Among the first reactors to the Arab Spring back in January 2011 were the oil markets. The oil price, already volatile in the aftermath of the global financial crisis, became even more unstable as concerns that the oil supply would be choked off if the political problems of the Middle East affected global oil production.
Now, the world is dependant on a few Gulf countries, namely Saudi Arabia, to fill the supply gap. But should the Arab Spring countries, the majority of whom are not big oil producers, be a primary concern for unstable oil markets? Indeed, sometimes the oil market can be wrong, like it was on Egypt. Sometimes the oil market can prepare for the worst case scenario as it did on Syria.
Rebel Economy asked Justin Dargin, an energy and Middle East scholar at the University of Oxford, to break down the misconceptions we have about the oil market and its relation to Arab countries in transition.
Dargin has advised some of the largest oil companies in the world and worked in the legal department at the Organization of Petroleum Exporting Countries also advising on multilateral initiatives.
The oil market has been at one of its most unstable points since World War Two. Many have linked the risks from the countries of the Arab Spring to this tumultuous period. Is this a fair assumption?
There was a chain reaction in the global economy. After the protests began in Tunisia and spread to other MENA countries, for a period of time, investors speculated that the instability would reach the major oil producing Arab countries. The trepidation that the major Arab oil producing countries were at risk for sustained political unrest caused the global oil market to react.
But, what is problematic for the global economy is not elevated oil prices, per se, rather it is that the oil market is much more volatile because of the tenuous political situation in the MENA region. Additionally, the Arab Spring began at an already delicate time for the global economy that was still reeling from the global financial crisis.
Much of the fluctuation in the global oil market is driven by what is known as the “fear premium.”
The fear premium is basically a rise in the price of a commodity, such as oil, that is based on the expectation that a certain event will happen that would significantly impact the market in a negative way. This relates to the Arab Spring as there was a fear that several events could potentially happen. Global investors speculated that in the beginning months of the Arab Spring, there could be oil production disruption in the oil producing Gulf countries.
There was also the fear that perhaps several important sea-lanes and canals, such as the Strait of Hormuz or the Suez Canal, could be blocked. Furthermore, a bit later on during the Arab Spring, terrorism fears grew and it was thought that the regional power vacuum could encourage militant groups to launch attacks on MENA energy infrastructure.
While these fears have largely subsided (although not completely), the international price of oil still remains extremely unstable because of this uncertainty.
So when we examine global energy price instability because of political instability in the MENA region, we must realize that this is “political risk” premium that keeps oil prices artificially high.
The oil market fundamentals are relatively sound at the moment, with increased oil and natural gas production occurring in North America due to the shale oil production boom and increased production in Iraq and other areas around the world.
Nonetheless, when we assess the actual impact of the Arab Spring, the oil producing country of note that had notable disruption was Libya. And, when viewed in context, Libya supplies a minor amount of the global oil supply, while Syria, Egypt, Yemen and other Arab countries that had their own “Arab Springs” are not major oil producers of any note.
The fear premium is based on the fear that the major oil producing Arab countries of Algeria and the Gulf (and perhaps Iraq) will have their production disrupted which would significantly reduce available oil on the market.
But the perception that the oil supply could be affected, even if it is incorrect, can still make more impact than real pressures. What is the long-term impact of this on oil markets?
The oil market is uniquely vulnerable to fluctuation based on fears, whether justifiable or not. This is because most oil exports hail from regions whereby state formation occurred relatively recently and nation-state legitimacy is still being constructed.
Because many of the nation-states in the MENA region are relatively recent creations, political stability is still evolving. The primary perception in most commodity markets especially that of oil, is that the region is prone to wars, coups, terrorism and civil disturbances in ways that can definitively disrupt production of the lifeblood of the global economy.
Ultimately, the long-term impact of investor perception in the oil market, or in other words, the fear premium, is that the oil price will become increasingly divorced from the supply fundamentals thereby leading to a much more volatile market. And, as commodity markets in general become more computerized and investors are able to make split second decisions regarding investments, this problem will be exacerbated.