Crude markets are being bullied by black swans – Reuters

Posted on March 20, 2011 by

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Heads are spinning on oil trading desks. Markets are now weighing two competing tail risks — sliding demand from an injured Japan versus no-fly zones in Libya and Saudi troops in Bahrain. But in the absence of black swans, the relatively abundant flows of oil should eventually drive Brent below $100.

Uncertainty over developments in Japan complicates the oil price calculation. As the world’s third largest importer of oil — just over 4 million barrels a day — Japan is big enough to move the needle on world crude. Initially the nation’s appetite will climb as it switches on back up oil-fired electric generators to compensate for nuclear outages — as happened after the 1995 Kobe quake. If this is followed by a modest slowdown in growth, as many economists expect, there could then be a fairly trivial reduction in oil consumption. Yet if Japan’s nuclear emergency worsens, and the economy freezes, the nation’s thirst for oil could dry up fast.

At the same time it is rational for traders to brace for the worst in the Middle East. The intervention of oil kingpin Saudi Arabia in Bahrain raises the risk of supply disruptions that would send the oil price rising fast. The situation in Libya is more complicated. Oil supplies have already largely been disrupted. If UN intervention brings a quick end to the Gaddafi regime, oil prices could even fall. But there’s also a risk that Gaddafi’s forces could sabotage oil market infrastructure taking capacity out of the market for the long term.

Still, extreme outcomes remain unlikely. It is also worth recalling that nuclear and oil supply different types of energy: electricity and transportation fuel are not simple substitutes. And for those without a crystal ball, a reminder of the present oil supply and demand outlook is reassuring. For a start, energetic pumping by Saudi Arabia has more than filled the gap left by Libya. Indeed, the global surplus is running at 900,000 barrels a day, against a shortfall of 1.6 million at the start of 2008, according to data from Oil Market Intelligence. Ample global inventories and plentiful OPEC spare capacity should also help sooth rattled nerves. Traders would be foolhardy to ignore mounting tail risks. But unless these black swans show up, the comfortable balance of supply and demand should bring prices back to more sober levels

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Posted in: Global