Mideast Tensions Add Supply Risk Premium to Oil

The Long Brent/Short WTI trade has continued to edge towards unwinding a bit over the last two days. We've been talking about this for the last couple of weeks as Brent lept ahead of WTI due to the combination of strong demand for refined products in Europe (a systemically short finished products region), troubles with North Sea and Norway production, and rising Asian demand vs. conditions in the U.S., which have been witness to full storage levels of crude (especially at Cushing) and weakish finished products demand (something that is about to reverse seasonally in the next few weeks).

See WTI vs Brent chart here.

Implications of Libya and Beyond:

Return of the Supply Risk Premium – Since late 2008, the supply risk premium has been largely absent from crude prices. You can tell by the fact that when Nigerian rebels blow up a pipeline, abduct local workers or shut down a platform, oil traders yawn. While Libya's 1.8 mm bopd represents 6% of OPEC 12 supply and "just" 2% of current global supply, it also represents one domino in a chain of many that could disrupt supply to a significant extent. Egypt was a small player on the crude market (0.68 mm bopd) with most of its production consumed internally. Not so with Libya and some of the names that come to mind when we think of what might be the next site for revolution.

Other areas that could jack up the supply risk premium (with daily production) include:

• Iran (4.2 mm bopd, 14% OPEC 12), which is violently putting down small protests so far.
• Algeria (2.13 mm bopd, 7% OPEC 12), where protests said to be gaining momentum.
  
• Nigeria (2.2 mm bopd, 4.5% OPEC 12) is tense but not out of the norm, hasn't seen organized protests as of yet -- but elections are in April and any sign of rigging at the polls could spark an outcry. Like Libya, this market is centered on light sweet crude that's not readily replaced by "make up" volumes that Saudi Arabia could bring to market in the short or long term.
• Yemen (0.3 mm bopd) is not a player but another area of rising protests
• Bahrain is only mentioned because it's home of the U.S. 5th fleet and it continues to violently put down protests.
• Morocco is only mentioned as it is the western neighbor of Algeria and revolutions, like misery, love company.

Other near-term implications:

• U.S. Refiners. Not what you normally think of as the "go to" hot sector in energy land, unless you mean for the last three months, when it definitely has been. The U.S. independent refining sector has rallied beyond all proportion to the short-term gains in cracks and the cheap local crude vs. Brent for the export product market. I expect this action to partially reverse in the near term, just as many sell-side firms are getting on board recommending U.S. indie and many of the smaller names, which are up 40%+ this year alone.
  
  

• U.S. Oil Resource Players. With foreign oil more of a question mark again, stability is going to be more desirable than ever for investors. The mini majors (like Hess (HES), which has regional exposure, and even Apache (APA)), which may see some questioning its ability to remain in charge of its assets in the region) and some majors in places like Libya don't have a firm grip on their own production levels, or the state of their infrastructure. It is at times likely that our positions in the Bakken via Brigham Exploration (BEXP), Kodiak (KOG), Northern (NOG), Whiting (WLL), etc. are likely to outperform. The same goes for the Eagle Shale, Niobrara, and Permian players. While some of these plays are still in their nascency (like the Niobrara outside of the Wattenberg core area) and there is, therefore, still a long list of unknowns (they may not be as homogenous as the core of the Bakken), I am pretty sure no one is going to rise up against their oppressors and disrupt oil flow out of North Dakota and Wyoming any time soon.

Disclosure: I am long BEXP, KOG, NOG, WLL.