Signs of increased Turmoil in Yemen gives Oil prices a boost

By Eithne Treanor

Signs of increased turmoil in the Middle East had the oil market on edge by mid-week. As Saudi Arabia and its Gulf Arab allies launched air strikes on Yemen, the oil price got a boost of more than 5 per cent. In early trading on Friday, the threat receded according to energy analysts, as did the oil price, with Brent crude priced just above US$58 with WTI around US$50 a barrel.

The fundamentals in the market have not changed, but any hint of geopolitical disruption adds to the uncertainty. While the Americans may be producing plenty of oil, the energy rich states of the Middle East do the same and remain hugely important to the global energy dynamics.

Shipments of Arab crude pass by the Yemen coastline via the Gulf of Aden on route to the Suez Canal every day and ultimately on the way through a key passageway to Europe.

Any interference with shipping routes would seriously impact price to the upside at a time when the market is so volatile. A coalition of 10 countries in the Arab world, led by Saudi Arabia and supported by the US, is discussing the possibility of sending ground troops to Yemen to counter the Houthi rebels if the situation demands.

The American Energy Information Administration sees this region near Yemen as a “chokepoint” for global oil supplies. The EIA estimates that more than 3.8 million barrels a day pass through the strategic Bab el-Mandeb, the 40-kilometre waterway between Djibouti and Yemen. The region is defending this territory after Egypt sent naval vessels to help secure the passage. Investment bank Goldman Sachs said the strikes in Yemen would have no effect on oil supplies as the country has little oil, with an average output of 145,000 a day.

The bank said that ships could take an alternative route in the event of closure, but other analysts make it clear that a different route would mean diverting traffic around Africa instead of passing Yemen. Iran also has a presence on the Strait of Hormuz and no one wants to see the escalation of a wider Middle East conflict.

Key players in the energy sector gathered this week for the annual International Energy Forum symposium on energy outlooks, hosted jointly with OPEC and the International Energy Agency in Riyadh. The mood was serious and unresolved, but few had any doubt that the market would recover.

While some American oil has been taken off the market, The Executive Director of the IEA, Maria van der Hoeven said there’s a fear that when the price recovers, absent players will return, so she warned that the IEA, OPEC and the IEF “must not get complacent.” She added that everyone needed to observe how “the market has changed, volatility will be there and there are new players in the market,” mainly referring to shale producers in the US that are not going away.

The OPEC Secretary General, Abdalla El-Badri cautioned the market about pulling back from investment at this volatile time due to “high risk and high cost of some non-OPEC producers and international oil companies.” El-Badri and OPEC ministers welcome the cutback from the higher cost shale producers, but he’s fearful of a more general industry retreat.

As he looked to the longer term he said todays decisions to cut back investment “could backfire” and would play out with possible consequences of prices “above US$100 a barrel again” if key investment is curtailed. He also said that the major OPEC producers were not curtailing investment.

The strength of the global economy is being closely watched, as demand has been stagnant in recent years. The good news is that China’s economy looks like it will slowly pick up momentum and the news from the Eurozone is improving.

Energy demand should also improve and accelerate in the US as Americans brace themselves for the traditional summer driving season. While the American economy is struggling, this will add to weakness in the dollar and help prop up the oil price as crude is transacted in dollars.

Where the oil price will go is anyone’s guess, but what’s clear is that everyone is interested. The dynamics are different with this price fall. Volatility and uncertainty has become the norm and OPEC’s steadfast behavior still surprises the market.

“These times are unique,” says Bob McNally, president of The Rapidan Group, speaking at the IEF symposium. “Its not just barrel-counters like us and oil experts who are interested, its macro economists, energy security experts and lenders; everyone’s wondering whats going on in the oil market these days.”

The Secretary General of the IEF, Aldo Flores-Quiroga agreed, “there are more questions than answers,” but he also added that new questions were being forced on the agenda, a situation he believes will help energy players make more informed decisions in the long term.

The former administrator of the Energy Information Administration and currently senior adviser in the energy and national security program at Centre for Strategic and International Studies, Guy Caruso said there will be “winners and losers” in this environment.

On the sidelines of the IEF symposium, he added that different investment decisions are being made. “Although the total investments will be lower, it’ll be more efficient, it’ll be more high graded; going after prospects that are lower cost, and we’ll come out of this market with higher efficiency.”

Looking at the wide range of viewpoints from analysts, Standard Chartered says that crude will rise to US$90 a barrel in the fourth quarter. Bank of America Merrill Lynch is being more conservative around US$58. Whoever is right, the winners and losers scenario will be with us for months to come. The good news remains that most analysts and energy organisations believe the price will remain positive and increase by “some” amount in the months to come.