Is Libya Rope-A-Doping Global Oil Market?

Market players have been extremely blasé about the large disruption to Libyan oil output since January 19, with the price of international marker Brent crude actually dropping more than two dollars a barrel.

An extended loss of Libyan oil early last decade spiked Brent over US$120/bbl (see Figure 1). At the time, there was plenty of spare crude capacity to cover the outage — as there is now—but it tended to be medium-sour quality or worse, a poor substitute for Libya’s light, sweet crude. This ultimately led the International Energy Agency (IEA) to co-ordinate a 60 million bbl release of high-quality crude from strategic reserves of its member countries in June 2011.

Figure 1. Source: EIA.

Since then the global market has barely noticed large ups and especially downs in Libyan oil output because of rapid growth of U.S. light-tight oil (LTO) production. To be blunt, the world has been awash with light, sweet crude most of the past decade.

However, market conditions may be changing, with the International Marine Organization’s (IMO) new sulphur rules for bunker fuel — known as IMO 2020 — pushing less complex refineries to run more light, sweet crude to meet the 0.5 per cent limit — compared to 3.5 per cent previously — and the rate of growth of U.S. LTO rapidly slowing.

Market players appear to be assuming a relatively short-lived outage of the bulk of Libya’s 1.2 million bbl/d output, which may or may not be the case, especially as IMO 2020 regulations will significantly tighten as of March 1. But even if the present outage is short lived, the potential remains for an extended one down the road when U.S. LTO production is expected to be growing at a substantially slower rate, if not in outright decline.

Hence, an extended loss of Libyan light, sweet crude, either now or later, could lead to another spike in Brent prices, despite the present insouciance of market players.

Short term?

Field Marshal Khalifa Haftar, leader of the so-called Libyan National Army (LNA), has had the capability of shutting down most of Libya’s oil production and export facilities since becoming de facto ruler of the east of the country, and to a lesser degree south, almost four years ago. The fact he has decided to do so now suggests he believes the end game is near for his country’s Second Civil War. In this case, and barring a sudden collapse of the U.N.-recognized Government of National Accord (GNA) based in Tripoli, the country’s capital city, an extended disruption to Libya’s oil is likely at this time.

Haftar has been following a classic divide and conquer strategy during his six-year campaign to dominate Libya, involving a combination of co-opting groups opposing the LNA, often with financial inducements, and when necessary through military conquest. The Haftar-led LNA has a bevy of global and regional allies—including Russia, the United Arab Emirates (UAE), Egypt, Saudi Arabia and even France — providing a mix of financial, diplomatic and military aid, despite an arms embargo being in place since the last days of the Gaddafi regime in 2011.

The LNA has had Tripoli besieged since April 2019, in an attempt to topple the GNA government headed by Prime Minister Fayez al-Sarraj and supported primarily by Islamic-based militias. Ironically, the GNA has been able to buy the support of these armed groups through revenues from oil produced in Haftar-controlled areas by state-owned National Oil Company (NOC) and transferred to the country’s central bank located in Tripoli. The central bank then distributes the funds to both the GNA and Haftar’s government based in the eastern city of Tobruk.

The eastern government has not been able to sell the oil directly to world markets because of a U.N. Security Council resolution prohibiting illicit crude oil exports from Libya — which foreign countries have respected, unlike the arms embargo. Haftar’s government is not internationally recognized, despite having many international supporters, whereas the GNA is.

By cutting off oil revenues to the GNA at the present time Haftar may be attempting to pry away militias allied to it to win the civil war and avoid further bloodshed and destruction in Tripoli. A key factor in the LNA gaining control of the strategic coastal city of Sirte in early January was the 604 Brigade, an Islamic-based militia, deserting the GNA and aligning with Haftar’s forces. The LNA has increasingly been attracting such militias to its cause, despite Haftar’s original hardcore opposition to them.

Both the GNA and Haftar governments are highly dependent on oil revenue for the basic needs of their people, to finance their war efforts, and to provide financial incentives to militia groups to support their side in the conflict. But the international allies of Haftar have much deeper pockets than the GNA — with Qatar its main financial backer; and Turkey its main military one —and hence the Haftar government appears much better placed to withstand an extended period of low or no oil revenue.

The start of IMO 2020 on January 1 may not have significantly tightened the global market for light, sweet crude, as prices increased in the autumn but have declined since the beginning of the year – although sweet-sour and light-heavy spreads have widened – but this could change shortly as the opportunity for ship owners to cheat dissipates.

"The next important target is fast approaching, when carrying non-compliant fuel oil on board ships becomes prohibited on March 1, 2020," IMO secretary-general Kitack Lim recently said.

Simple refineries with limited ability to upgrade and desulphurise residue need crudes with less than 0.3 per cent sulphur to meet the IMO’s new very-low-sulphur fuel oil (VLSFO) specification, which as a rule are light, sweet crudes — medium and heavy crudes tend to be sour.

Longer term?

On the other hand, Haftar may have overestimated the LNA’s position and underestimated the position of the GNA at the present time, which could force him to re-instate oil production and exports relatively quickly. He predicted a swift decisive victory when he first attacked Tripoli last April, but the ground fighting has remained mostly stalemated in the city’s suburbs despite Russia providing the LNA with hundreds of mercenaries from the notorious Wagner Group in September.

At the same time, Haftar’s international patrons may not prove as generous as he hopes, and militias supportive of the GNA in Tripoli — and the battle-hardened city of Misrata — may prove more loyal than expected. In this case, Haftar could see militias desert from his side while GNA-affiliated militias remain loyal.

However, it is hard to see a major reversal in the Libyan civil war given facts on the ground and the level of international support the Haftar government has relative to the GNA — especially all important Russian support, as seen during the Syrian civil war. As a result, it could be only a matter of time before Haftar shuts down Libyan oil production yet again in an attempt to defeat the GNA.

And the global oil market should be significantly tighter down the road than it is now, especially the market for light, sweet crude, with an expected slowdown in U.S. LTO production growth. After increasing a record 1.88 million bbls/d year-on-year in August 2018, LTO growth has dropped by more than half to 897,000 bbls/d in December. Among the major LTO regions, growth remains strong in the Permian, moderate in Bakken and Niobrara, while both Anadarko and Eagle Ford saw a modest decline last month.

After significantly ramping up its medium-term outlook for U.S. LTO output the last few years — having massively underestimated growth for most of last decade — the IEA is now forecasting it to grow 3.29 million bbls/d to 9.59 million bbls/d between 2018 and 2024. But as with all of its forecasts since the beginning of the U.S. LTO Revolution, growth is front end loaded. The agency has it increasing an average of 1.07 million bbls/d in the first two years, but only an average of 289,000 bbls/d in the final four years, with production virtually flat between 2023 and 2024.

In addition, the IEA, and other major oil forecasting organizations such as U.S. Energy Information Administration (EIA) and OPEC, may have jumped onto the U.S. LTO bandwagon just in time for it to lose a wheel. The industry is facing increasing headwinds both above and below ground. These include less access to investment capital retarding drilling activity, the so-called parent-child well issue negatively impacting well productivity, and two of three frontrunners for the Democratic Party’s 2020 presidential candidacy Bernie Sanders and Elizabeth Warren being anti-oil and anti-fracking.

To conclude, the global oil market appears to have been lulled into a false sense of security when it comes to its need for Libyan oil. The extended loss of up to 1.7 million bbls/d of Libyan oil beginning in February 2011 caused the price of Brent crude to increase roughly US$20/bbl. A similar magnitude jump is possible next time a Libyan outage is both substantial and extended.