Before political instability enveloped the Middle East and North Africa, oil prices were already trending up on increased demand as the global economy emerged from the doldrums. In early April, oil futures closed at $107.24 but traded at $107.93—an intra-day high that bested a price that had stood since late September 2008. The commodity is up 27% from a year ago.

But political unrest and the disaster troika of earthquake, tsunami and nuclear failure in the world's third-largest economy, Japan, have made the market seemingly inscrutable.

And as the mid-year mark neared, investors and industry players alike sought insights on pricing, demand and conditions needed for favorable markets in the U.S. and abroad.

The butterfly effect and supply

The civil unrest in the Middle East and North Africa was triggered by the self-immolation of street vendor Tarek al-Tayyib Muhammad Bouazizi, who was protesting the Tunisian regime after having his wares confiscated. Scott Sheffield, chief executive officer and chairman of Pioneer Natural Resources Co., said in a presentation at the 39th annual Howard Weil conference in late March that he was in Tunis at the time, working on the deal to divest the company's Tunisian assets. He was assured that the resulting protests would be managed, Sheffield said, but civil unrest spread from the small North African nation to a number of other countries.

Egypt's upheaval followed soon afterward, heightening concerns for oil production in the region. But this proved to be unwarranted. Apache Corp.'s chief executive officer, G. Steven Farris, told investors at the same conference that his company experienced zero production loss in Egypt as a result of the largely peaceful protests and subsequent resignation of long-time president Hosni Mubarak.

World oil demand is again outpacing supply.

Egypt, however, is not as substantial an exporter as is Libya, which the International Energy Agency (IEA) estimates produces more than 1 million barrels per day. Also, Libya's revolution has become a much more violent and sustained event than the Egyptian uprising.

Macquarie oil economist Jan Stuart suggests a less optimistic outlook for Libya's production. "We assume that more than 90% of Libya's roughly 1.5 million barrels a day of exports will remain out of the market through May," he said in a March oil economics update. Libya's production is 6% of the region's exports, and one-third of the world's spare capacity, Stuart notes.

BP's recent Statistical Review estimates Libyan maximum output at 2 million barrels per day in 2009. Libya's high-quality crude usually makes its way to European refiners, and according to the IEA, Europe is making do so far. It will have to adjust, however, as no one knows how much and how long Libyan production will remain off-line.

The agency's latest production note reveals global supply touched an all-time peak in February at 89 million barrels per day—but not because of OPEC production.

"OPEC crude oil output in February fell by 95,000 barrels per day to 30.05 million barrels per day," according to the note. "A near 200,000-barrel-per-day average monthly loss of Libyan supply was partly offset by higher production from Gulf states. OPEC's 'effective' spare capacity, excluding Libya, is now near 4.08 million barrels per day, its lowest since the end of 2008."

The agency's Oil Market Report from mid-March projects oil demand for the remainder of 2011 and supply into the first of the year. It looks for demand to rise in 2011 to about 90 million barrels a day, with supply at some 88- to 89 million barrels per day.

U.S. domestic production has been a driver of global supply growth since the beginning of the year, according to the IEA. The agency expects a slight uptick during the rest of 2011, based on Alaskan and Canadian increases.

Macquarie's Stuart looks for production increases from 2010 levels in Saudi Arabia and the United Arab Emirates, with substantial growth also from Iraq, Iran and Brazil. However, he expects continued production slides in Angola, Mexico and Venezuela.

"Non-OPEC oil supply rose 0.3 million barrels per day to 53.2 million barrels per day on reinstated Alaskan output," he says. "2010 non-OPEC estimates are left unchanged at 52.8 million barrels per day, while the 2011 forecast is raised by 0.1 million barrels per day, to 53.6 million barrels per day, on stronger-than-expected Canadian output."

Landlocked West Texas Intermediate is still trading at a roughly $10 discount to Brent crude, which is easier to move to ship transport. The gap has closed in recent weeks.

Analysts at investment bank Raymond James base their oil-pricing expectations for the coming 18 months on the combination of continued supply-disruption risk and economic recovery. They anticipate higher spikes and lower troughs arising from this combination in the near future.

The firm forecasts a $90-per-barrel average price for WTI this year, increasing to $100 per barrel in 2012. Its Brent forecast is $97.50 per barrel and $104.50 per barrel in 2011 and 2012, respectively, due to the disparity between overstocked Cushing and the European benchmark crude.

Demand trends

Global demand picked up last year as the world grappled its way out of recession, according to Stuart. "Global demand growth accelerated to fully 3.7% last year, and the pace of growth picked up rather than slowing down in the second half of 2010."

Emerging markets continued to gather steam, despite continuing economic struggles in Europe and elsewhere. Stuart sees strength in middle distillates, and his team projects worldwide demand will top 2010 levels, and the previous three-year average, for the remainder of 2011.

Even when oil supply is sufficient, in a best-case scenario, China's ability to impact global oil prices has become a constant concern. Worry about Chinese oil demand during supply disruption is not unfounded but, at this point, is not particularly justified, according to Stuart's recent update on oil fundamentals.

"China's growth is apparently decelerating as Beijing is fighting palpable overheating in certain sectors." Data indicates this will be a short-term lull, however, and could subside in the second half of the year, he says.

"At the margin, signs are emerging that the slowdown is targeted and temporary." The effect of Chinese demand witnessed in the last price run-up could be offset by stabilization of Europe's demand, he says.

High oil prices and increased global demand could have a chilling effect even on the Chinese economy. "If the price of oil averages $100 a barrel this year, China will have to spend $206 billion on oil imports in 2011—over $50 billion more than it did last year," the IEA notes, adding that this could compound inflation in the country.

The global thirst for oil is being driven by an aggregate of demand from other nations as well, notes Stuart. "The underlying growth trajectory is rather steeper than conventional wisdom believes," he said. "At the core are positively booming emerging market economies (including Brazil and China, and also Saudi Arabia, Indonesia and a host of smaller economies across Asia, Latin America and Eastern Europe)."

Though prices generally trend up for all regions, there is volatility, and the U.S. price has decoupled from the other averages. U.S. imports of crude oil have fallen significantly.

Recovering Japan

According to the U.S. Energy Information Administration (EIA), Japan's estimated 2010 oil consumption averaged 4.4 million barrels per day. In its late March weekly petroleum update, the agency suggests Japan will experience two stages of oil use in its recovery: the current initial, low-demand period, and a growing demand period sometime after the country can solidly assess the extent of the recovery and rebuilding required.

The agency expects Japan's oil demand to rise at that point, but it doesn't wager a guess as to when that might occur, or how long it might last. For now, it says, Japan's quiet oil-use period is generally offsetting the supply situation in Libya.

Domestic concerns

China's demand continues to grow, but it is insignificant compared to the U.S., says Stuart. "China's roughly 2-million-barrels-per-day gasoline market is, however, nowhere near approaching the 9.2 million barrels per day of gasoline use in the U.S." Gasoline prices have been rising, however, and may hit a price at which demand destruction will occur.

"Traditionally, we've looked at what price it would take to get U.S. drivers to drive less. We suspect that prices approaching US$5 a gallon may be required to get an effect as quickly as this summer," he says.

While it may be possible to effect a demand slowdown here with prices in excess of $4 per gallon, as recent history suggests, Stuart says demand growth was strong last year, and he projects continued increases. Until that time, he sees light-vehicle sales growth picking up in both the U.S. and China.

"Oil demand in the U.S. should continue to expand modestly as a more robust reacceleration phase of the recovery generates more jobs and higher incomes," he says.

Domestic oil production has rebounded.

Bloomberg reports that U.S. light-vehicle sales may be down for the first time in seven months. Citing research from JPMorgan analyst Himanshu Patel, the news agency notes that every $1-per-gallon increase in gasoline prices could shift 5% of demand from light trucks to cars.

Before the Middle East turmoil, producers globally were shifting their attention to oil extraction as prices stabilized at around $80 to $90 per barrel, fueling investment. Beyond that plateau, into sustained triple-digit pricing per barrel, is where the outlook gets cloudier.

Conrad Barnes, manager of Hart Energy Research's energy pricing center, describes the relationship between oil supply and demand as a balancing act. "If gasoline and jet fuel for travel, and diesel for the transport of goods, become too expensive, it eventually does have an impact on consumers and global growth. That in turn would have a negative impact on prices," he says.

"The question is, what is the threshold price when demand destruction occurs? Unsustainable high prices don't only weigh in on personal consumption, but also creep into inflation and crude and refined product import costs for many consuming nations."

Barnes says that right now, with the market pricing a risk premium of $10 to $20 into the per-barrel price, pushing WTI over $100 and benchmark Brent above $120, we are fast approaching the danger zone. "However, prices need to stay at this level for a sustained period for things to flip."

Political unrest in the Middle East and North Africa has made price forecasts even dicier.

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