Automotive industry hardest hit by supply-chain disruptions

Of the industries that have been most effected by the supply chain disruptions the car industry has taken the biggest hit with 52% of automotive supply-chain managers saying that disruption from COVID-19 to supply was very significant. The reasons for the automotive problems are:

Production stoppages – 48%
Trade restrictions – 24%
Access to raw materials – 12%

According to The Economist Intelligence Unit the problems associated with the shortage of semiconductors could have been avoided. Automotive producers cancelled orders of semiconductors at the start of the COVID-19 as they assumed that their spare capacity could meet the demand. Although the industry realised their mistake the allocation of semiconductors was mopped up very quickly by other sectors. The consumer electronics industries boomed as more people worked from home and spent income normally prioritised for leisure activities to other forms of entertainment. Access to raw materials was a major disrupter of other sectors – healthcare and food. With people in lockdown there was a considerable demand for food with eating out not a viable alternative.

East v West
It seems that more traditional supply chains (West) that have been developed over many years have been harder hit than more recent supply chains (East). Regionalisation has been the focus in North America and Europe but less so in Asia. Smaller companies are now localising their supply chains as COVID has been the catalyst to rethinking strategies with a renewed focus on flexibility.

Source: DISRUPTION, DIGITISATION, RESILIENCE: The future of Asia-Pacific supply chains. The Economist Intelligence Unit. 2021

Cost-Benefit Analysis of the Auckland Harbour cycle bridge

Reading Michael Cameron’s blog this morning I was intrigued to read that New Zealand’s Transport Minister Michael Wood did not provide the cost-benefit data when he announced the new $785m Auckland harbour cycle bridge earlier this month. However it has now been revealed the initial assessment by Waka Kotahi is only 0.4 to 0.6. That meant for every dollar spent on the bridge, there would effectively be a 40 to 60 cent loss. If a project is less than 1.0, the project’s costs outweigh the benefits, and it should not be considered.

You wonder about the rationale for this amount of expenditure when there is an opportunity cost – money that could be spent on the areas that seemed to be constantly deprived of government funds e.g. Health (especially with the vaccine rollout), Education etc.

Evaluation of Cost-Benefit Analysis
It is clearly more efficient for public spending to be subject to rigorous analysis, rather than based on the whims of politicians. However, there are a number of criticisms of CBA when projects are given the green light

1. It is often very costly to undertake, though usually this forms a very small proportion of total project spending.
2. Assessing the monetary value of external costs and benefits is often very difficult. What precisely is the value of the congestion that would be reduced if a new bi-pass were built around a busy town? How much extra tourist revenue will actually be gained from a new airport? How long will the building be used as a venue, as in the case of the Viaduct area in Auckland for the 2020/21 America’s Cup. One solution to this problem is shadow pricing, where analysts attempt to place a value on the costs and benefits of a decision or a project where an actual market price does not exist.
3. Changing circumstances can make initial projections appear grossly inaccurate. The Wembley Stadium project in London went considerably over-budget, and the majority Olympic Games are far more costly than originally estimated. For instance the Montreal Olympics in 1976 was eventually paid off in December 2006. Higher interest and inflation rates, and falling exchange rates can all dramatically affect costs.
4. Actual costs can also rise above planned costs as a result of moral hazard, where project managers go over budget because they expect that those who fund the project will make extra funds available, providing an insurance against their over-spending.
5. Ultimately, decisions to go ahead with projects are only guided by CBA, leaving politicians to make the final decision. Politicians are free, of course, to ignore the results of an appraisal. It looks like they have with the cycle bridge.

Mega ships and diseconomies of scale

The mega ship the Ever Given was a familiar name in the news recently with it getting stuck in the Suez canal and thus preventing any marine traffic in both directions. The Ever Given is operated by the Taiwan-based firm Evergreen and is a so called mega ship and was carrying over 18,000 containers.

Mega (container) ships have been built in increasingly larger sizes to take advantage of economies of scale and reduce expense as part of using multiple forms of transport without actually handling of the freight itself. The big container ships can carry up to 23,964 twenty foot equivalent unit (TEU) whilst the smaller capacity ships have a maximum capacity of 1,000 TEU.

Herd Mentality and Prisoner’s Dilemma
This being said there is some dispute over the extent that the mega ships achieve economies of scale. A follow the leader mentality in ordering bigger ships have been since the mid 1990’s with firms following Maersk in ordering bigger capacity ships. In most cases it only takes two years for other carriers to catch-up to Maersk and in some cases they can hold more TEU. This has led to operators facing prisoner’s dilemma. Operators are trying to outdo their rivals by building larger ships which help increase its market share through their reduced costs but are fully aware that what actually is needed is capacity rationalisation. This strategy has not only fuelled the never-ending competition for large ships but also led to mistrust among operators, entangling them in the prisoner’s dilemma. The ideal scenario is for operators to refrain from acquiring mega ships and let supply and demand prevail.

Infrastructure costs to cope with mega ships
The graph below shows the savings and costs increases from increasing the capacity of mega ships. There is a saving with carrying more TEU’s but terminals will incur significant capital expenditure to handle larger vessels and terminal yards areas will need to increase by 33% to avoid congestion, even with no growth in volume. There are negative externalities to consider that arise from upsizing as dredging deeper channels and expanding yard area will have environmental effects.

Source: Diminishing economies of scale from megaships? Marine Money Japan Ship Finance Forum, Tokyo 12th May, 2016

A lack of containers adds to shipping costs and inflation.

Covid-19 has severely impacted the global trade for a number of reasons:

  • Container shortages as early as February 2020
  • Port congestion caused by increased checks at ports
  • Ship carriers cannot add more capacity as the entire global fleet is mobile.
  • Slow down in container emptying has led to a backlog of containers at many ports

Major Chinese ports like Qingdao, Lianyungang, Ningbo, and Shanghai are experiencing severe container shortages. This means that ships are leaving Chinese ports without a full load. Containers filled with consumer goods from Asia are usually unloaded, then filled with exports of other commodities. Products like meat, pulp and coffee, crops and lumber are then shipped in containers back to China. But, without the containers landing in these ports, there is nothing to fill for the home journey. As you’d expect, this is leaving exporters frustrated and very stressed, especially with seasonal crops needing to be shipped. See chart below for the increase in shipping costs from three major shipping companies – Maersk, Cosco and Triton.

SOURCE: Bloomberg

Baltic Dry Exchange – what is it?
The Baltic Dry Index (BDI), is issued daily by the London-based Baltic Exchange. It is reported around the world as a proxy for dry bulk shipping stocks as well as a general shipping market number cruncher. Every working day, a panel of international shipbrokers submits their assessment of the current freight cost on various routes to the Baltic Exchange. The routes are meant to be representative, i.e. large enough in volume to matter for the overall market. See chart below.

The challenges for the oil market with COVID-19

Another good video from the FT this time on the future of the oil industry. There is a movement towards more cleaner fuels by major companies in Europe but the same can’t be said about the US. Oil producing countries have been hit by lower prices but some like Saudi Arabia have sufficient reserves to fall back whilst others like Nigeria and Venezuela are financially exposed. Below is a graphic from the video looking at supply and demand – useful for an introductory lesson on the market.

Source: FT

Covid-19 and impact on the airline industry

The global airline industry has been one of those that has been hardest by Covid-19. In the US passenger volume is down 96 %, whilst globally losses have topped US$314bn worldwide. Based on booking patterns Air New Zealand will lose over NZ$5bn in revenue per year and a loss of 3.500 jobs. What makes it even worse is that the latest Oxford Economics forecast shows that the loss in global output could be double that of the GFC. This has implications on the speed of the recovery in air travel in the second half of 2020. The table shows that Asia-Pacific takes a big hit financially and is second behind Middle East/Africa (51%) with a 50% loss in RPK.

Source: IATA Economics

RPK = Revenue Passenger Kilometres is an airline industry metric that shows the number of kilometres traveled by paying passengers

IATA estimate that RPKs will decline by 48% in year-on year terms and passenger revenues will be US$314 billion lower this year compared to 2019- see table below. IATA note that a typical airline has cash to cover around two months of revenue loss.

Below is a short video from PBS Newshour with Paul Solman looking at the airline industry.

Baltic Dry Index – the forgotten indicator

A lot of attention has been paid to the drop in oil prices to $28 per barrel as of today which is indicative of the increase in supply from US shale producers and the fall in global demand especially from China. However there is another indicator that shows the global economy is in pause mode and that is the Baltic Dry Index which measures the cost of shipping raw materials – iron ore, coal, metal etc.

In mid January this year the index fell below 400 (see graph) for the first time since records began in1985. In June 2015 the index was comfortably above the 1000 mark and in 2010 approximately 4000, therefore transport costs are at a very low level.

Why are shipping costs at such low levels?

It comes down to simple supply and demand. On the supply side shipping companies have increased their dry bulk capacity as the cost of borrowing money is at very low levels. On the demand side it was assumed that global trade would keep expanding but according to a World Bank report global trade has slowed down sharply in recent years to around 3% and it predicted to slow further.

Cost for ship owners

Owners of the largest container ships (known as capsize vessels) reckon it costs $8,000 per day for running costs. However in today’s market, users of these ships only pay around $5,000 in fees which makes it uneconomical for ship owners to offer their service. With this is mind shipping bankruptcies are bound to feature this year and unless China produces a new growth spurt the Baltic Dry Index will keep heading south.

Baltic Dry Index – Jan 2009- Jan 2016

Baltic Dry Index

Elasticity of Demand for Air Travel

At the most basic level, demand for air travel is stimulated by economic activity and economic and social linkages between countries and cities. Travel is also stimulated by economic linkages (i.e. international trade) and social linkages (i.e. international migration). In general, there will be greater demand for travel between countries that have larger economies and populations. In addition, destination attractiveness is a key driver of demand for leisure travel.
There are many other factors that affect demand for air travel. When the economy grows, greater economic activity stimulates business travel and leisure travel increases as people’s income increases.

  • Demand is stimulated by lower prices, both airfares and the price of tourism expenditure (e.g. accommodation and food) ‘on the ground’ at a destination.
  • Demand for travel to any particular destination also depends on the price of travel to alternative destinations. Other factors that affect demand include distance, safety, and other one-off events such as health and terrorism scares.

The concept of elasticity is very useful for understanding demand drivers. Elasticity measures the responsiveness of demand for air travel to changes in some other variable such as prices or income. A price elasticity of -0.5, for example, means that a 10% increase in price leads to a 5% reduction in the level of demand for travel. Or an income elasticity of 1.2, for example, means that a 10% increase in income leads to a 12% increase in the level of demand for travel.

Many studies have attempted to estimate various demand elasticities for air travel. In terms of price and income elasticities, a meta-study by Gillen et al (2008) summarised 254 different estimates from 21 published studies and found an overall median price elasticity of -1.1, indicating that demand for air travel is relatively sensitive to price changes.

As would be expected, the results also indicate that travel for business purposes is less price sensitive than travel for leisure purposes with business short/medium hail elasticities between -0.8 and -0.6 and long haul elasticities between -0.5 and -0.2, compared to -1.5 to -0.9 for short/medium haul and -1.7 to -0.5 for long haul leisure travel. Gillen et al also report a median income elasticity of 1.4, suggesting that demand for air travel is relatively sensitive to changes in income. The table below represents the median for each market segment – Source: Air Travel Demand Elasticities: Concepts, Issues and Measurement.

PED Air TravelGiven that someone has decided to travel, their choice of airline and airport, when such a choice exists, depends on a number of micro-level factors including purpose of travel, ease of access to the airport, flight frequency, expected delays, and departure/arrival times (Ishii et al, 2009). Thus the demand faced by a particular airline depends on macroeconomic factors as well as other factors more directly under its control.

Source: The New Zealand Aviation Operational Environment: A Guide for the Tourism Sector 2010

Quirky Economic Indicator – length of a ladder

Listening to “From Our Own Correspondent” on the BBC World Service I came across an interesting piece by Kate Adie on Global Trade. With the downturn in global trade the international transport industry has been very much affected. Those that have been associated with the distribution of goods get an early indication of the slowdown in global growth. The obvious indicators are: idle cranes, queues of merchant ships dwindle etc. But what about the speed of cargo ships and the length of ladders to climb aboard?

When the world economy was “steaming” ahead the captain of a merchant ship said that they cruised at 20 knots but when the economic crisis of 2008 arrived we slowed to 16 knots. A harbour pilot summed up the state of world trade by the length of the ladders that he climbs on the sides of ships.

A long climb up the ladder signifies that the ship is high in the water and exports are correspondingly low.

A short climb up the ladder signifies that the ship is low in the water and exports are correspondingly high.

The seafarers say that they take air to China before they load up with goods for the US.

Petrol Tax in New Zealand

The New Zealand Parliamentary Library “Monthly Economic Review” published a feature on taxes and levies on petrol.

Taxes and levies on a litre of petrol in New Zealand account for approximately 43 percent of the overall price.

July 2014 – Retail price = 223.9 cents per litre

A forecast $1,702 million is expected to be raised through the excise duty on petroleum in the year ended June 2015. This includes:

– $936 million in petroleum excise duty on domestic production
– $766 million on petroleum imports.

The following diagram shows the taxes and levies on a litre of petrol (including GST).

Petrol Tax NZ

Holiday reading – “Deep Sea and Foreign Going”

Deep Sea bookDeep Sea and Foreign Going is an account of a 5 week trip from Felixstowe in the UK to Singpaore. Rose George explains how on a train journey that most items of clothing, electronics, food etc are brought to the UK by ship. The reason being that shipping has become so cheap that it makes sense to import items. She uses the example of cod – it is less costly for Scottish cod to be sent to China to be filleted and then exported back to UK restaurants than it is to pay the (small) salaries of Scottish filleters. Some interesting facts from the review of the book in the Guardian Weekly:

* Containers are the largest man-made moving objects on the planet;
* Triple-E class boats are around 400 metres in length and can carry 18,000 boxes;
* In 2011, 360 commercial ports in America took in international goods worth $1.73tn – 80 times the total value of all US trade in 1960;
* Even in the UK, whose sense of itself as a seafaring nation has long waned, the shipping industry employs nearly 635,000 people;
* Port authorities inspect less than 10% of boxes, making them of great interest to counterfeiters and drug barons.

How big can container ships get?

BBC business correspondent Alastair Fee boards a Chinese container ship off the coast of England and reports on the enormous size of it – holds 13,500 containers. And they are getter bigger. More than 40% of the UK’s sea trade comes into the Southampton Dock and to meet increasing demand from container ships a new 500 metre birth is being dredged. However trade goes the other way as in 2012 the demand for cars from the growing Chinese middle class saw over 20,000 BMW Minis make their way to Chinese ports.

US infrastructure could create those jobs

US InfrastructureSome alarming figures have been banded about with regard to America’s infrastructure. It is estimated that over 700,000 bridges are rated as structurally deficient. In 2009 Americans lost approximately $78 billion to traffic delays – inefficient use of time and petrol costs. Also crashes which to a large extent have been caused by road conditions, cost a further $230 billion.

According to the American Society of Civil Engineers the US needs to spend $2.2 trillion bring their infrastructure up to standard. The Congressional Budget Office estimated in 2011 that for every dollar the federal government spent on infrastructure the multiplier effect was up to 2.5. Other indicators state that every $1 billion spent on infrastructure creates 18,000 jobs, almost 30% more than if the same amount were used to cut personal income taxes. – The Economist

Positive Externalities from infrastructure.

Investment in infrastructure has a lot of positive externalities – faster traveling time for consumers and companies, spending less time on maintenance. Research has shown that the completion of a road led to an increase in economic activity between 3 and 8 times bigger than it initial outlay with eight years after its completion. But what must be considered is that now is the best time to invest in infrastructure as it is very cheap – much cheaper than it will be when the economy is going through a boom period.

AS – Supply and Demand – Oil refineries stumble on hard times

Although oil producing nations might not like the recent troughs in oil prices, refineries in Europe are experiencing good times even with petrol and diesel prices being relatively high.

According to The Economist refining hasn’t been the most profitable business as overcapacity has dogged the industry. Oil companies had assumed that the world demand for petrol would continue to expand rapidly and built refineries to cope with the this added pressure. However with oil demand peaking this led to an over-supply in the market. Furthermore in the developing world new and more efficient refineries have added to the problem and this had led to some changes in the market players this year.

* Petroplus (Swiss refinery) went out of business
* Shell bought a former Petroplus plant in London and downgraded it to a storage facility.
* Sunoco biggest refinery in north-eastern US is in trouble financially
* Refineries in Pennsylvania and the Virgin Islands have ceased production

Demand for petrol is falling in both the US and Europe as:

* People are driving less
* People are switching to more fuel-efficient cars – especially diesel. This has caused some concerns as Europe’s refineries cannot easily switch to producing more diesel.

Oil Prices 2012

The chart below from the Sustainability Blog shows the oil production has reached an effective cap at around 75 million barrels of regular crude per day.  Production over the past six years has increased little despite continued upward oil prices. This they argue has occurred as the oil industry passed a transition point and moved from an elastic supply curve to an inelastic supply curve.

While global oil demand remains relatively weak today, with the International Energy Agency predicting global oil demand growth in 2012 of around 1.1 million barrels per day, that inelastic supply curve could yet push oil prices back up to record levels which in turn will increase costs for the refining industry.

Airbus + China + ETS = Prisoner’s Dilemma

Last week saw Chinese officials indicating that Chinese airlines will not buy European airplanes as long as the EU insists on including foreign airlines in its emission trading system. Orders of 35 Airbus A330 planes have been cancelled and another 10 A380’s were in danger of being cancelled because of the ETS. The Chinese argument is that it is not reasonable to charge Chinese airlines taxes at the same time that the plane is made in Europe. China currently buys more than 1 in 5 Airbus planes being produced and the total of Chinese orders amounts to US$9bn. Therefore one could say that the future of Airbus hinges on the ETS. This raises the question of climate change and what are the options that countries face.

Climate Change as Prisoner’s Dilemma
The initial impression from the discussions over climate change is that of a typical Prisoner’s Dilemma and some of the data provided in the Stern Review (2006) can be used to populate the payoff table.

–The cost of tackling climate change is approximately 1% of annual per capita GDP. However, if nothing is done about the issue the cost is estimated to be between 5% to 20% of GDP. So that defines what happens at the extreme of cooperative or non-cooperative behaviour. From the table above, a country that refuses to act, whilst the other cooperates, will experience a free-rider benefit – enjoying the advantage of limited climate change without the cost. On the flip side, any country that imposes limits, when its competitors do not, incurs not just the cost of limiting its own emissions, but also a further cost in terms of reduced competitiveness – estimated here at an additional 3.0%. From the table it seems predictable that countries should prefer to be self-interested: the best national policy, if others reduce emissions, is to defect; likewise, if other countries are not taking action, then it is pointless to be the only sucker to take action, and one should again defect.

Repeated Prisoner’s Dilemma and Cooperation
The dynamics of the prisoner’s dilemma do change if participants know that they will be playing the game more than once. In 1984 an American political scientist at the University of Michigan, Robert Axelrod, argued that if you play the game repeatedly you are likely to see emerging is cooperative rather than defective actions. He identified four elements to a successful strategy which is this case can be applied to climate negotiations:

1. Be Nice – sign up to unilateral cuts in emissions, as deep as your economy and financing capacity allows.

2. Be Retaliatory – single out countries that have not commenced action and, in collaboration, find ways of pressurising them until they do so.

3. Be Forgiving– when non-compliant countries come onboard give them generous applause; signal that good behaviour will be rewarded with even deeper cuts in your own emissions.

4. Be Clear
– let everyone know in advance exactly how you are going to behave – that you will work with them if they take action on emissions, and that you will retaliate if they do not.

It is the belief of Michael Liebreich that this research by Axelrod should be put into practice by the world’s climate negotiators. As treaties on climate change are on-going and therefore become part of the game.

Economies of Scale – Sending a T Shirt from China to Europe for 2.5 cents.

The Economist had interesting piece on the economics of very big ships. If you wanted a good example of economies of scale look no further than sending a T shirt from China to Europe – 2.5cents is the cost. What allows it to be so cheap is the enormous scale of the new container ships that are now being produced – mainly in South Korea.

Maersk container ships transport a considerable percent of the world’s ocean freight and they have a fleet of over 500 container ships that sail every major trade lane. The big ships are 400m long and the ship can carry 7,500 40ft containers each of which can hold 70,000 T shirts – that makes a total of 525,000,000 T Shirts per container ship. Furthermore it only takes 3 weeks for the T shirts to arrive in Europe and the combination of the largest combustion engine ever built and a minimum crew of 13 personel to run the ship leads to signifiacnt economies of scale (see graph below – Point A being the lowest point on the long-run average cost curve LAC).

Given the rising price of fuel many companies feel they need bigger ships to improve efficiency and ultimately improve their margins. Maersk are looking to increase the size of container ship so that it can hold 18,000 x 20ft units. Freight rates have dropped significantly over the last year with the downturn in global demand and the oversupply of container ships in the market – the main players are:

Maersk – Neptune – K Line – Orient Overseas

According to The Economist shippers will seek economies of scale not only from bigger ships but also from mergers.

Emirates reduces fares to fill A380’s

Another hat tip to Andrew Larkey for this piece from the Arabian Business website. It seems that in order to fill their 517 seat A380 Airbus planes Emirates have decided to reduce its fares considerably.

Emirates will resist the urge to cut routes and flights as oil prices threaten the profitability of some destinations and instead aims to stir up demand with cheaper tickets.

It is estimated that 43% of the daily cost to airlines is fuel which is out of their control. However, Emirates believe that capacity reduction is not an option as it has been responsible for the collapse of so many carriers. Industry practice has generally been to halt growth when times are hard and costs high, focusing on the most profitable routes that can sustain higher fares. Emirates will stick with a rapid-growth model based on building Dubai into a high-volume, inter-continental travel hub using a wide-body fleet featuring 90 A380 superjumbos with 45,000 seats.

While cutting fares to sell tickets on the 517-berth planes will push up the occupancy level needed to break even, the impact of government spending cuts in many overseas markets means that strategy is more likely to succeed than one based on curbing capacity and raising fares.

That strategy is not advised as it reduces sales and dampens consumer confidence which ultimately affects, airports, holiday companies and businesses in destination cities, so that traffic often never returns. US-based Trans World Airlines (TWA) and Pan American World Airways are examples of major carriers that went bust by reducing the amount of destinations that they flew to.

Emirates engine overhaul shop – economies of scale

A hat tip to A2 student and airline fanatic Andrew Larkey, for this piece from the Emirates website.

Emirates Airline has unveiled plans for the construction of the most technologically-advanced Engine Overhaul Shop in Asia. The state-of-the-art Engine Shop will complement the present Test Cell Facility in Dubai and will be constructed on a 90,000 square meter piece of land at an estimated cost of US $120 million. The growth of the Emirates fleet and the subsequent number of operating engines have necessitated the need for an in-house Engine Shop in Dubai to provide the most cost-effective, efficient engine maintenance.

The Engine Shop will have the capability of performing 300 engine repairs per annum for the GE90 and GP7000 engines fitted to the B777 and A380 aircraft. Emirates has signed a Letter of Intent with General Electric (GE) to oversee the design and construction of the Shop using the most advanced technology, equipment and best practices in the industry.

A contestable market gone wrong – Taxis in South Africa

Just covering contestable markets with my A2 and came across a relevant article in the Otago University EcoNZ@Otago magazine. Up to 1987 the transit authority in South Africa had a monopoly on public transport. It was near impossible for private taxi firms to operate and the use of public transport was very expensive – many spent 20% of their incomes on the commute. In this context the demand for taxi services was high and many illegal operations started to appear. The government, believing that a more deregulated transport market would improve its effectiveness, eased restrictions on private taxis.

A huge number of taxis appeared on the market of which the majority were large 15-seat vehicles (aka Kombis) and they ran late-night and rural services, and travelled to locations that busses and trains did not. However in order to reduce the running costs of the Kombi the road-worthiness of vehicles became a concern whilst passenger numbers grew considerably. With the transport authority basically giving a ‘free reign’ to operators and displaying no control over operation location or price, operators banded together and formed ‘taxi associations’ to compete over taxi drivers and routes. By 2003 60% of South African commuters used the taxi industry which was believed to be worth approximately R12 billion (NZ$2.2 billion) each year. Rivalry amongst taxi firms got out of hand and many resorted to violence and blackmail in order to secure rights over the most profitable routes. In fact the industry became more like something out of the ‘Sopranos’ with the hiring of hit men against rival associations.

By 1999, in response to this on-going problem, the South African government increased spending on public infrastructure and overhauled the taxi industry.

Taxi-related violence and deaths in South Africa – 1991-1999

Libya and world oil

In 2008, at the height of the financial crisis, a barrel of oil reached $147 and amidst the turmoil in the Middle East there are concerns that this figure will reach over $200 a barrel. If this transpires there is a real risk of a double-dib recession especially in the US and Europe – if not New Zealand. In Libya, as rebels took control of the port of Tripoli its critical oil supplies remained squeezed, production from most of Libya’s oil fields was down to very low levels. The country’s wealth largely comes from oil and whoever controls the oil fields will ulitmately control the country.

Libya in the Global Oil Market

The Economist website has some good statistics about the oil industry. Libya sends 1.4m barrels/day to global markets which is around 2% of global demand. This makes Libya the thirteenth largest oil exporter. Saudi Arabia the worlds biggest exporter, and country with significant spare capacity, is already pumping an extra 600,000 barrels per day to make up for the shortage on world markets.

A recovering global economy had convinced traders that demand for oil was going to rise by about 2 percent in 2011. Some industry experts and Wall Street visionaries were predicting a gradual return to $120 and even $150. The thinking was that investors would pour money into the commodity markets. This was due to the huge increase in demand from developing countries which was threatening to obliterate OPEC’s spare capacity – see graph below.

If prices keep climbing, consumers will in all likelihood tighten their belts. If prices stay high for long, the impact could be severe: every oil shock of the past 40 years has helped push the global economy into recession. Nariman Behravesh, senior economist at IHS Global Insight, said that every $10 increase in the price of a barrel of oil reduces economic growth by two-tenths of a percentage point after one year and a full percentage point over two years – New York Times.

However, as the world is so dependent on oil there is little room for supply disruptions. Spare capacity is at 5 million barrels a day which is approximately 6% of what the world consumes every day. Although this is 4% higher than in 2008 it is still worringly low when one considers the demand pressures coming from developing countries like China and India. However that is not even taking into account the loss of about one million barrels a day exported from Libya. If Libyan oil was to be removed from the oil market it would represent the 8th largest oil shock in history – see graph below.
Much now hinges on what happens next in the Middle East. The price spikes that accompanied the two Persian Gulf wars did not have deep impacts because of they did not last long enough. But several oil price increases have preceded economic downturns. The biggest shock followed the 1973-74 OPEC embargo, which quadrupled oil prices and helped produce stagflation, a period of slow growth, high unemployment and inflation. The 1979 Iranian revolution caused another shortage, and again American motorists were forced to wait in long lines for gasoline. Oil prices surged, but they did not stay elevated for long, as Mexico, Nigeria and Venezuela expanded production and OPEC lost its unity. Oil prices remained low for years, and the economy through the later half of the 1980s and most of the 1990s was generally strong. New York Times