Kiran Stacey Why do oil markets care about Libya?

Over the past week, the oil price appears to have moved in sync with events in Libya. When Gaddafi looked close to quashing the revolution, prices dropped with the expectation that Libyan oil would start flowing again. Every time the rebels have been given a boost, oil prices have gone back up.

So last Tuesday, as pro-Gaddafi forces neared Benghazi, oil dropped 3.9 per cent. But when UN Resolution 1973 was passed on Thursday, it went up 3.5 per cent. It fell again after Gaddafi announced a ceasfire, but rose as evidence came in of his attacks on rebel-held towns. Today, as markets react to the concerted bombing campaign over the weekend, oil has continued to rise, taking Brent back over $115 a barrel.

Amid this turmoil, the question remains, why is oil moving at all? Of course, Libya is in the top dozen oil exporting countries, but it still only exports about 2 per cent of world oil supply, and what has been lost in the last few weeks has largely been accounted for by increased Opec production.

Over the weekend, Shokri Ghanem, the head of the Libyan national oil corporation, said production had fallen from 1.6m barrels a day to less than 400,000. Traders have talked about, in effect, writing off Libyan oil – at least in the short term. Oliver Jakob of Petromatrix says:

As far as oil supplies, in the short term the attacks of the coalition do not change much as exports were already down to almost zero.

So what matters now is the longer-term outlook. As analysts begin to talk about a protracted campaign and politicians talk more seriously about regime change, the worry is that Libyan oil supplies could be curtailed for some time to come.

And while Saudi Arabia is currently able to keep supplies buoyant, traders are not sure for how long that can remain the case. This is from Stephen Schork of the Schork Report:

There is a question that the Saudis have been overproducing recently – and at these prices, who wouldn’t overproduce? But that begs the question, how much spare capacity is Opec already using?

Others have suggested that the market is reflecting concerns that trouble could spill over into Saudi Arabia, which is the world’s top oil exporting country. What really worries the Saudis is the risk that the sectarian dispute in Bahrain could spill over into the east of their own country, which, like Bahrain, is home to a majority Shia population ruled by a minority Sunni elite.

But with the US insisting that the Bahraini dispute should be sorted out internally, it looks increasingly likely that the regime there will be able to quell the rebellion. This will be as much of a relief to the Saudi regime as to that in Manama.

And when the Saudis are happy, so are the oil markets.