- Libya remains the immediate focus of the oil market - Tensions in Bahrain may prove more significant - Ongoing regional issues to sustain high oil market volatility

By Chris Shaw

For the global oil market the immediate focus remains Libya, with Barclays Capital taking the view a protracted civil war is now under way. This view is at odds with growing market optimism the success of Libyan rebels in taking back some key oil towns could speed up a re-introduction of Libya into the global oil market.

A further risk related to Libya, according to Barclay,s is reservoir damage, this due to a lack of maintenance and oil well shut-ins. This is set to reduce Libya's oil production profile if and when the current dispute is settled. Such a trend was already underway, Barclays noting since Libyan production peaked at 6mb/d in the 1970s it has been a struggle to subsequently produce more than 4mb/d.

Looking beyond Libya, Barclays suggests an escalation of tensions in Bahrain may be of even greater significance to the global oil market. This is because the situation in Bahrain is a key reference point for the Middle East as a whole given it touches on sectarian divisions, the US relationship with Saudi Arabia and an ongoing regional power struggle between Saudi Arabia and Iran.

Given the current risks, and with potential for issues in the likes of Iraq, Yemen, Egypt, Oman and Algeria to also emerge, Barclays expects one long-run result will be a curtailing of foreign investment in the oil industry and the region generally. Shorter-term there is also likely to be continued high levels of volatility, given market nerves in relation to a lessening of space capacity in the oil market.

Looking at the history of the oil market, Barclays notes more recent times have seen two periods of significant change. The first was the period combining the 1960s and 1970s when price control passed from international oil companies to producing countries. During this period, the combination of rapid demand growth and limited spare capacity generated the first oil price shock.

The second period started when a revolution in Iran and the subsequent Iran-Iraq war impacted on capacity. As producers attempted to maintain prices above a sustainable equilibrium level, there was a weakening in demand. The result was to bring to the fore the role of the market in setting prices.

For almost 25 years the oil market has been relatively stable, but 2011 has brought with it new questions. These include whether key producers are now set on periods of higher social expenditure that require higher oil prices and whether or not periods of supply capacity tightness imply greater price swings and faster energy transitions and demand side changes.

Barclays estimates global spare capacity in the oil market was already down to around 3mb/d before the Libyan crisis, while at the same time the large inventory overhang that had previously been in evidence has now disappeared.

With Saudi Arabia the only swing producer of any note, Barclays suggests any escalation of tensions in Bahrain may postpone any attempts to calm the oil market or push prices lower via production increases.

This quickly thinning capacity buffer is also increasing market volatility, Barclays taking the view this trend will now be heightened and more prolonged. Given this, Barclays suggests the status quo that was in place at the start of the year in the MENA region has been disturbed to such an extent there is very little chance of a swift return to previous conditions.

What also makes a swift return less likely is a deterioration in US-Saudi relations, which has emerged in recent years as the Saudis have become more diversified in terms of interacting with other economies such as China and Europe.

With less emphasis on the US, Barclays suggests the fact higher oil prices have a negative impact on the US economy are now of less significance to Saudi Arabia than might have previously been the case.

Key producers can therefore take their time in trying to limit oil price upside, to the extent Barclays suggests control of the market may only be re-established at prices above US$120 per barrel for the OPEC basket.

Overall, Barclays sees the current political unrest in the Middle East in particular as creating a series of significant inflexion points in these countries. While some producing nations such as Saudi Arabia appear reasonably well shielded from any full-blown uprising, instability in the region is likely to continue.

This suggests a lasting period of unease for the global oil market, as previous foundations have now been cracked. This is forcing new actions and political responses, Barclays taking the view this will create further pressures in an already resource constrained global oil market.

Barclays Capital's average annual oil price forecasts stand at US$112 per barrel for Brent Crude this year, US$105 per barrel in 2012 and US$125 per barrel in 2013. For West Texas Intermediate Barclays forecasts average annual prices of US$106 for both this year and 2012 and US$125 per barrel in 2013.

FN Arena is building the future of financial news reporting at www.fnarena.com . Our daily news reports can be trialed at no cost and with no obligations. Simply sign up and get a feel for what we are trying to achieve.

Subscribers and trialists should read our terms and conditions, available on the website.

All material published by FN Arena is the copyright of the publisher, unless otherwise stated. Reproduction in whole or in part is not permitted without written permission of the publisher.