, it will be difficult to escape from a context with increased volatility in prices of oil in relation to severity of the crisis observed, which require a redesign of the international geopolitical relations.

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  1. […] the article “The crisis in the Arab world and price of oil“ we highlighted that the volatility of prices would remain as a consequence of the sources of […]

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