Issue of the week: What war in the Caucasus means for oil prices

Just when oil prices were finally returning from the stratosphere, the prospect of all-out war in the Caucasus has unsettled the oil market again, said Kenneth Musante in CNNmoney.com. Before Russian forces moved into neighboring Georgia last week, the price of oil had sunk to around $114 a barrel—down 22 percent from the mid-July peak of more than $147—thanks to reduced demand from the U.S. and Europe. But when fighting broke out in the separatist Georgian province of Ossetia, traders quickly shifted their attention to Georgia’s two oil pipelines and pushed the price back above $117. Unlike the other pipelines carrying oil from Central Asia to Europe, Georgia’s two pipelines don’t run through Russian territory. But if Russia should occupy Georgia, that would give Vladimir Putin “control of all the oil and natural gas flowing through the region.” In recent years, Russia has punished both Ukraine and the Czech Republic by temporarily cutting off their energy supplies, and Western Europeans worry that they could be next.

Europe has gotten a foretaste of what a supply cutoff would be like, said Polya Lesova in Marketwatch.com. BP, which operates Georgia’s pipelines, shut down the smaller of the pair “as a precaution.” The larger one, known as the BTC pipeline, was shut down earlier after a fire damaged a section that runs through Turkey. The shutdowns have left traders wondering which way oil prices are heading, said Madlen Read in the Associated Press. While prolonged closure of the pipelines would send prices higher, “signs that China’s energy demand could be leveling off” convinced some traders that prices would trend lower in coming months. With the conflicting signals, said U.S. energy analyst Darin Newsom, “the market’s kind of reeling.”

Whatever the short-term course of oil prices, the fighting in Georgia can’t bode well for the long term, said an unsigned commentary in Platts, an oil industry newsletter. Until the fighting broke out, Georgia was busily adding pipeline capacity, with assistance from the West. The U.S. helped finance the construction of the BTC pipeline, and the European Union was planning to help build a new pipeline to carry energy supplies from Azerbaijan through Georgia to the West. But the fighting in Georgia raises serious doubts about “the ability of international companies to raise finance and secure financial guarantees for new projects in the South Caucasus.”

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That’s one of many reasons “the old days of $30 oil” are gone for­ever, said investment strategist Barry Ritholtz in BigPicture.com, a financial and economics blog. The biggest reason, though, is that since 2003, the global economy has been growing while global oil production arguably has been hitting its peak. Even if China’s demand for oil slows temporarily, economic growth in China and the rest of the developing world will make “huge demands on global energy reserves” for the foreseeable future. And that means that despite short-term fluctuations due to war and other man-made catastrophes, oil prices are headed inexorably upward.