The recent unrest in the Middle East has sent world financial markets into turmoil. Oil and gold have risen sharply while other commodities such as copper have dropped steeply. Equity markets have also reacted poorly to the continued situation in North Africa especially Libya. The main question everyone is asking now is how long will this last, and will there be any effect on the continued global economic recovery?

At present the political situation in Egypt and Tunisia has calmed down. However the situation in Libya has caused even greater concern. Libya, which is only responsible for some 2% of global oil production, has all but shut down shipments. At present OPEC which has spare capacity of 5 million barrels per day (6% of world supply) is making up the difference. We are still well above the pinch point of 2% spare capacity that saw prices rise above $140 a barrel in 2008. However, the main concern of investors at the moment is whether the protests will spread, particularly to Saudi Arabia. In our view that is unlikely. Despite almost record oil revenues, the Saudi Government has gone into deficit this year. This is due to massive public works programmes aimed at reducing youth unemployment and moving the country off of its oil addiction.  All in all Saudi youths seem more content and the security services seem to have a better handle on the situation than in other countries.

In addition to the spare capacity of OPEC the USA now has a glut of supply in oil. Brent crude is trading at a premium of around $15 to West Texas Intermediate (WTI). Much of this premium has been caused by the completion of new oil pipelines from Canada and insufficient refining capacity in the USA to deal with the extra supply.

With the ability of the US and OPEC to react to the drop in supply as well as the contained situation in Saudi Arabia it seems that oil prices above $100 a barrel may be an overreaction and may come down sharply  in coming weeks.

Effect on the Global Recovery

The main impact on the global recovery is likely to be from higher oil prices. Much will depend on how high and how long the price rises. It is estimated that a price above $120 would cause a sufficient shock to kick off a world recession.

A price of $100 a barrel is likely to dent growth prospects however that will depend on whether or not prices stay high for long. The effect of a sustained high oil price is likely to add to some of the inflation spikes being seen in countries such as the UK and China, however many nations from Australia to the USA and the Euro Zone are far more worried about deflation in 18 months than inflation.

Gold has risen of the back of the crisis while copper has fallen. However Gold prices above $1400 seem expensive in the long term unless we see a much larger crisis encompassing larger oil producers such as Russia or Saudi Arabia. At present this seems unlikely.

While Libya may descend into Civil War it seems more likely that Gaddafi will be defeated in the coming weeks. While the prospects for new Middle Eastern governments may lead to more radical Islamic governments can we really believe that a world without Gaddafi will be a worse place?

It seems more likely to us that in the coming weeks things in most countries will calm down; oil will fall along with gold, and equity will rise along with industrial metals.