An article in the business section of the Washington Post yesterday suggested that a third of the price was the "political premium." The article further suggested that $10-$15 of the price of oil (per barrel) was due to market fear of conflict with Iran. The article suggested that the "political premium" (including other fears, like Nigeria and hurricanes) translates to 60 cents a gallon at the pump. This would suggest that fear of conflict with Iran was contributing somewhere between 24 cents to 43 cents to the price of a gallon at the pump.
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A Price Inflamed By Fear Up to a Third of Oil's Stunning Ascent Traces to Psychology Steven Mufson Washington Post Friday, July 14, 2006; D01 http://www.washingtonpost.com/wp-dyn/content/article/2006/07/13/AR2006071301686.html
Add this to the costs of political instability and violence around the world: The price of crude oil hit a record yesterday, topping $76 a barrel.
Oil prices rose as fighting spread in Lebanon, the standoff continued over Iran's nuclear program and a Nigerian newspaper reported that explosions had rocked two pipelines in the West African nation. Although supplies of oil were virtually unaffected, traders and analysts said anxiety about political violence and tension around the world had once again driven up the "political premium" for oil.
"The oil price has really become a Richter scale for geopolitical turbulence and upheaval," said Daniel Yergin, the head of Cambridge Energy Research Associates. "The market's fundamentals are actually getting a little better, but fear and uncertainty is mounting over Iran, the Middle East and Nigeria."
The record oil price -- benchmark crude for August delivery closed at $76.70 a barrel on the New York Mercantile Exchange -- set an ominous backdrop to the meeting of the Group of Eight major industrialized nations set to take place this weekend in the Russian city of St. Petersburg. "This is a market in which fear is very strong, and it certainly is a stark message to the G-8 meeting in St. Petersburg, which was planning to discuss energy security," Yergin said. "Right now, oil prices are reflecting a lot of energy insecurity."
Anxiety gripped other markets, too. U.S. stocks, already plagued by worries about interest rates and some disappointing second-quarter earnings reports, fell steeply on news of Israel's military offensive in Lebanon and record oil prices. The Dow Jones industrial average tumbled 166.89 points, or 1.5 percent, to close at 10,846.29, its second day of triple-digit declines. The Standard & Poor's 500-stock index fell 16.31 points, or 1.3 percent, to close at 1242.29. The Nasdaq composite index dropped 36.13, or 1.73 percent, to finish at 2054.11.
Gold futures, often a haven in turbulent times, rose $3.10 an ounce to close at $654.40 on the New York Mercantile Exchange. Major markets in Asia and Europe were also down about 1 percent or more.
In oil markets, the causes of the price increase were virtually all political and psychological as traders fretted that Israel's conflict with Lebanon could provoke wider fighting or unrest in the Middle East, where 31 percent of the world's oil is produced and where 62 percent of proved reserves lie.
Adam E. Sieminski, chief energy economist at Deutsche Bank AG, explained that one way to calculate the political premium would be to multiply the odds of a supply cutoff by an estimate of its effect. So if the chances of military action against Iran or of a supply cut there are even modest, given the huge impact such events would have on oil prices, then worries about Iran alone could account for $10 to $15 a barrel in the current world price of crude.
Sieminski said oil traders could also add $5 for possible hurricanes, $5 for risks in Nigeria (where militant groups have attacked pipelines and cut oil output by more than half a million barrels a day), and $5 for other risks.
"Supply and demand are not the only things people look at," Sieminski said.
Altogether, the political premium could make up a third of the price of crude oil. That premium translates into about 60 cents a gallon at the gasoline pump. And it's a source of political controversy, because even though the reasons for the high price may be psychological, real money is still transferred into the hands of oil-producing countries and companies.
Gas prices posted yesterday by AAA were $2.96 a gallon for regular unleaded gasoline, up 6 cents in the past month and 64 cents from a year ago, according to the auto club.
In the physical world of oil, experts said that if anything, the supply balance was better than it was a couple of years ago, when prices were much lower. A new pipeline was formally opened yesterday, carrying oil from Azerbaijan through Georgia to the port of Ceyhan in Turkey. The pipeline will carry 430,000 barrels a day and is expected to move up to 1 million barrels a day by the end of next year.
On Wednesday, the International Energy Agency issued a monthly report forecasting adequate crude oil supplies, with new non-OPEC production coming on stream later this year and sharply higher OPEC capacity by the end of 2007. The IEA also slightly shaved its estimate for 2006 demand growth. It has trimmed the estimate by 820,000 barrels a day since first making a 2006 estimate a year ago, noted John Herrlin, an oil analyst at Merrill Lynch & Co.
Meanwhile a European oil industry source said that the Nigerian newspaper report, which said that explosions had cut off 120,000 barrels a day of oil supplies, was overstated. The source, who spoke on condition of anonymity to protect business relationships, said that the explosions had cut off only 50,000 barrels a day and that the production venture, run by the Italian state oil company, Eni SpA, would restore output within a couple of days.
But with excess oil production capacity much lower than it was a few years ago, markets remained sensitive to any future risks. Sieminski said that would explain why companies were keeping higher inventories than they did a year ago.
"When this kind of thing happens," Edward Morse of Hess Energy Trading Co. said of the price run-up in the past week, "it's political risk and nothing more than that. The issue is really Iran."
Crude oil prices have bounced up and down for the past two weeks depending on the latest statement from Iranian officials. On Tuesday, oil rose for the first time in four trading sessions after President Mahmoud Ahmadinejad said his nation would not back down "one iota" over its right to conduct nuclear research.
With Western nations turning to the U.N. Security Council for possible sanctions to stop Iran from continuing its nuclear research program, Morse said oil traders were looking for evidence that Iran might be using its leverage to exert pressure back. "Is Iran going to use an oil weapon? Almost certainly not. But where might Iranians put pressure?" he asked. Most likely through proxies, Morse said. For example, Iran could pressure the United States by using allies in southern Iraq or its Hezbollah allies in Lebanon, and that might explain Hezbollah's foray into Israel this week.
Separately, the possibility of a hurricane in the Gulf of Mexico still hangs over oil markets. In an interview yesterday, Brian M. Storms, chief executive of insurance broker Marsh Inc., said that worldwide hull insurance rates have gone up and that rates have gone up sharply for offshore oil platforms and rigs. A company spokesman said later that oil facilities in the Gulf of Mexico had undergone "severe and punitive" insurance rate increases, averaging about 150 percent but in some cases reaching 400 percent since Hurricane Katrina.
Investor interest in oil markets continues to run high as more endowments, pension funds and other institutions allocate portions of their portfolios to commodity funds. One indicator of such interest: On July 1 Lehman Brothers launched a new commodity index that was 56.2 percent based on energy prices.
Though oil prices set a record for the New York Mercantile Exchange, which stared trading oil in 1983, they still didn't match the all-time inflation-adjusted peak. A quarter-century ago, after the Iranian revolution and the outbreak of the Iran-Iraq war, the price of crude oil climbed over $90 a barrel when expressed in today's dollars.
-- Robert Naiman Just Foreign Policy