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Oil price risk: Egypt dejà vu

After weeks of grassroots campaigns, mass protests in Egypt erupted over the weekend, where as many as 14 million people were said to have taken to the streets demanding the resignation of elected President Morsi of the Muslim Brotherhood. On Monday, the army issued a 48-hour ultimatum to the government to find a resolution to Egypt’s political crisis. Today, President Morsi and the government rebuffed the army’s ultimatum saying it was “not consulted” and that it could “cause confusion in the complex national environment”. Two and a half years after the Arab Spring erupted in Egypt resulting in the ousting of President Mubarak, political chaos has returned to the nation. As the most imminent danger for the oil market, the demonstrations are firstly sparking concerns about the security of the strategically important Suez Canal chokepoint and/or interference with the Suez-Mediterranean (SUMED) pipelines transporting around 2.4m b/d (two parallel pipelines).

The SUMED pipeline and the Suez Canal are important transit points for oil and liquefied natural gas (LNG) shipments from Africa and Persian states to Europe and the Mediterranean Basin. Fees collected from operations of these two transit points are significant sources of revenue for the Egyptian government. Thus, both the Suez Canal and the SUMED pipeline are strategic targets for strikes or attacks against the government.

In 2011, 17,799 ships transited the Suez Canal of which 20% were petroleum tankers and 6% LNG tankers (EIA). Total oil flows through the Suez Canal reached almost 2.2m b/d in 2011, but this is still below the levels seen before the financial crisis and global recession in 2008/09. The decline in transits over the last years also reflects the changing dynamics of international oil flows. Increasing demand from Asian countries especially China, the shale revolution in the US and falling demand from Europe have redirected oil flows from west to east. Security issues and piracy activity around the Horn of Africa have forced shipowners to take the longer route around South Africa to reach the West African oil markets at the expense of routes passing the Suez Canal.

Suez Canal and SUMED pipeline

Source: US Energy Information Administration

A temporary shutdown of the Suez Canal would have the biggest effect on the crude, petrol and middle distillate markets in the US and Europe as around 470k b/d of crude, 420k b/d of petrol and 200k b/d of middle distillates were shipped through the Suez Canal in the northbound direction (PIRA figures from 2010).

A temporary shutdown of the canal will redirect the shipping traffic the long way around Africa, pushing up freight costs and increasing the delivery time.

The SUMED pipeline is the only alternative route to transport crude oil to the Mediterranean Sea from the Red Sea. A temporary closure of the Suez Canal and/or the SUMED pipeline would add around 6,000 miles to transit and could have a dramatic impact on tanker rates and oil prices. The crude and product supply routes would be extended by around 8-10 days to Europe and 15 days for transport to the US according to the IEA. The longer voyage will cause a significant build in in-transit inventories and increasing tanker demand. Delayed loads and losses to the oil market and increasing transportation costs will push up the price of crude oil and products as well as the longer-haul routes will increase demand for bunker oil to fuel the ships. The fear that Egypt would close down the Suez Canal at the outset of the Arab Spring in 2011 pushed up oil prices by around USD 7/barrel.

Egypt is the largest oil producer on the African continent which is not a member of the OPEC and the second-largest natural gas producer after Algeria. The country’s oil exports are limited, only 114k in 2012, as most of the oil is consumed domestically. Thus the crisis in Egypt is first and foremost a big threat to the oil market as an important transport chokepoint and not as a supplier of oil and natural gas to the global markets. A shut-in of the country’s oil production would need to be replaced by increasing production (a cut in OPEC spare capacity) from other oil suppliers and cut down on OPEC’s (the world’s) spare capacity buffer. This will in turn put more pressure on the world’s supply/demand balance and thus increase the risk premium in oil prices in the short term as the oil market starts once again to worry about the spill-over effects if the protests spread to the oil-producing regimes of the Persian Gulf. The Persian Gulf accounts for around 30% of the world’s oil production and controls around 56% of the proven reserves.

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