As a trickle of oil began flowing from war-torn Libya this week, some market watchers saw signs the recent surge in the price of crude may be subsiding.
But until the shooting stops — in Libya and the rest of the oil-rich Middle East — the situation will remain murky.
Most experts are predicting a short-term drop in prices, but the long-term threat to global supplies remains unclear.
The price of Brent crude backed off its 2-1/2-year high of $123 a barrel Wednesday amid reports that an oil tanker left the Libyan port of Tobruk carrying the first shipment of crude sold by rebels, who control the country's east. That would mark the first shipment of Libyan oil since the fighting erupted early last month, taking roughly 1.5 million barrels a day off the global oil market.
But the restoration of oil shipments represents just a drop in the bucket of estimated global demand of close to 89 million barrels a day, according to the International Energy Agency. And no one is expecting Libyan production to return to full capacity anytime soon.
"At best, the rebels are in control of maybe three fields, 300,000 barrels of capacity a day," said Helima Croft, an analyst at Barclays Capital. "We think at most right now they could probably export 50,000 barrels (a day) of production. That's important for the rebels in terms of cash — around $15 million a month — which is money to buy arms. It is not going to move the needle in terms of oil exports in global balances."
Even if Libyan rebels can maintain control of those oil fields, they face a number of hurdles to get their crude to market. Drilling and processing facilities need to be secured and shipping operations restored. And until some form of reliable government is established, most conventional oil buyers may balk at doing business with rebels, according to William O'Grady, chief market strategist at Confluence Investment Management.
"They do have oil to sell," he said. "The problem is: Who do you send the check to? Who do you trust to take the money?"
Following the cutoff of Libya's oil supplies last month, Saudi Arabia pledged to make up that shortfall by its boosting production by 1.5 million barrels per day. The extra oil will come from a surplus capacity of about 4 million barrels per day, the result of a massive investment over the past several years to expand the available output.
Despite Saudi pledges to make up the Libyan shortfall, oil prices have surged as the cushion of spare capacity has been squeezed closer to its limit. O'Grady estimates that as demand rebounds to fuel the global economic recovery, oil consumers are using roughly 90 percent of total global production capacity.
"Any time you get above 90 percent you start to scrape the bottom of the barrel, so to speak," he said. "That last 10 percent is stuff that's harder to refine."
The slim cushion also means any further supply interruption would be that much harder to make up. That fear has many oil market watchers predicting that any price pullback will be short-lived.
Since the latest rally began in June 2010, oil prices have rocketed from a low of about $70 a barrel to more than $120 a barrel – a gain of more than 70 percent.
Many market watchers say the price surge has gone too far and oil is due for a pullback. The consensus sees the price of Brent crude falling below $120 by the end of June, with some calling for prices to fall back toward $100 by the end of the quarter, according to 32 oil traders, bank analysts and hedge fund managers surveyed this week by Reuters.
But any pullback, they say, will likely be short-lived. More than half expect Brent to rebound above $130 a barrel in 2011, with one in five predicting prices will hit a record $150 a barrel by the end of the year.
"There are a lot of uncertainties in the market right now," said Fadel Gheit, managing director at Oppenheimer & Co. in New York.
Those uncertainties extend beyond the turmoil in the Middle East. One big unknown is whether global demand will remain strong. Recent signs of a renewed slide in home prices have prompted some economists to pare back their forecasts for growth of U.S. gross domestic product in 2011. Rising gasoline prices — up 90 cents in the past year — have prompted drivers to begin to cut back on consumption.
Higher prices for oil and other commodities are also putting pressure on high-growth economies like China, where the government recently raised interest rates to try to slow inflation and cool its red-hot economy.
Then there's the cloudy outlook for the dollar. At least some of the rise in the price of oil — quoted in dollars — can be attributed to the weakness in the U.S. currency. Since the oil rally began last June, the dollar has fallen roughly 10 percent on a trade-weighted bases, according to the Federal Reserve Bank of St. Louis.
That period coincides with the U.S. Federal Reserve's $600 billion bond-buying spree designed to keep interest rates low. That program is expected to expire in June. If the dollar begins rising again, that could help temper the upward pressure on prices (in dollar terms) brought by fears of the loss of additional supplies caused by further turmoil among Arab oil producers.
Those fears are driven largely by worries that violence could spread in Saudi Arabia, the world's largest oil producer and, with one-fifth of the world's proven reserves, the only country with any significant surplus capacity.
Saudi Arabia shares many of the same conditions that have sparked riots and toppled governments in neighboring countries: Some two-thirds of the population is under the age of 35, unemployment is high and the country is ruled by a long-standing, autocratic government. So far, the regime has maintained relative calm by spending its oil wealth heavily on social programs to win public support and appease political opponents.
But the Saudi regime has become increasingly nervous about U.S. and European support for pro-democracy movements sweeping the Arab world.
On Wednesday, Defense Secretary Robert Gates met with Saudi King Abdullah in Riyadh to try to calm those fears. Those recent efforts include the sale of U.S military hardware to bolster Saudi defenses against Iranian missiles.
But the Obama administration has been walking a fine line between public support for the Saudi government and privately criticizing the regime for moving too slowly to implement political reforms.
Relations grew more tense last month after Saudi Arabia sent troops to neighboring Bahrain to quell protests from Bahrain's Shiite majority, who are demanding Sunni minority rulers grant them equal rights and a political voice. The fear in Riyadh is that the Sunni-Shiite rivalry could spill over and spark more violent protests within Saudi Arabia's borders.
Lest the oil markets underestimate the potential impact of a Saudi uprising, former Saudi oil minister Sheikh Zaki Yamani was ready Tuesday with a reminder.
"If something happens in Saudi Arabia, (oil prices) will go to $200 to $300," he told Reuters at an oil conference in London. "I don't expect this for the time being, but who would have expected Tunisia?"
As U.S. and other western officials continue to press Arab regimes for political reform, Yamani's comments were likely intended for a wider audience.
"(The Saudis) are shooting a warning shot across the administrations bow," O'Grady said. "They're saying 'If your government keeps supporting all these movements, you're running a bigger risk than you think you are.'"