The oil price has skyrocketed over the past few months. The finger has been pointed at the troubles in Libya and claims of supply disruptions have dominated the press. However, are these claims grounded in fact or are we watching yet another sentiment driven bubble? What are the issues we should be aware of and how should we best invest in the face of such turmoil?
Expectations are often more damaging than reality
Libya's contribution to global oil production is in stark contrast to the column inches it has been awarded in the press. As quoted by the National Journal, the country produces around 2% of the world's oil. OPEC (Organization of the Petroleum Exporting Countries) has claimed that they have managed to "accommodate most of the shortfall" and instead attribute the rise in the oil price to fears of a shortage rather than any genuine supply issues. Oil reached a 2.5 year high last Friday . This is against a flattish demand side dynamic. Paris-based International Energy Agency and the U.S. government's Energy Information Administration left fuel demand growth for this year unchanged and OPEC only raised their forecast by a relatively small amount (to 87.9m b/d from 87.8m b/d) .
EU Sanction: A further boost for the oil bulls
On Tuesday, the EU extended sanctions against Libya to include energy companies, freezing assets in an attempt to force leader Muammar Gaddafi to relinquish power. Phrased another way, by the German Foreign Minister, this is a "de facto embargo on oil and gas" . Approximately 85% of exports are for delivery to Europe and importers will now have the task of finding potentially more distant and/or expensive alternative sources.
The pent-up downside risk
Nevertheless, many are not paying attention to the downside risk to the oil price as we move forward. Libya has Africa's largest proven oil reserves but 75% of the country's petrol needs are met with imports because of limited refinery capacity . Any improvement on this front, if a regime change is eventually secured, could therefore significantly reduce imports and boost global supplies.
Is water the next oil?
In addition to oil reserves, one asset belonging to the Libyan government which is rarely mentioned is an ability to bring water to the desert. With the largest and most expensive irrigation project in history, the $33bn GMMR (Great Man-Made River) project, Libya is able to provide 70% of the population with water for drinking and irrigation . The United Nations estimates that by 2050 more than two billion people in 48 countries will lack sufficient water, making this an enviable asset indeed .
How can the US pay for the Libya intervention?
It is interesting to note, with all the claims being made that the intervention is oil motivated that, Libya has another form of 'liquidity'. According to the International Monetary Fund (IMF), the country's central bank has nearly 144 tonnes of gold in its vaults ...
How to best invest: Retain context
The tide is starting to turn, Goldman Sachs has called the top for commodities in the near-term and oil fell by 4.5% on Monday and Tuesday alone (Source Bloomberg) . With this amount of volatility, short term noise can sometimes overwhelm. For a long term investor, looking for steady and stable returns, an ability to cut through the sentiment (whilst acknowledging it's importance in driving returns in the shorter term) is valuable. Often many factors are at play and it will 'pay dividends' to be well-informed as they become wider known and priced in by the markets. Knowledge may be king but preparation will come up trumps.