Libya, Mid East in focus, seen driving up oil risks

(Reuters) - UN-sanctioned aerial and naval attacks on Libyan air defence and ground forces at the weekend are likely to see oil prices vault higher this week, overcoming demand-side jitters stemming from Japan’s earthquake and Chinese monetary tightening.

French planes fired the first shots in what is the biggest international military intervention in the Arab world since the 2003 invasion of Iraq, destroying tanks and armoured vehicles in the region of the rebels’ eastern stronghold, Benghazi.

On Monday, Brent crude , which closed at $113.93 a barrel on Friday, could target a February peak of $119.79 a barrel. U.S. crude, which closed at $101.42 a barrel on Friday may also extend last week’s 4.2 percent gain, adding to concerns about inflation around the world.

“The Middle East and North Africa are a powder keg attached to a slow-burning fuse. The attacks on Libya and naval blockade, the troubles in Bahrain which are causing tension between Saudi Arabia and Iran, could cause the whole thing to blow up,” said Jonathan Barratt, managing director of Commodity Broking Services.

“The key is really how Saudi and Iran play out. Cool heads need to prevail. It’s contained at the moment but if things worsen, you see a Mid East premium very quickly. If they start exchanging fire, it could easily drive the market above the record high.”

Simmering tensions in North Africa and the Middle East, sparked by a revolt in Tunisia in January that spread to other nations including Egypt, Yemen, Bahrain and Libya have helped drive up oil prices by around 20 percent so far this year. Brent crude traded at almost $120 a barrel, its highest since a spike

to just below $150 in mid-2008.

So far in March, Brent has risen just 2 percent on expected lower demand following the Japan earthquake and eased on Friday after two days of gains, as Libya declared a ceasefire, easing the threat of further damages to oil facilities.

Oil production in the nation, the world’s twelfth biggest exporter, has fallen dramatically since the unrest started -- down from around 1.6 million barrels per day to around 400,000 barrels.

Oil exports have slowed to a trickle, but they will likely dry up as military action continues.

JAPAN FEARS, CHINA TIGHTENING

Weighing on oil and other commodities on Friday was another increase in China’s rate reserve requirements and uncertainty about near-term demand from Japan as it comes to terms with the

deadly earthquake and tsunami of a little over a week ago that may have killed thousands and its continuing battle to prevent a nuclear disaster at a stricken power plant.

On Sunday, Saudi Aramco said it expected global oil and gas demand to rise slightly in the medium term, driven by a rise in consumption from Japanese industry and regional energy producers, but is will not have a significant impact on global markets.

Out of China, the nation’s Vice Premier Li Keqiang said it will stay focused on stifling inflation even as global economic uncertainties multiply.

“We will make stabilising the overall level of prices the primary task of macro-economic adjustment,” said Li, who islikely to succeed Wen Jiabao as premier two years from now.

Away from oil, gold markets were also likely to be well-bid supported by safe haven buying and a potential physical supply squeeze from Japan.

But the geopolitical and economic headwinds developing may undermine industrial raw materials and grains.

The recovery in risk appetite on Friday that sent U.S. grain futures soaring may reverse. On the week, nearby CBOT corn futures ended 3.7 percent higher after a 37 cent surge on Friday to $6.83-1/2 a bushel.

Wheat rose 4.0 percent after leaping 12-3/4 cents a bushel to $7.23. May soybeans rose 27-1/4 cents Friday to $13.62-1/2.

London Metal Exchange three-month copper shed $55 Friday to close at $9,510 a tonne, but ended the week 3.5 percent firmer.

“There is still a lot of worry in the market about demand in Japan and China. The Japan story is getting easier to see and we don’t have longer term worries about demand there. China is causing a bit of disquiet. Inflation-busting policy moves could depress consumption,” said a Singapore based trading source.

“The situation in Libya is a non-story as far as the fundamentals go. It will feed into risk sentiment across a range of markets and weigh on prices, but it won’t last long.”