Will the Conflict in Libya Lead to Higher Prices for Oil in the Long Run?

There certainly are no shortages of bad news lately, from the earthquake and tsunami in Japan (NYSE:EWJ), to the uprisings in the Middle East, to the continued stagnation of markets in Greece and Ireland one would expect continuing volatility in the stock market. Libya, the 12th largest exporter of crude oil (NYSE:USO) in the world is particularly troubling. Not only has the conflict reduced the number of workers showing up for their jobs, but the UN airstrikes have also damaged segments of the Libyan oil production infrastructure. These developments have led to the largest spike in crude oil prices in 29 months, but will it continue to rise?

There are assurances from our government that a combination of using strategic reserves both in America and abroad, coupled with increased production from other OPEC countries will keep the cost of crude from spiking too much. What is alarming is that there is no guarantee that OPEC will increase production, although they do have the capacity. The U.S.’s strategic reserves are only large enough to supply the country for 35 days before running out, so opening them up will not be enough to offset a price spike in the long run. Doing so however will demonstrate to the world the U.S.’s resolve in using this resource, which could impact OPEC’s decision on whether to increase production.

There are also fears of a double-dip recession occurring, and given the U.S. economy’s dependence on foreign oil, these developments are likely to have a strong impact. In 2008, when crude hit $140 a barrel, prices at the pumps spiked to a little over $4 a gallon. Analysts are saying that the current unrest in the Middle East could cause crude to go as high as $200 a barrel and that under the current economic conditions, a rise to the $150 per barrel price point could cause a spike upwards of $5 a gallon at the pump. Certainly this could be very damaging to the recovering U.S. economy.

In 2000, President Clinton opened up the Strategic Reserves in order to offset a spike in the price of oil, but this effort was thwarted a month later by OPEC, who cut production in response. Understanding OPEC’s strategy in these types of situations is critical to handling this situation properly. However, there is still a bit of a silver lining to this economic quagmire. The consumer confidence levels are the highest they’ve been since 1984, which according to Austan Goolsbee, chairman of the president’s Council of Economic Advisors, will have a positive impact on the psychological aspects of the market. He further notes that the interruption in supply will only be temporary, and that transportation costs are only 10% of consumer expenditures.

In conclusion, is the current spike in crude oil (NYSE:USO) prices directly related to the conflict in Libya? Yes. Is the government taking measures to offset this spike? Yes. Will this impact the price of crude in the long term? No, as long as the UN minimizes damage to oil producing infrastructure in Libya, and helps to bring a swift end to the violence. The more protracted this operation becomes, the more damaging it will be to the economy (NYSE:SPY).

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Alexis Bonari is a Wall St. Cheat Sheet reader who submitted this Letter to the Editor. She is currently a resident blogger at College Scholarships, where recently she’s been researching grants for minorities as well as scholarships for Hispanic students.