| Kippreport.com

Double trouble

February 24, 2011 2:52 by Reuters

Oil prices have entered unsustainable territory. Recent price surges provide strong indications of a bubble in an advanced stage.

Brent prices vaulting over $117 per barrel in the last 12 hours imply the need for a global slowdown or outright recession to bring consumption back in line with diminished expectations of supply, as rising turmoil in the Middle East causes the market to start pricing in serious output disruptions.

If sustained for more than a few weeks, current oil prices will push weaker economies such as the United Kingdom back into recession and cause sharp slowdowns in the United States and oil-importing emerging markets such as China.

No one actually believes a recession-induced reduction in demand is needed at this point. OPEC has over 4 million barrels per day of surplus capacity, more than 2.5 million bpd even if Libyan production was lost entirely. Commercial inventories of both crude and refined products are ample, more than enough to cover a temporary loss of output.

OECD countries hold commercial crude and product stocks amounting to 2.7 billion barrels of oil. In addition, OECD countries hold 1.5 billion barrels of government-controlled strategic stocks that could be released in an emergency, according to the International Energy Agency (IEA).

Combined commercial and strategic stocks amount to 91 days consumption. They could cover the total loss of Libyan exports for 8.9 years and the complete loss of exports from all OPEC members for almost 5 months.

China and other developing economies have been building their own reserves to insulate themselves from physical shortages or severe price movements. While the extent of non-OECD strategic stocks is not reported, total global inventories are very high, and there is no physical threat to the adequacy of global oil supplies.

In a narrow sense, it is true to say “the market cannot accommodate another disruption … with the problems in Libya potentially absorbing half of OPEC’s spare capacity,” as analysts at Goldman Sachs observed in a research note.

It is easy to construct doomsday scenarios justifying almost any price level. Prominent analysts have recently been busy publishing some extreme projections at $150 or even $220. But it is harder to assign a probability to such scenarios.

The market is pricing as if such doomsday scenarios were a virtual certainty rather than merely an outlying possibility. Investors risk becoming fixated on tail risks while neglecting the central part of the probability distribution.

Pages: 1 2

Tags: double dip, double dip recession, economic threat, market instability, oil crisis, oil demand, oil instability, oil price danger, oil price rise, oil prices consequences, rising oil prices