Friday, December 9, 2011

Arab Spring Drives Up Oil Prices

The United Arab Emirates' oil minister, Mohammed Al Hamli. recently defined a “reasonable” price for as oil as between $80 and $100 a barrel. This is quite a jump up from just five years ago when OPEC oil ministers said that a “reasonable” price for oil was about $50 a barrel.

But a look at the price that Middle East countries need to survive economically today explains why oil ministers are now targeting such higher prices.

Not long ago the International Monetary Fund provided a timely update on the so-called 'breakeven price' for oil needed by Middle East producers to balance their fiscal budgets.

In the IMF's latest semi-annual “Regional Economic Outlook: Middle East and Central Asia” report, it estimates that the breakeven oil price for the UAE has now risen about $80 a barrel, up from $60 a barrel in 2008.

For Saudi Arabia, the IMF estimates that $80 a barrel is the breakeven price, up nearly $30 a barrel in just three years.

Part of this increase in the breakeven price can be explained by the sharp increase in spending earlier this year in response to the 'Arab Spring'.

But even before 'Arab Spring', budgets in Middle East countries were ballooning nearly out of control as governments try to deal with little non-oil revenues, rapid population growth and a very generous welfare system where governments pay almost everything for their citizens. These include payments for utilities, fuel, education, housing and health.

The rapid rise in breakeven oil prices means that key members of OPEC now have a strong incentive to defend much higher prices.

It also means that Middle East countries are unlikely to spend any large amounts of money in building spare oil production capacity. This is simply no money in their budgets for such undertakings.

The bottom line for investors and consumers is that oil prices would be extremely unlikely to below $80 a barrel for more than a brief period of time.

This is obviously bullish for oil. Investors can participate easily through the use of an exchange traded fund. The ETF which best reflects global oil prices the United States Brent Oil Fund (NYSE: BNO).

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