Oil Markets Cope with Libya and Japan Crises

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Mar 18, 2011, 07:54 ET

LONDON, March 18, 2011 /PRNewswire/ -- Oil markets work well when they are allowed to. Major unexpected disruptions to energy infrastructure over the last month, first in Libya, then after the tragic and devastating earthquake in Japan, have shown this, according to analysis by leading energy price reporting agency Argus.

Clear price signals from spot markets have allowed oil supply to be allocated efficiently. Refining capacity has either been turned down in the Mediterranean or turned up in Asia in response to the different crises. Nascent markets such as LNG, which promises to make natural gas trade global, can learn much from how the oil market has responded. Oil is, physically, an extremely flexible substitute for other forms of energy. It can be stored and easily transported. And, beyond its physical characteristics, oil is traded in large enough spot market volumes to allow strong price signals to determine where supply should go.

Price signals encouraged Saudi Arabia to boost production and partly offset the loss of more than 1.2mn b/d of light sweet Libyan crude exports because of civil war. Roughly 200,000 b/d of extra Saudi loadings are going west this month compared with January, according to consultancy Oil Movements. Price signals quickly encouraged Mediterranean refiners to cut runs or bring forward maintenance to limit demand.

The 11,000MW of nuclear generation capacity shut in by the earthquake and tsunami that hit Japan on 11 March will be largely replaced by oil-fired generation in the short term. Low-sulphur fuel oil and crude are burned in peaking generation in Japan, called on when demand hits the highest points in summer and winter. Utilities used less than 25pc of their oil-fired generation capacity last year.

Expectations that more of this capacity will be called on have already boosted markets for low-sulphur fuel oil and the kinds of heavy sweet crudes that can either be burned directly in power stations or refined to produce fuel oil that can.

In theory, there is just under 30,000MW of fuel oil and crude-fired generation capacity that can be called on to replace lost nuclear and other thermal power plants, although the intricacies of Japan's electric grid make some of this capacity unavailable to the earthquake-stricken regions in the northeast of Honshu island. Utilities have built more natural gas-fired plants in recent years. But these plants have been running at higher capacity rates, nearly 60pc, leaving less available as back-up.

Oil-fired power plants remain in reserve in many industrialised countries that turned away from using them after the oil shocks of the 1970s. Small-scale middle distillate-fired plants operate to cover the extremes of peak demand, starting up only in the highest heat of the summer or during the coldest of cold snaps in the winter. But large heavy fuel oil plants still lurk in the generating stacks of European, US and east Asian power grids, to be called on as a last resort.

Oil's value as a generation fuel lies in its flexibility. But there is no turning back to the 1970s, when heavy fuel oil-fired power plants ran around the clock to provide base-load power generation. Stark questions about nuclear power's safety are being raised. But the current global overhang of natural gas, with its lower carbon burden, make it the more logical long-term solution for power generation.

The LNG sector has much to learn from oil markets about how to operate efficient global supply chains. Natural gas is more of a global market now because it can be transported on ships. But most LNG is sold through term deals. And some spot supplies, including Japan's LNG imports, are still linked to oil prices.

The oil market's ability to efficiently allocate resources to meet sudden demand spikes through robust spot price signals should serve as a guide to the globalisation of once-provincial natural gas trade.

About Argus Media

Argus is a leading provider of price assessments and indexes, business intelligence and market data on the global crude and products, natural gas, coal, electricity, emissions and transportation industries. It is headquartered in London and has offices in Houston, Washington, New York, Portland, Johannesburg, Dubai, Singapore, Tokyo, Beijing, Sydney, Moscow, Astana, Kiev, Santiago and other key centres of the energy industry. Argus was founded in 1970 and is a privately held UK-registered company. Learn more at www.argusmedia.com.