Will political unrest in the Middle East cause disruptions to oil production or transportation? During today's OnPoint, Kevin Book, managing director of research at ClearView Energy Partners, gives his analysis of the growing political turmoil in the Middle East. He discusses how oil prices may change in the short term and explains the significance of the Suez Canal and Yemen's Bab el-Mandeb in the energy discussion.
Monica Trauzzi: Hello and welcome to OnPoint. I'm Monica Trauzzi. With me today is Kevin Book, managing director of research at ClearView Energy Partners. Kevin, thanks for coming back on the show.
Kevin Book: Thanks for having me, Monica.
Monica Trauzzi: Kevin, at a recent hearing Senator Bingaman, chair of the Senate Energy and Natural Resources Committee, said the political turmoil in the Middle East would not result in major disruptions in oil production or transportation. What's your take on all of that? Do you think we're going to see a significant shift?
Kevin Book: Well, it's certainly a hopeful outcome that it doesn't disrupt oil production or transportation. But if it were going to disrupt one of the two, transportation would be the one most likely to be disrupted. It doesn't have to be the Suez Canal either, there's other parts of the region where oil flows on the seas through narrow checkpoints and obviously contagion spreading to Yemen creates the concern that there could be problems getting through Bab el-Mandab on the south of the Suez Canal going in through the Red Sea. So, I mean it's really, ultimately, I think it's a hopeful statement and it's one that seems currently true, but I can't say that you could guarantee it.
Monica Trauzzi: So, where do you see prices over the next few months? I mean, can you even make a guess based on what's happening there and the volatility of the situation?
Kevin Book: You can, actually, and part of the thing that has come back is there's the notion of geopolitical risk premium. What we have are fundamentals that are clearly not saying what the market is saying in terms of price right now. We have a weak demand situation throughout the OACD, especially here in the U.S. If you look at the Brent-WTI spread what it suggests to you right away is that somebody is pricing a risk premium into Brent that suggests maybe there's somewhere between 5 and 8, $11 intraday sometimes of fear about the delivery of supplies. That's the upper bound of the premium, but whatever it is, there are still fundamentals plus a premium in price. I don't think you're going to go above $100 in WTI as an average for the year. And I don't think we'll even kiss it necessarily during the year.
Monica Trauzzi: So, we're not going to see a super spike?
Kevin Book: Not a super spike, we will have moments of volatility for sure. Any tight market is characterized by super spikes. This is not a tight market, this is a well-supplied market and reality will come back awfully fast to someone who's too far out in a long position.
Monica Trauzzi: In terms of inventory, what are the numbers coming out of the Suez Canal and what impacts could we see if it was closed down for a short amount of time?
Kevin Book: In terms of career travel we're talking about 600,000 barrels per day, which is not a particularly large volume of oil. But in terms of the products travel, and that's obviously much more important going into Europe, we're now talking about 1.2 million barrels per day and it could go up from there with economic recovery. The issue isn't necessarily disruption, so much as rerouting. You take a 15 hour trip through the Suez Canal, which is about what it takes for the tankers, and you now have to go somewhere between 6000 and 7250 miles and that turns it into somewhere between a 300 and 600 hour trip, depending on where you're going and how. And, obviously, that means that you're going to have an effective capacity loss for a little while. The presumption is that tankers would come to market and fill the gap.
Monica Trauzzi: And you mentioned a second checkpoint of significance and that's in Yemen, Bab el-Mandab. How is Yemen significant in this energy discussion? We don't hear about it often, but it seems like it's going to play a key role here.
Kevin Book: Yemen's role is really twofold. The first one, obviously, if you do have a resurgence of violence that leads to a Yemeni outcome that is essentially chaos, where Al-Qaeda and the Arabian Peninsula and the Islamist groups have an opportunity to threaten transit through Bab el-Mandab, then you have a disruption risk that's significant. And it's significant only because you have additional volumes that went through the SuMed pipeline that are also going to be traveling by sea when they go through Bab el-Mandab, plus additional production. What you do have though is a second order of effect that's not trivial, which is the Saudi Arabian production picture, well protected, well insulated, and, frankly, domestically I don't think there is much risk of uprising. But attacks from Yemen as a potential stronghold for Islamist groups looking to try to harm the West certainly could increase if you have sort of the failed state scenario.
Monica Trauzzi: You're also concerned that countries like Iran or Venezuela may take advantage of what we're seeing happening in the Middle East for their own financial gain. Explain that.
Kevin Book: Well, it goes back to the capacity utilization of the oil system right now. Again, if you end up losing some of the capacity that's going through Suez for a little while, nobody is really going to be undersupplied. Inventories will cover. But when you get to Bab el-Mandab level of magnitude, you're starting to actually disrupt products flow into the world and you're starting to seriously see probably a real bid on crude because there's concern. Will there be enough of the light, sweet oils that are needed to make the refined products that the world is short of? And that's the moment in time where you'd expect some of the countries, producer nations, where their agenda is aligned with oil. Venezuela and Iran are easy ones because Venezuela, we're talking about socialist organization. Iran, we're talking about trying to essentially deflect sanctions and win respect. And both of these pulpits generate wealth for the leaders of the country if they manage to ultimately scare the price of crude up. So it's essentially a no-lose proposition when capacity gets tight. The thing is, capacity is not tight enough right now to give a pulpit to that sort of sovereign geopolitical risk.
Monica Trauzzi: What's the biggest risk for a U.S. misstep in all of this?
Kevin Book: In all likelihood, if it's going to have been taken, it's probably already been taken. The challenge, and when we talk to some of our foreign-policy experts and state department sources, the challenge was always whether or not we had an affirmative voice one way or another. The risk is if you pick a side at the presidential level, as we have now done, the question would be whether or not you are sincere in the aftermath of whatever takes place in Egypt. If there's an abrupt and chaotic transition, the next government may resent the fact that the United States wasn't more supportive and we could lose an ally with massive regional implications. The other side of that though is that if we weren't more supportive of Mubarak, in the eyes of some of our allies throughout the region, the concern may be that the United States is a fair-weather friend to other regional powers with whom we have strong trade, security, and oil relationships. And, obviously, that won't be good either. We'll have to see how it plays out.
Monica Trauzzi: What's the worst-case scenario and should the U.S. be preparing for that?
Kevin Book: Well, the worst-case scenario is a significant supply disruption with the propagation of uprisings throughout the oil-producing parts of the Middle East. I think we probably should be preparing for it more than we are. We do have a significant strategic reserve. But when you look at the length of time where, if we are in that situation, it could last, we're not talking about two or three weeks, a thunderstorm. We're talking about potentially months or in the case of the Suez Canal, the history is years. So, if we're going to look at a significant disruption risk, obviously, the tendency in our country and our policy is to react, not to prepare. The costs of preparation are high and the politics are even harder. So our expectation is that we're probably as prepared as we're going to get.
Monica Trauzzi: All right, we're going to end it there. Thank you for coming on the show again.
Kevin Book: Thank you, Monica.
Monica Trauzzi: And thanks for watching. We'll see you back here tomorrow.
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