Sunday, April 17, 2011

The impact of japan disaster and libya war on the oil market

Up until recently, crude oil prices had been trading in a higher but relatively narrow range, with the OPEC Reference Basket fluctuating between $106-$112/b (Graph 1). However, at the beginning of April, prices havemoved sharply higher to currently stand at $120/b. In light of the recent upswing in prices, it is worth taking a moment to review the factors driving recent oil price movements.

Prices initially spiked in February with the onset of the supply disruption in Libya and concerns that supply outages could spread to other producers in the Mideast and North Africa. Indeed, Libyan unrest has cut output by almost 80% from normal levels of 1.6 mb/d to around 250-300 tb/d, all of which is said to be consumed domestically. Given the quality of Libyan crude, this has widened the premium of light sweet grades. The bulk of these losses has been compensated by higher output from some Member Countries. As a result, estimated OPEC production in March stood at 29.3 mb/d, down slightly from the levels seen in December prior to the onset of unrest in the MENA region.

Supply concerns, and the associated risk premium, were later dampened to some degree by the triple catastrophe in Japan of the earthquake, tsunami and nuclear problems, which has led to a persistent disruption in the Japanese energy complex. The overall impact of the tragic events in Japan on oil consumption is far from clear. While the devastating earthquake caused a sudden decline in the country’s use of oil, this is likely to be broadly offset by the need to substitute some of its shut-in nuclear power capacity with oil-based generation.Moreover, with the start of reconstruction efforts — currently estimated at $300 billion — this is expected to require even higher energy use.

In the immediate aftermath of the earthquake, Japan has responded to product shortages by maximizing refinery runs at unaffected plants to deliver more products. At the same time, Japan has released around 66 mb from its strategic petroleum reserve (SPR) to ease fuel shortages. The country is also seeking a large inflow of crude oil to meet refinery demand and its need for crude-burning power generation. Even before, the disaster, Japan’s oil consumption was estimated to shrink by 1.5%. With the exception of 2010, this decline is a continuation of the trend of the past few years (Graph 2). Japan’s efficiency efforts along with the reduced consumption needs of its aging population are the main factors behind this trend.

The recent tragic events in Japan are having a strong impact on the country’s economic growth. The projection for Japan’s growth for this year has been lowered to minus 0.1% from a previous 1.5%. The heavily affected areas in Japan produce around 6% of GDP and another 1% might be impacted due to associated factors, such as power shortages. While this 7% shortfall is expected to have some impact on the first quarter, the major effects will be seen in the second quarter of this year. However, countermeasures by the administration and catch-up effects in the second half of 2011 should partially compensate some of the earlier decline. The negative impact on Japan’s trade partners in the Asian region is expected to be low and the shortfall for global economic growth is currently forecast at only 0.1%. As a result, the forecast for global growth in 2011 now stands at 3.9%.

While events in the MENA region and Japan continue to set the background for the market, more recently, crude oil prices have moved higher on concerns about potential unrest in some West African producing countries. Although global inventories have gradually been declining, they still remain above the historical trend, especially in terms of days of forward cover. Moreover, the current supply/demand balance shows that demand for OPEC crude is expected to average 29.0 mb/d in the second quarter, still below estimated OPEC production for March, indicating sufficient supply in the market. Despite this, crude oil prices still remain at high levels – out of step with the realities of supply and demand.

In terms of fundamentals, the recent events alone do not justify the current high price levels. Instead, these represent a sharp increase in the risk premium, reflecting fears of a shortage in the market in the coming quarters.Since the supply disruption in Libya, OPEC Members have accommodated most of the shortfall in production,ensuring that the market is well supplied. 

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