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Why Is Egypt Driving Up Oil Prices?

by Michael Levi
January 31, 2011

There’s no shortage of commentary on the fact that continuing unrest in Egypt appears to have driven up oil prices. But what is it precisely that’s sparking market concern?

Much of the market reaction may be (sort of) irrational. Big and unexpected things are happening in the Middle East, and people rightly associate the Middle East with oil. Traders didn’t have time to analyze the full consequences of Friday’s developments before placing their bets. Odds are that many bought oil as a simple and instinctinve way of protecting themselves against an uncertain situation.

But there are also “real” reasons to expect increased prices.

Some have pointed to the fact that Egypt produces about two-thirds of a million barrels of oil each day. But it also consumes roughly as much. Production cuts in Egypt are unlikely to lead to big price rises.

How about oil transit? The Suez canal and the Sumed pipeline each carry on the order of a million barrels a day of oil. Disruptions there would be significant. But oil shipments can be rerouted around the Cape of Good Hope. Yes, that would increase the cost of shipping Middle Eastern oil. It’s unclear, though, whether that would significantly raise world oil prices, since the cost of producing most oil in the Middle East is well below the world oil price in the first place. To put that another way: The extra cost of transport might well be borne by Middle Eastern producers rather than  by consumers.

The bigger issue, I suspect, is the possibility that unrest could spread to other countries that are much bigger producers. After so many pundits wrongly predicted that the Tunisian protests wouldn’t spread, analysts are going to be less confident in their predictions about spillover from Egypt. Even a small probability of significant contagion – particularly to Saudi Arabia, whose spare capacity is a key buffer against broader market disruptions – could translate into a non-trivial increase in the price of oil.

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