Libya really doesn't matter in the oil markets. It's all about Saudi Arabia and whether its touted ability to replace lost production is genuine or fake. If genuine, oil prices will stabilize, perhaps fall, in spite of the Libyan civil war and protests elsewhere in the Arab world; if fake, $200 (U.S.) a barrel oil or higher is a distinct possibility.
Libya is the world's 13th-largest oil producer, making it a relative pipsqueak. It normally exports about 1.4 million barrels a day, accounting for 2 per cent of the market. Half to two-thirds of those exports vanished as Libyan rebels and forces loyal to Moammar Gadhafi battled for control of cities, ports and oil fields. Oil prices shot up. Brent (North Sea) crude reached $120 a barrel in late February, though the fear factor, not the lost production, was probably the real price driver. Note that the regime change in Egypt, a country that imports more oil than it produces, was enough to propel prices before the Libyan uprising took hold.
Prices have since declined to about $114 a barrel because of assurances from the OPEC countries, led by Saudi Arabia, that they have ample wiggle room. While reports vary considerably, it is said the Saudis have about 3.5 million barrels a day of spare capacity – more than enough to make up for any lost production in Libya and its North African neighbours. Saudi Arabia says the spare capacity figure is accurate and has promised to pump another 700,000 barrels a day.
Saudi Arabia and the rest of the OPEC mob have come to the rescue in the past. In 2008, oil prices surged to a record $147. They later crashed, partly because of the credit crisis and the start of the Great Recession, but also because the Saudis cranked the oil spigots wide open. By December of that year, oil was at $35. Global economic recovery and voracious demand in China had pushed the price up to $100 before Tunisia, Egypt and Libya erupted.
The big question is whether the spare capacity story is true. For many years, doubts have been raised about the ability of OPEC to keep raising production to meet global demand as the old super giant fields – among them the North Sea, Mexico's Cantarell and Alaska's Prudhoe Bay – go into terminal decline. OPEC has met the challenge, with a little help from its non-OPEC friends. Canada, thanks to the Alberta-munching oil sands projects, has turned into an export middleweight. After decades of decline, U.S. production is up by more than 10 per cent since 2007 because of the prolific Gulf of Mexico and clever new exploration and drilling gizmos.
Saudi Arabia's ability to act as the swing producer forever, however, is open to question. Six years ago, Matt Simmons wrote a book called Twilight in the Desert: The Coming Saudi Oil Shock and the World Economy. Using as much technical information as he could find – Saudi Arabia's oil reserve data are notoriously opaque – he warned that some big Saudi fields were in decline and that peak production might be dangerously close.
The doubts about OPEC's spare capacity have persisted. Last month, The Guardian published the contents of U.S. embassy cables from Riyadh, which were released by Wikileaks and based on information provided by Sadad al-Husseini, a geologist and former head of exploration at the national oil company Aramco. They suggested that Saudi Arabia may not have enough capacity to prevent oil prices from galloping ahead and that the kingdom's reserves were greatly exaggerated.
Earlier this week, the oil analysts at Goldman Sachs accused the Saudis and the other cartel members of, in effect, fudging their output figures. "We believe that Saudi Arabia has been producing 0.5 million to one million barrels a day above the official numbers since November ... implying that OPEC spare capacity is significantly lower than reported," they said.
Using available data, and backing out some figures, Goldman concluded that OPEC's true spare capacity is a mere two million barrels a day, not the 2.5 million to three million that Goldman previously estimated. Another problem is the quality of the Saudi crude, even if there seems to be a bit more of it around. Saudi oil is heavier, and more laden with sulphur, than oil from Libya and West Africa. That means many refineries can't process the stuff, which could lead to regional supply shortages.
If the civil war in Libya comes to a conclusion soon, and Saudi Arabia's claims of comfortable spare capacity are not misleading, oil prices probably will not rise to economy-wrecking levels. But if the rumours are true about the spare capacity, or lack thereof, the world faces a genuine shock. A deepening crisis in the Arab world would no doubt test the whole thesis.