The spill-over of the political revolutions from the neighbouring countries to Libya and the resulting civil war have highlighted the threat caused by production downtimes in politically unstable countries. Although with an oil production of about 1.65mn barrels/day (2010; some 1.5mn barrels/day of those were exported) the country accounts for only 2% of global production, the price of Brent increased by about 25% between February and April last year. The influence of downtimes on the oil price does not only depend on the quantity of the production shortfall, but on many factors :
• Quantity vs. quality: The quality of the lacking oil is a crucial element in the establishment of the price after the downtime. The Libyan oil is of high quality (light, low sulphur content); most of the local blends (e.g. Es Sider, El Sharara, Sirtica) are comparable to the benchmark blends Brent and WTI and cannot easily be replaced. Here the downstream segment plays an important part: if the refineries are focused on oil that can be easily processed (i.e. high grade), much like in the case of many European refineries, it has to be substituted on the world market, which pushes up the price of these specific brands. In addition, the reserve capacity of OPEC consists mainly of heavy, sulphuric brands (mainly from Saudi Arabia), which cannot fully offset the loss of light crude oil.
• Global consequences: Since crude oil can be shipped worldwide, downtimes do not only affect the immediately next member of the value chain. Because they will buy other brands on the world market in order to make up for the non-delivery, they will pay a higher price and thus force other buyers to source elsewhere.
• Distance between producer and buyer: The closer the downtime to the buyer country, the faster the effects of the disruptions. At the same time, the distance to alternative sources is relevant. Due to the proximity of Libya to Europe, the downtimes came with a direct effect on the European oil market.
• Crude oil vs. oil products: The consequences of crude oil production downtimes are not limited to the crude oil market, they also extend to the market of oil products beyond. Even if the affected country does not directly influence the oil product market with its delivery disruptions, the market may be affected all the same. Italy, for example, is the biggest importer of Libyan crude oil, but at the same time it also exports many of the finished oil products and thus passes on the distortions.
• Market environment: The market environment existing at the time of the supply outage is a crucial factor. Supply and demand, as well as inventories, reserve capacity, and refinery capacity play a role. At the moment of the Libyan downtime, many inventories were well-stocked (e.g. in the US), whereas the European ones were running at substantially lower volumes. This is another reason for the drastic price increase in Brent.
• Strategic reserves: Some countries have to decide whether, in case of downtimes among their suppliers, they want to tap their strategic reserves as was the case in the US in June 2011.
• Blockade of transit routes: Supply disruptions do not have to be limited to production as such, but can also be caused by the blockade of important transit routes. We will discuss the risk of a blockade of the Strait of Hormuz in the following pages. Given the revolution in Egypt, a potential blockade of the Suez Canal or sabotage to the SUMED pipeline constituted further risks.
• Risk of contagion: The fear that the unrest in one country could also affect others was a crucial driver of prices in spring 2011. A spillover of the unrest to the Kingdom of Saudi Arabia was by far the biggest risk, and the oil producers Algeria and Iran were also under threat of contagion.
The following graph shows the time series of the Libyan oil production. After an abrupt decline in production (international oil companies were withdrawing their personnel) and months of minimal output (during the civil war), production rebounded massively. It would not have been possible to resume production that quickly if the oil and gas industry had not been largely spared by the civil war. It seems as if the warring parties had made an effort not to damage the country’s most important source of income (oil and gas accounted for 95% of export revenues in 2010). It will take a while to reach pre-war production levels; we expect to see this level in 2013 at the earliest.
Slump and rebound of oil production in Libya
Sources: Bloomberg, Erste Group Research
By. Ronald Stoeferle of Erste Group
Erste Group is the leading financial provider in the Eastern EU. More than 50,000 employees serve 17.4 million clients in 3,200 branches in 8 countries (Austria, Czech Republic, Slovakia, Romania, Hungary, Croatia, Serbia, Ukraine). As of 31 December 2010 Erste Group has reached EUR 205.9 billion in total assets, a net profit of EUR 1,015.4 million and cost-income-ratio of 48.9%.