Image: Oil drums © Kevin Phillips-Digital Vision-age fotostock

Related topics: oil, OPEC, politics, economy, Anthony Mirhaydari

A great horde of disaffected youth stretching from the Moroccan coast to the banks of the Caspian Sea, frustrated by a lack of opportunity and a rising cost of living, has created a wave of political bloodlust. Uprisings already have removed two North African tyrants from power, and one now challenges Libya's Moammar Gadhafi as Western powers deploy air and sea assets in support of the opposition.

Protests that started with a desperate Tunisian fruit vendor have washed over the Middle East, stirring disaffection in such places as Iraq, Iran, Algeria, Oman, Yemen, Kuwait, Syria, Jordan and Bahrain.

The loss of more than 1 million barrels per day of Libyan sweet crude oil production and fears of additional supply disruptions have pushed crude oil prices up more than 40% from last August. Omani and Bahraini oil refinery workers have staged protest strikes over the past week. And Saudi Arabian Shiites have taken to the streets in Qatif, near the heart of the kingdom's oil infrastructure.

Meanwhile, the horrific Japanese earthquake, tsunami and nuclear tragedy is pushing crude even higher as traders anticipate that lost nuclear production of electricity will be replaced by oil and gas.

Where do we find salvation? Because, heaven knows, we need to be saved: Oil has traded near $104 recently and gas prices have pushed toward $4 a gallon -- a price some economists say would tip the economy over.

Do high oil prices mean recession?

A spike in fuel prices driven by political unrest is economic kryptonite, and it's the worst possible problem we could have right now. Rising prices are forcing central bankers around the world to start policy-tightening cycles and move up interest rates. At the same time, higher energy costs tax consumers, reducing spending power.

Image: Anthony Mirhaydari

Anthony Mirhaydari

Keep in mind that every single recession from 1973 on has been preceded by or coincided with a sharp rise in oil prices.

Hapless investors are glued to their trading monitors, subject to daily headline risks and the fortunes of rebel fighters and protesters half a world away. Consumer and business confidence, which had become cautiously optimistic, is sinking again. Wall Street economists are busily marking down their first-quarter and full-year growth estimates.

Since all of this is driven by political unrest and armed rebellion, policymakers in the West are helpless. If the Federal Reserve tries to loosen policy further, it risks making the problem worse by pushing hot, speculative cash into the commodity market and forcing food and fuel prices even higher. Remember that increases in the prices of these necessities are what catalyzed the protests in the first place.

Unlike with the financial crises of the past few years, more cheap money isn't the solution, and the Fed can't be our savior.

Nor can we just, to borrow a phrase, "drill baby, drill": Offshore production in the Gulf of Mexico is as difficult as anything humans have ever done, and opening new fields in, say, Alaska would take years even if it were politically possible. Time is our enemy here. Before higher prices could encourage new production, the damage to the economy would already have been done.

Salvation from the House of Saud

Instead, the future depends on the ability of King Abdullah and the House of Saud to quickly fill the gaps in global crude supplies while also tamping down protests throughout the region. OPEC controls the world's supply of spare oil. And Saudi Arabia is overwhelmingly the largest contributor to that supply.

Moreover, the kingdom sits at the political center of the Persian Gulf. Riyadh is the seat of power for Sunni Muslims. It plays a key role in the struggle to control Iranian ambitions. It is also on the front lines of the fight against al-Qaida's ambitions on the Arabian Peninsula.

Saudi Arabia already has committed itself to filling any oil supply deficits and has worked with European importers to replace lost shipments of Libyan sweet crude.

On the unrest front, more than 1,000 Saudi troops have crossed the King Fahd Causeway to bolster Bahrain's royal family. And now the Saudis are poised to play a role in the future of Yemen as that country's military leadership abandons its president.

While President Barack Obama has been outspoken in his support of rebels in Libya, Egypt and Tunisia, his administration has been less forceful in supporting protests in Saudi Arabia's sphere of influence. The Saudis had previously expressed disapproval of America's abandonment of Egypt's Hosni Mubarak. This is realpolitik at work. Only so much newfound freedom can be tolerated when oil is at stake.

Saudi Arabia is our bulwark, against both an oil supply crunch and an uncontrollable political contagion sweeping across the world's key energy production and transit hub. Whether its leaders are up to the task will determine the course of the economy and stock prices in the months to come.

Supply constraints

The most important metric is the balance of crude oil supply and demand. And it's more tenuous than most realize.

Right now, a 1.1 million barrel per day (mmb/d) loss of Libyan production has dropped global spare production capacity to 3.6 mmb/d, according to Credit Suisse. That loss represents 4% of the total global supply. All of the excess capacity comes from OPEC, since non-OPEC production is falling. And more than 75% of OPEC's oil comes from Saudi Arabia.

But this estimate hinges on the belief that Saudi Armaco had around 3.5 mmb/d of extra capacity before the Libyan shutdowns. Some experts aren't so sure. Goldman Sachs suggests that OPEC has less than 2 mmb/d of spare capacity, based on anecdotal evidence that the Saudis have been pumping upward of 1 mmb/d more than the official production numbers since November.

There are other factors at work which effectively weaken the cushion as well. Incremental Saudi production is of a lower grade than the lost Libyan oil. And Morgan Stanley analysts say they believe that only 1.5 mmb/d worth of additional Saudi supply can be put into service within six weeks. Increasing Saudi Arabia's total production capacity would "require close to three months and is likely to prove very costly and challenging logistically," according to Morgan's Hussein Allidina.