The Reality of Libya

 | Aug 22, 2011 | 6:37 AM EDT
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As the murderous Gadhafi regime falls, prices for Brent crude have begun to drop -- down almost $3 this morning -- as the world awaits the returned flow of Libyan oil. Economists are getting excited, as a controversial U.S. and NATO action seems to be coming to a close in a spectacularly successful way: We've helped topple a ruthless dictator while saving countless civilian lives ... and without any American or European boots on the ground.

It's all upside from here, right?

Not so fast.

Lots of questions need to be answered before even one barrel of the 1.6 million barrels a day of Libyan production returns to the global marketplace.

The first question is about infrastructure. Most of the fighting in the Libyan revolution has taken place in the North Eastern portions of the country where the rebels were garrisoned. In Misrata particularly, the rebels withstood a daily barrage of tank and artillery fire from the Gadhafi forces. This region is also unfortunately where all the pipelines and refineries are situated to take advantage of the lion's share of Libyan reserves, which are piped to the three port cities of Benghazi, Lanuf and Sirte for export. There have been varied reports of damage to pipelines and skirmishes around refineries, while other reports have rumors of booby-trapped oil fields laid by Gadhafi loyalists.

Whatever the real damage, cleaning up the mess from war and restarting operations is a slow process even in the most stable of countries, and it's a nightmare in Middle Eastern nations with unsure political outcomes (as we have been finding out in Iraq).

I believe the best estimates the analysts have been making on full infrastructure restoration and full production return in the best of circumstances is 18 months. And that assumes a government that is unified and ready to restore production.

And that is far from assured. The National Libyan Council, which will likely make up the new coalition government once order is restored, is an unknown political entity made up of rebel groups and tribal leaders. Their biggest new job will be in restarting and, maybe even more importantly, reapportioning the leases on Libyan oil assets to the foreign oil companies that have run Libyan production with Western oil services technology and foreign workers, all of whom have abandoned the country since fighting started.

But some of these companies will certainly be "non grata" with the new Libyan government, particularly Eni, the Italian oil company that had controlled more than 40% of Libyan production. While their leases are in force for another 30 years, no one knows whether those agreements will be honored by a new government, considering Italian Prime Minister Silvio Berlusconi's friendly ties with the outgoing Gadhafi. Other oil companies with a history in Libya that will be vying for increased exposure will be the Spanish giant Repsol, the French Total (TOT) and American companies Conoco-Philips (COP) and Marathon Oil (MRO).

As for the oil market, today's price drop does not signify a reaction to restoration of supply; it is merely the knee-jerk reaction of traders who don't want to be long in the face of an eventual return of supply. How far this totally psychological reaction can drive down prices is anyone's guess, but mine is that it won't eventually be much. The stock market correlation and continued investment interest as a "safe-haven" play of oil will continue to dominate oil trade -- particularly when it is seen that oil supply from Libya still has more than a year to go before any of it returns to the market.

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