How Libya’s oil shock is spreading: Maley

Oil prices climbed higher overnight as the conflict in Libya grew more violent, intensifying fears that the surge in commodity prices will derail the global economic recovery.

The price of Brent crude, an important benchmark for oil traded in London, climbed 2.4% to reach $105.21 a barrel, its highest level in two and a half years. Meanwhile, worries about growing global instability pushed precious metal prices higher, with silver soaring above $33 an ounce for the first time in 30 years, while gold climbed 1.2% to $1,405 an ounce.

Oil traders fear that the growing violence in Libya will disrupt oil supplies. There were reports overnight that Libyan strongman Muammar Gaddafi’s embattled regime had retaliated against mounting protests, by ordering armed militiamen to fire on protestors in the capital city of Tripoli. Meanwhile, the country’s second largest city, Benghazi, remains under the control of protestors.

Libya is the world’s 12th largest oil exporter, and is a key supplier to European markets. Although Libya’s state-owned national oil company controls most of the country’s oil production, it operates joint ventures with a number of major oil companies.

Major international oil companies have responded to the growing political instability by evacuating staff from the country, and closing down some operations. In addition, foreign sub-contractors operating in the country have begun repatriating staff, which could make it difficult to maintain operations at some Libyan oil-fields. Already there are reports that oil loading has been disrupted at some terminals and refineries.

The revolt now gripping Libya is the latest in a series of uprisings that have spread across the Arab world, and that have already led to the departure of long-term autocratic rulers in Egypt and Tunisia.

So far, global oil supplies have been little affected by these political upheavals. The countries where the protests have been most intense – Tunisia, Egypt, Libya, Yemen and Bahrain – account for only 3.4% of global oil production. But there are growing fears that the protests will spread to neighbouring countries such as Iran, Syria and Algeria, which together produce about 8% of the world’s oil.

At the same time, soaring commodity prices are adding to global inflationary pressures. This comes at a time when most developed countries are still grappling with high levels of unemployment, and lots of unused capacity.

At this stage, the central banks in most developed countries are wagering that this large output gap – which in most developed countries is estimated to be around 3-4% of GDP – means that their inflation rates will remain low, despite soaring food and energy prices. As a result, they’re refusing to tighten monetary policy, even though it’s clear that their inflation rates are moving higher.

But this is a tricky calculation. Bond markets are already becoming nervous that inflationary pressures are growing in the developed countries, and long-term yields are edging higher.

But if bond markets start to panic that inflationary pressures are moving out of control, they’ll push long-term interest rates sharply higher. And this would quickly short-circuit the global economic recovery.

This article first appeared on Business Spectator.