Understanding Egypt: The Suez Canal

Editor’s note: The Blaze is featuring some guest posts to help our readers gain a deeper understanding of the situation in Egypt.  This post, by veteran journalist Bill Tucker, looks at the strategic importance of the waterway connecting the Red Sea with the Mediterranean.

While the world has been captivated by the pictures from the streets and reports of journalists being mobbed by pro-government forces in the streets of Cairo, the financial world’s attention has been off to the east. Traders have been fixated on a 120-mile thread of silvery water known as the Suez Canal. It is through those canals that trade moves between the Red Sea to the south and the waters of the Mediterranean Ocean to the north.

The most notable commodity travelling the waterways is the Middle East’s best-known export: oil. About 4-miilion barrels of the world’s daily supplies of oil passes through those canals every day. Fears of that supply being interrupted briefly sent crude oil prices above $100 a barrel for the first time in a couple of years last week. Trading in futures options, notably options which give the holder a right to buy at a set price which are known as calls, jumped and demand for calls at $250 a barrel soared as the market panicked. (Understand that options cost a fraction of their value so this move amounted to a cheap bet for a potential big lottery win.)

While financial markets enjoy the reputation as being rational, the truth is, they don’t always behave rationally. Fear, panic and political insatiability often have a distorting impact. In this case, Egypt is not a major producer of oil; it is just the conduit of some oil… and not even the majority of oil.

The reality is major producers in the Middle East need to get oil to market in order to realize a gain. It is in Egypt’s interest to allow that oil to transit because they collect tolls on that oil movement and it is in the interest of whoever governs Egypt to keep the pockets of its Arab neighbors lined. In addition, there are other means of transporting their oil besides going through Egypt. There are a myriad of pipelines available to spread distribution and while the Suez Canal is the shortest shipping route it is not the only available shipping lane. Shippers can choose to go around the horn of Africa although that route adds two weeks between supplier and market.

Of much greater concern would be the spreading of unrest from Egypt to the region. That is the real meat of the issue according to energy analyst Stephen Schork who publishes The Schork Report. A report issued by Barclays Capital agrees saying that, "Given the phenomenal recovery in demand (last year), price breakouts due to geopolitical reasons have become more likely,” In other words, "That means that geopolitics is always likely to re-establish itself in 2011 as a major component of the oil market."

The sabotage of the natural gas pipeline out of Egypt to Jordan and Israel fuels those concerns. Already there are reports that nations like Jordan, Saudi Arabia and Algeria are beginning to hoard wheat supplies to ensure against food shortages.

For now, oil prices are well off their highs reached last week. Crude in the U.S. is now trading slightly below $88 a barrel. For the moment, traders appear more focused on the U.S. economy and its prospects for growth. Growth fuels demand and demand pushes prices higher. For those who follow the markets, here is a useful piece of math; economist Peter Morici of the University of Maryland School of Business calculates that for ever $10 a barrel rises, it translates into 24-cents a gallon at the pump.

For Bill Tucker's bio click here.