Events across Middle East, especially the rebellion in Libya and resultant disruption of oil extraction, and expectations of similar events in other major oil producers have naturally increased market uncertainty and put upward pressure on oil prices. Last week crude oil prices breached the psychologically important $100 per barrel mark.
There are widespread fears of a repeat of the $147 peak in 2008, which would adversely affect recovery in the developed economies. However, unlike then, when spare capacity was just 2% of daily production, it is now at a more comfortable 6%, or 5 million barrels per day. But there are also market specific factors that puts pressure on prices. For example, Libyan "sweet" crude, with its low sulphur content, is not easily replaced with the "sour" crude produced elsewhere since many European and Asian refineries are not equipped to refine "sour" crude. The resultant increased demand for "sweet" crude from Algeria and Nigeria will invariably push prices up.
If oil prices remain high for long, it is feared that the already weak economies of the developed world will slip further into recession. It is estimated as a thumb rule that every $10 increase in the price of a barrel of oil reduces the growth of the GDP by half a percentage point within two years. Its ripple effect on the developing economies, in terms of reduced exports and resultant lower economic activity, can be considerable.
In a reiteration of its critical, albeit less appreciated, role in stabilizing global oil prices, Saudi Arabia has responded to higher prices by increasing its crude output to more than nine million barrels a day, roughly 700,000 barrels more than at the end of 2010. Saudi Arabia has a total production capacity of 12.5 million barrels per day (bpd) and uses its 3.5 m bpd excess capacity to cushio the global oil market from supply shocks. Its officials are also asking European refiners, who are most directly affected by the drop in Libyan exports, how much and what grades of crude they need for quick shipment.
Update 1 (9/3/2011)
See this NYT Room for Debate which discusses why oil prices have are going up.