The Fear Factor

I've posted several notes on oil: e.g., "Two, Three, or Many Oil Wars" (May 26, 2004); and "Got Faith?" (June 3, 2004). Here's a follow-up (thanks to a tip from Michael Perelman, a professor of economics at California State University, Chico, and the author of The Perverse Economy: The Impact of Markets on People and the Environment [NY: Palgrave Macmillan, 2003 ] and numerous other publications). Fadel Gheit, Senior Vice President for Oil and Gas Research with Oppenheimer & Co., Inc., estimates the "risk premium" of each "fear factor" in the "two, three, or many oil wars":

With demand high, supplies squeezed, prices climbing and refineries already running flat out, what if something really went wrong? Something like a terror attack on crucial oil installations in Saudi Arabia or in the United States, or something less sinister but just as disruptive, like a fire or accident at a major refinery or port or a flare-up of civil or labor turmoil in Nigeria or Venezuela?

Industry experts say that the drum-tight American fuel market has become unusually vulnerable to any such nasty surprises, because there is little spare capacity available and because traders, executives and policy makers are nervous about terrorism and other threats -- to the point that crude oil now carries a "risk premium" of 12 to 25 percent, analysts estimate.

"The problem is, we've already tasted some of these events in one form or another," said Daniel Yergin, chairman of Cambridge Energy Research Associates, an energy analysis company. "The threat of an oil shock is very tangible. If an oil trader wants to think about risk, all he has to do is turn on the television."

Just how big a risk premium traders will demand on oil is a subjective calculation, driven up or down from day to day by news developments. One energy strategist, Fadel Gheit of Oppenheimer & Company in New York, estimated that worries about Nigeria contributed about $1 a barrel; Venezuela another $3; the situation in Iraq, $4 more; and jitters about new trouble in Saudi Arabia, $5 a barrel. "In a psychologically charged market, bad news travels faster than good news," Mr. Gheit said.

Without the black cloud of vulnerability from the market, many analysts say, crude might trade for $30 or $35 today instead of nearly $40. (Simon Romero, "If Oil Supplies Were Disrupted, Then . . .," New York Times, May 28, 2004, p. C1)

Listen, also, to Ian Masters' interview with Fadel Gheit: (Ian Master's Background Briefing, May 30, 2004).