Brian Fallow: Fight for freedom fuels oil threat

It is not just at home that the economic recovery suddenly faces new headwinds.

The bloody events in Libya have sent oil prices climbing and share prices falling.

It could be the harbinger of worse to come.

It may be crass, when presented with what could yet prove to be a new dawn of freedom in the Arab world, to fret about the risks of another 1970s-scale oil shock. But the world economy is every bit as dependent on oil as it was then.

It is remarkable how swiftly unrest has spread since the fall of the Tunisian regime across North Africa and onto the Arabian subcontinent.

It is starting to look as if we may be witnessing the early stages of a truly epoch-making change, comparable to the fall of the Soviet empire 20 years ago.

And it is natural to feel, even from this distance, some sort of vicarious satisfaction and hope as despotic regimes totter and fall.

But it is a characteristic of such regimes that they suppress organised political opposition, so that the vacuum they leave is liable to be filled by military or religious power structures. How many of the people who took to the streets in Iran in 1979 to overthrow the Shah envisaged the theocracy which followed?

A peaceful and orderly transition to better governments and freer societies is hardly assured.

The region's governments are not all of a piece. Some may avoid, or be able to see off through some combination of concessions and force, threats from the "the street" to their authority - for the time being. So who knows how it will all play out?

In assessing the risk of a repeat of the disruptions to supply that occurred in 1973 and 1979 there are two factors to consider: the likelihood of it happening (which may still be quite low) and the impact on the global economy if it did (which would be very high).

Libya accounts for less than 2 per cent of the world's oil production.

Emergency oil stocks held in developed countries could in theory cover the loss of Libyan production for about three years. In addition, Opec said last month that its members had spare capacity of six million barrels a day, which is four times Libya's output.

But in something like the oil market small changes at the margin can have big effects on price.

The relatively limited drop in demand during the global financial crisis and subsequent recession, about 2 per cent, saw oil prices tumble from a peak of nearly US$150 a barrel in mid-2008 to less than US$40 later that year. They are now back above US$100.

What must be rattling the markets is not just the spectacle of atrocities and fleeing oil men in Libya, but the risk of unrest, even revolution, spreading to the Gulf. There the stakes are much greater. The Gulf provides nearly 40 per cent of world oil exports and contains more than half of proven reserves.

So it is a worry that it looks a powderkeg with several fuse cords running from it, some of which are smouldering already.

Protests in Bahrain, once seen as one of the more progressive Gulf states, are a stark reminder of the sectarian fault line, between Sunni and Shia, running through that part of the world.

The Sunni ruling dynasty seems to fear that if push came to shove the Shi'ite majority of Bahrainis would identify more with their co-religionists in an increasingly assertive Iran than with their fellow Arab rulers. As discrimination engenders resentment and resistance which is met with repression, that fear could be self-fulfilling.

Across the causeway in Saudi Arabia, Shia make up a substantial minority in the oil-rich eastern provinces.

Then there are the demographic factors, the challenge of providing gainful employment to a relatively young and increasingly well educated population.

How long can their aspirations be contained within essentially feudal political structures and mindsets? How do you reconcile two very different notions of how oil wealth should be distributed - a ruler's largesse or a citizen's entitlement?

On such imponderables our supply of transport fuels depends.

Oil prices were already steadily rising before the latest turmoil in the Arab world became a factor. In the course of 2010 Dubai crude, the relevant benchmark for our part of the world, rose 17 per cent to US$90 a barrel. A strong exchange rate limited the rise in New Zealand dollar terms to 10 per cent.

Prices at the pump have also been boosted by domestic policy changes - the introduction of a carbon price, higher ACC levies and a higher GST rate.

Between them taxes, levies and the emissions trading scheme account for 88c a litre, or 44 per cent, of the retail price of petrol, according to Ministry of Economic Development figures.

So while the international price of crude may still be well below its mid-2008 peak, the price the New Zealand driver faces is only 17c a litre or less than 8 per cent off its 2008 high.

For a remote and thinly populated country, with a correspondingly greater sensitivity to transport fuel costs, that is not a comfortable starting point to contemplate the possibility of major global oil price shock.

There is also a message in the increasingly daunting places the oil industry is having to go in search of new supplies to cope both with rising demand and the need to replace exhausted fields.

They include deeper and deeper offshore waters (like the unfortunate Gulf of Mexico), central Asia (as far from the open sea as you can get and with geopolitical challenges of its own) and potentially the Arctic.

In addition, the International Energy Agency expects unconventional sources of liquid hydrocarbons to play an increasingly important role.

Canadian tar sands and Venezuelan extra-heavy oil provide less than 3 per cent of world oil supply, but with coal-to-liquids (like the diesel facility Solid Energy would like to build in Southland) and gas-to-liquids (like the defunct Motunui operation) the IEA expects them to meet about 10 per cent of demand by 2035. All of these developments imply higher capital and environmental costs.

For businesses and individual consumers the conclusion is pretty clear: budget for higher transport costs or figure out ways to reduce them.