Looking for the next threat to your returns

THOUGH difficult to predict which of the many hotspots of conflict – military or political – will flare up next, with crude and equity prices moving in close correlation with risk sentiment, it is worth looking at the risk hotspots that have the potential to drive price over the coming months

Crude prices have spent the year to date bobbing around the $100 a barrel mark. There has been some upside from the relative European stability, though these days European stability has come to mean “temporary lack of defaults, bank runs and other credit events” rather than financial stability as one might usually view it. This has been boosted by a hope that stronger demand will be seen from China and other emerging markets – China is the world’s second largest oil consumer behind the US. It was reported that December imports of crude oil grew by 6 per cent and it is expected that this demand growth will continue through 2012.

However, this upside has been dragged down by political tensions in Iran, Libya and Nigeria.

Yesterday evening, news broke that Gaddafi diehards had launched an attack on the Libyan city of Bani Walid, 110 miles southwest of Tripoli. Bani Walid was one of the last footholds of Gaddafi loyalists to hold out in the uprising against the Libyan dictator.

The latest attack will likely be another stumbling block to a peaceful Libya. And until the interim National Transitional Government – or indeed any replacement government – can put its internal squabbling and rivalries to one side, it is unlikely that we will see any acceleration in the return of Libya to the oil-producing Big League.

Shut down after Nato forces started a peace-keeping bombing campaign in March to protect civilians against the Gaddafi government, levels of Libyan oil production have been slowly moving towards pre-civil war levels of around 280,000 barrels per day. According to Opec, Libya’s oil industry is almost back to normal, but the oil cartel is hardly known for its full and transparent dissemination of information.

Though Nigerian President Goodluck Jonathon appears to have achieved some form of peace with unions after an agreement to cut the cost of petrol, it looks like a fragile ceasefire.

At the start of the month, the markets reacted to news that Nigerian unions would go on stike in protest over the removal of the huge government subsidy on fuel – threatening to close down the country’s oil production.

Though Nigeria is Africa’s biggest oil producer and supplies nearly 5 per cent of daily US crude demand, it relies mainly on imported refined fuel – decades of corruption has left the country with little capacity to process oil itself.

The removal of the subsidy caused refined oil prices in the country to almost double, leading protesters to take to the streets – with the police responding with tear gas. The unexpected move was made on 1 January, partly in response to IMF pressure to deregulate the industry.

As he announced what is likely to be a temporary reinstatement of the subsidy – estimated to cost around $8bn per year – the president said that his government would “continue to pursue full deregulation of the downstream petroleum sector.”

Following Iranian military maneuvers in the Strait of Hormoz, European Ministers have moved ahead with their threats to place an embargo on the importation of Iranian oil into the EU.

The move could escalate tensions with Iran – the second largest oil producer in the Opec tree house exports around 20 per cent of its oil to Europe and has threatened to close the Strait if the embargo goes ahead.

But analysts are divided about just what an effect this move will have on oil prices. It is likely that arrangements will be made with Saudi Arabia and Kuwait to pick up the slack. At the same time, a drop off in European demand – in part driven by a sliding euro-dollar making dollar-denominated crude increasingly expensive for the European market.

While European and US politicians – if nothing else – possess a great aptitude when it comes to finger wagging at other countries, they do not have the best of track records when it comes to practicing what they preach. Though on one hand urging the likes of Iran and Libya to achieve national unity and communication, they are more than capable of grinding their respective economies to a halt with political posturing and bickering.

As the race for the Republican nomination continues and those on both sides of the house eye this year’s presidential elections, the potential for a repeat of September’s US deadlock looms large. Whatever the supply issues in the Middle East, they will be trumped by a major US slowdown or political shot to the foot.

“We don’t know what or where the next diplomatic hotspot will be, but we are sure there’ll be something and that the markets will continue to worry about security of supply,” says Bill Mott of the PSigma Income Fund. “In this environment of a stronger-for-longer oil price, we think the oil majors will continue to do well.”

The likes of Royal Dutch Shell, BP and Premier Oil should see sustained growth, with the smaller players struggling to keep up with the costs of entry to the club, but for real volatility, spot crude is the do-or-die shot.