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Middle East turbulence: Impact on economic activity and risk assets.

There are no clear answers, given the fluidity of the situation and uncertainty over whether violence will spread further...

Article also available in : English EN | français FR

The spread of violence in the Middle East transformed the investment environment last week. Oil prices spiked when news emerged of the bloodshed in Libya, where the Gaddafi regime has been fighting to cling onto power. Equity markets sold off; there was a flight to quality in bond markets, while the traditional safe-haven currencies benefited, with the CHF and JPY strengthening during the week, before a rebound in equities on Friday. This writer received several questions last week on what the violence in the Middle East means for economic activity and for risk assets. There are no clear answers, given the fluidity of the situation and uncertainty over whether violence will spread further. Indeed, we claim no expertise in geopolitics. However, the recent events can be placed in perspective.

Oil prices are close to their all-time highs in real terms. Using historical data from the BP Statistical Review of World Energy (June 2010) and updating for more recent price action, the current Brent crude price of $110/bl (if sustained) would be the highest price in inflation-adjusted terms since 1864. Crude in real terms would exceed the previous peak in 2008 (when the spot price touched $150/bl) and 1980 (after the fall of the Shah of Iran). Such a comparison clearly assumes that prices remain at current levels, an outcome that the Saudis have stated they will seek to prevent by increasing crude supplies.

Libya was producing 1.6mn barrels of oil per day until the output disruptions of the past few days. Europe is particularly affected as it reportedly imports 21% of its oil from Africa with half of that coming from Libya. Libya accounted for 3.3% of proven world reserves in 2009 (with Egypt adding a further 0.3%). From an historical perspective, this compares to Iran, which accounted for 8.7% of total world reserves in 1980. So, for the current situation to remain manageable in terms of the possible economic impact, markets will hope that the turbulence does not spread to Saudi Arabia (20% of total reserves), Iran (10%), Iraq (9%), Kuwait (8%) or UAE (7%)

The impact on world real GDP from the spike in oil prices is unclear. As a rule of thumb, it is said that a (sustained) increase in the oil price of $10/bl lowers global growth by approximately 0.5%. One sell-side house estimated that, historically, there tends to be a negative shock to activity when global oil consumption rises to 5½% of GDP. This research also estimated that this risk would crystallise if the oil price breached $120/bl. Despite all this, the global economy is undergoing a robust upswing, judging by recent economic releases. In the past week alone. Meanwhile, US economic surprise data remain strongly positive, with the Citigroup series now at its highest level since 2008 (indicating positive growth surprises in the releases).

David Shairp March 2011

Article also available in : English EN | français FR



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