Arab unrest latest threat to European markets

Political unrest has raged across the Middle East and North Africa for much of 2011. Aside from the tragic human cost in the region, the knock-on effects pose a threat well beyond the Arab world, which could derail the global economic recovery.

Oil prices have spiked around the world, although promises from Saudi Arabia to make up any shortfall have, for now, allayed fears of an energy crisis.

While there are investment options for the Middle East and North Africa, most Canadians face greater exposure to Europe, which faces elevated risks as the region’s closest neighbour.

Europe imports almost all of its fossil fuels from either the MENA region or former Soviet republics, which carry their own political baggage.

“The near-term outlook is for a near complete drop-off in Libyan oil production, not just because of actions upstream in the mostly remote oil and gas fields, but also because of bottlenecks and problems en route to market,” writes Catherine Hunter, an analyst at economic research firm IHS.

Opponents of the Libyan regime have effectively blockaded the exports from the country’s oilfields in an attempt to starve Moammar Gadhafi’s regime of financial resources.

“This is compounded in the western regions by ongoing bloodshed, violence and the savage defence of an apparently dying regime by Gadhafi loyalists, with Gadhafi himself also making threats, if not as yet understood to have followed through with them, to sabotage oil infrastructure,” Hunter writes.

Europe imports about 10% of its oil from Libya alone, according to Earl Sweet, senior economist at BMO Capital Markets, and demand outstrips supply by roughly half a million barrels per day.

The political upheaval is “clearly not isolated,” says Paul Taylor, chief investment officer at BMO Harris Private Banking. If unrest spreads to major producers like Saudi Arabia or Iran, crude could top the highs of 2008 in very short order.

“This is the one exogenous factor that has us very concerned,” he says.

Both Sweet and Taylor believe the global economy can withstand $100 crude in the short-term, but if oil were to breach the $120/barrel mark for a sustained period, the risk of another downturn would return.

Not only are European economies facing higher energy costs, they are also facing tough choices on rebuilding relations with the countries in turmoil. As new regimes assert control in Egypt, Tunisia and possibly Libya, many EU member states will want to re-establish the close ties they had enjoyed with the deposed regimes.

This could have an economic impact on Eastern Europe, according to IHS analyst Sarah Tzinieris.

“It is likely EU relations with the bloc’s other close neighbourhood to the east will be affected by the recalibrating of EU foreign policy,” Tzinieris writes. “The EU is expected to shift billions of dollars of aid to the MENA region, largely at the expense of countries to Europe’s east.”

The EU has another reason to boost North African aid. The unrest has sent a flood of refugees into southern Europe, imposing an economic burden on the EU members least able to manage this cost.

“France, Spain, Malta, Cyprus, Greece, and Italy have called for a special 100-million-euro solidarity fund to help deal with the influx, and for a common EU asylum system to be put in place by 2012,” Tzinieris writes. “These governments have also demanded that a relocation programme be established immediately to redistribute the large number of asylum seekers fleeing North Africa.”

So far, northern European governments have been far from enthusiastic about that suggestion.

Taylor says European equities might appear undervalued compared to North American stocks, but the credit issues facing Europe remain the biggest problems.

“There’s a lot on the political front to be decided in terms of more coherent, more consistent policies within Euroland, and that enters into the political forum,” Taylor says. “We’re not, at this point in time, sending new money to Europe.”

Sweet points out that while the sovereign and bank debt situation is relatively calm at the moment, there are new major financings in the offing for Portugal and Spain, which could roil the markets.