It’s been a wild week for crude oil prices, and as always in periods of dramatic price gyrations, the inevitable question comes up: where are oil prices going? With West Texas Intermediate (WTI) hitting $US 100 per barrel this week on the North American exchange—and prices for Brent in the UK trading even higher than this—it’s a question that has fascinated investors, speculators, and business page writers.
What factors are at play, and what will it all mean for Alberta's economy?
The first factor has to do with the uprisings in Libya, an oil-producing nation in North Africa. Following similar protests in neighboring Egypt a few weeks ago, and in Tunisia late last year, the Libyan people are expressing discontent with the current leader of the country, Moammar Gadhafi, and the situation has turned violent. Experts on the geopolitical situation in Libya and the Middle East are divided as to what will happen next. But one immediate result has been that at least part of Libya’s 1.7 million barrels of oil per day is now unable to reach markets.
While Libya is a relatively small global producer (about 2% of world output), the global supply and demand situation is tight. That means that a supply disruption of even 1-2% can cause big price increases, which is part of the reason why oil prices suddenly spiked this week.
But the larger factor affecting oil prices is uncertainty. Uprisings against certain autocratic dictators in other Middle Eastern countries is a distinct possibility, and if that happens, global oil supply could drop even lower. There are a few possible scenarios that could play out:
Worst case scenario: the Libyan situation escalates, with the gover-nment and supporters of Gadhafi resorting to extremely violent suppression of the protestors. Gadhafi has even suggested bio-chemical weapons. The uprisings spread to other Middle Eastern oil producers such as Saudi Arabia, Iran and Algeria. Global supply of crude oil is severely curtailed, and other oil producing nations (including Russia, the US and Canada) are unable in the short term to increase supply sufficient to offset this decline.
Best case scenario: the Libyan leader steps down, the uprisings turn to euphoria (as they did in Egypt), a peaceful and non-violent new regime is set up in Libya, and other Middle Eastern countries follow suit. A sea-change of new leaders, governments and democratic reform sweep the region. Oil supply is not affected, and indeed the changes prompt waves of new investment in Middle Eastern oil production.
The most likely outcome is some scenario in between these two extremes, but global oil investors are clearly betting that the former (the “worse case scenario”) is more probable than the latter.
Where does this leave oil prices? And what will it mean for Alberta?
Oil prices are affected because investors are buying oil on the futures market—in other words, they are betting on the direction that spot oil prices will go in the future. Right now, with all of the uncertainty, investors are nervous and are betting prices will rise due to further violence and disruption in the Middle East.
Given a worst-case scenario in the Middle East, prices for WTI could easily top $US 150 a barrel, or higher. One Japanese investment bank this week said $US 220 was possible. But a best-case scenario could push oil prices down to a range of $US 60-80 per barrel, where global supply and demand fundamentals would suggest.
With oil over $US 100 per barrel, Alberta’s oil and oilsands producers will do well. Investment will continue strongly in bitumen projects, and new technologies in horizontal drilling will prompt activity in some of the older conventional oil fields around the province. Royalties to the provincial government will rise, helping to offset the severe drop in natural gas royalties.
But $100 oil brings some unpleasant-ness to Alberta’s economy as well. The province is home to the headquarters of a major airline, a major railway, and several large and small trucking companies—all of which will feel the hit to their revenues and bottom line. While airlines and railways may be hedged against fuel price increases, higher prices will still cut into their volumes. And of course, Alberta households will see higher prices at the gas pumps.
The Middle Eastern violence is alarming and tragic, and in no way do Albertans wish for financial gain because of bloodshed elsewhere. And what goes up quickly can also come crashing down just as fast. The best Alberta can hope for is a peaceful scenario in the Middle East, a growing economy in China, India and the US—and gradual, steady improvements in oil prices.