Sudden spikes in crude oil price not necessarily good news for Alberta

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?

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 — it’s a question that is fascinating investors, speculators, and business page writers.

Uprisings in Libya

The first factor has to do with the uprisings in Libya, an oil-producing nation in North Africa. Following similar protests in neighbouring 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 two per cent of world output), the global supply and demand situation is tight. That means that a supply disruption of even one to two per cent 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 other autocratic dictators in other Middle Eastern countries are a distinct possibility and if those happen 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 government and supporters of Gadhafi resorting to extremely violent suppression of the protestors. Gadhafi has even suggested bio-chemical weapons.

The uprisings then spread to other Middle Eastern oil producers such as Saudi Arabia, Iran and Algeria.

Global supply of crude oil is therefore severely curtailed, and other oil producing nations (including Russia, the U.S. 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 “worse case scenario” is more probable than the latter.

Where does this leave oil prices? And what does 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 West Texas Intermediate 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, which is where global supply and demand fundamentals would suggest they should be.

As for Alberta, with oil over U.S$100 per barrel, Alberta’s oil and oil sands producers will do well. Investment will continue strong into 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 due to low prices for that resource.

What goes up usually comes down

But $100 oil brings some unpleasantness, even to Alberta’s economy.

Our 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 East 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 U.S. — and gradual, steady improvements in oil prices.

Todd Hirsch is a senior economist for ATB Financial and a business columnist with Troy Media.