Crude Oil Pricing: Don't Underestimate The Fear Factor

Source: Business Week

The Middle East money gusher is fed by many wellsprings, and one of them is fear. The market is justifiably worried about a massive disruption of oil supplies, possibly caused by a terrorist attack such as the unsuccessful one against the world’s largest oil-processing facility at Abqaiq, in eastern Saudi Arabia, on Feb. 24. This fear is pushing oil prices higher and sending additional billions into the coffers of oil-producing nations.

The sums involved are astonishing. According to a rough BusinessWeek estimate, the world paid the Persian Gulf oil states an extra $120 billion or so last year because of the premium in prices due to fear of unexpected supply disruptions.
How did we come up with that number?
To get a rough handle on how the fear factor affects current oil prices, we checked with three industry experts. James W. Ritterbusch, an oil economist at Ritterbusch & Associates in Galena, Ill., says it’s impossible to estimate the size of the fear factor, although he agreed there is one. Sarah Emerson, director of petroleum market analysis and research at Energy Security Analysis Inc. in Wakefield, Mass., estimates that fear adds an additional $15 to the price of each barrel of oil. Tim Evans, senior energy analyst for IFR Markets in New York, goes even higher, with an estimate of $25 to $30 a barrel.
We used Emerson’s $15 “subjective guess” because her argument for it made the most sense. She argued that oil prices would be somewhat above their historical average anyway because there’s little spare capacity. But, she said, prices wouldn’t be this high without fears of instability: “If you said every country in this world was stable, and we didn’t have to worry about a disruption, I think it would get back to the $40s,” she said, vs. the current price of around $60 a barrel. The $120 billion comes from multiplying that $15 premium by the annual oil exports of Algeria, Iran, Iraq, Kuwait, Libya, Qatar, Saudi Arabia, and the United Arab Emirates.
Some cynics argue that oil producers welcome the fear of disruption because it boosts their revenue. While the Saudi royal family takes pains to assure the world that it’s a reliable supplier, saber rattlers like Iranian President Mahmoud Ahmadinejad and, outside the Mideast, Venezuelan President Hugo Chávez, don’t seem to mind if their threats against the West scare markets higher. Fear, says IFR’s Evans, is a “gift” to oil producers.
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