The link between current unrest in the Middle East ' specifically between Israel and the Palestinian...
The link between current unrest in the Middle East ' specifically between Israel and the Palestinian people ' and the world's energy markets may not be immediately obvious, as neither side is a major oil producer.
The key is that the wider Arab region, which forms the core of Opec, is a powerful supporter of the Palestinian cause. Commodity markets are therefore concerned an oil embargo may be implemented in support of the Palestinian people, which would drive oil prices to unacceptable levels, so raising inflationary fears that would, in turn, almost certainly derail the economic recovery.
Iraq has already implemented a 30-day embargo of oil supplies in support of the Palestinian people and is encouraging other countries to follow its lead. To put Iraq into context, it produces approximately 3% of daily supply, although this level has recently moved lower due to pricing disagreements with the United Nations.
Iraq's oil for food agreement with the United Nations expires at the end of May and part of the renewal process will focus on the United States' demand for weapons inspectors to be allowed back in.
Perhaps surprisingly, one can see a scenario where Saddam Hussein allows their return, making the case for a US military onslaught much harder to justify to the US population and the world.
Opec and the G7 nations have agreed the Opec oil price band of $22-$28 as an acceptable oil price for both parties. There is significant correlation between oil prices and economic growth and Opec is wary of stifling oil demand, and thereby GDP growth, with an oil price that is too high.
The Opec cartel has a pessimistic view of the economic recovery, resulting in a cautious attitude towards production increases. This strategy raises the risk of oil prices moving above the Opec band and possibly cramping economic growth in the second half of 2002.
The oil price has rallied from the lows of $18 late last year to $28 in April of this year. To put this into perspective, if this $10 increase were sustained, it is estimated the annualised economic impact would reduce global GDP growth by approximately 0.3%, which is significant but manageable.
On the inflationary front, the Federal Reserve views higher commodity prices as a tax that reduces consumer spending, while the ECB appears to have a more traditional view of the inflationary implications. In response, US monetary policy is likely to favour a low interest rate environment, sustaining the liquidity injection.
Longer term, we expect the oil price to trade broadly within the Opec band due to the strong fundamental drivers of an economic recovery and an effective Opec cartel that is successfully managing the marginal supply of crude oil.
Any breakout above or below should not be seen as a failure of Opec but as the result of volatility associated with the commodity, mostly due to political uncertainty in the Middle East and other oil producing nations, most recently Venezuela.
Opec has managed downturn expertly.
Oil price has rallied recently.
Opportunity for re-rating of energy sector.
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