POLITICAL UNREST

Political Unrest

Political Unrest

Introduction

The North African countries that have undergone the greatest political unrest so far—Libya, Egypt and Tunisia—collectively account for only a miniscule slice of the global capital markets and economy. However, ongoing developments in the region can impact the global financial markets in a variety of ways, particularly through their influence on crude-oil prices and the geopolitical risk premium for financial assets.

Impact of These Situations on the Oil Market

While turmoil in Tunisia and Egypt put upward pressure on global crude-oil prices, the negligible petroleum production from those countries meant there was little impact on the global supply/demand balance for crude oil. However, Libya accounts for roughly 2% of global oil production and 3% of world oil exports. Reports indicate that significant amounts of Libya's production have gone off-line; there is likely some fundamental impact from the region's unrest on the global economy. Losing Libya's production from the global crude-oil markets, however, is not likely to be a traumatic event because the world is reasonably well supplied with oil and has some supply cushions that could help prevent near-term disruptions of this magnitude. Crude-oil inventories held by the 34 countries that are members of the Organization for Economic Cooperation and Development (OECD) are at above average levels, with nearly 58 days of supply on hand versus an average of 53 days from 2005-2008 (Mitchell, 2011).

Spare production capacity, primarily in Saudi Arabia, is estimated to be more than twice the size of total Libyan production, and Saudi has already brought a portion of this online. In addition, several countries, including the United States, maintain strategic petroleum reserves that could be utilized as well.

From a fundamental supply/demand standpoint, the outlook for higher crude-oil prices in 2011 was already expected, with prices having moved up 12% in the fourth quarter of 2010 due largely to the strengthening U.S. and global economies (LAT, 2011,).

At this point, however, the majority of the increase in crude-oil prices in recent weeks has been due to an increased “risk premium” for the commodity, which reflects the possibility of political unrest spreading to additional and particularly larger crude-oil producers in the region. Since Egypt's “day of rage” on Jan. 25,

2010, the per-barrel price of U.S. crude oil has risen to almost $98, from $85, while European crude-oil prices spiked above $110, from $96.iv If any additional producers from the Organization of Petroleum Exporting Countries (OPEC) were to experience supply disruptions, such as Saudi Arabia and Iran—which together account for roughly 20% of global exports—it could cause a far greater spike in crude-oil prices.

Impact of These Situations on the Stock Market

Stock and bond markets in the Middle East and North Africa are small by global standards, but the potential for the spread of political instability can have an impact on the risk premium for financial assets around the world. So far, the biggest impact on performance has been to securities in countries most directly affected, with Egypt's stock market down about 20% in 2011 before it was suspended in late ...