Oil Shoots Higher On Libya Protests As Investors Fear 'Nightmare'

This post has been updated.

NEW YORK -- As violence escalates in Libya and diplomatic support for ruler Moammar Gadhafi erodes, markets worldwide are on edge.

The price of oil , a key economic indicator, has reached a level not seen since 2008, when economies plunged into recession. Mideast unrest has already begun to affect markets in the United States, as the Dow Jones Industrial Average and the S&P 500 stock indices have stumbled. As the price of oil shoots higher, both the national and global economic recovery could be at risk.

Experts urge calm, but are keeping a close eye. "From an objective standpoint, there is no reason to panic right now," said Jeffrey Garten, a professor of international trade and finance at Yale University who served as undersecretary of commerce for international trade in the Clinton administration. But, Garten added, major geopolitical developments could change his mind.

"The real nightmare scenario would be if the rebellion spread to Saudi Arabia," he said. "Anyone who says it couldn't happen and it couldn't happen in a short period of time is just [guilty of] wishful thinking."

Brent crude , a widely influential oil benchmark, hit $108.70 a barrel on Monday, a two-and-a-half year high.

To some extent, investors' fears of an oil supply disruption are being realized. Libya, the largest oil supplier in Africa, typically produces about 1.6 million barrels per day, according to Reuters . But Wintershall AG, a German oil producer, has already begun flying workers out of the country, forcing a decline from the 100,000 barrels the company usually harvests there daily.

Eni SpA, the Italian oil producer, derives about 14 percent of its oil production from Libya, and experts fear that that source could be cut off, Bloomberg reports .

As the oil supply from Libya is constricted, the price of oil will likely shoot higher. If prices rise at the gas pump, consumers will feel the squeeze as heating becomes more costly and the transportation of goods becomes more expensive. A $1 per gallon increase at U.S. gas pumps tears more than $100 billion from the economy each year, economists say.

Under a nightmare scenario, in which the price of oil reaches $150, a range not seen since the summer of 2008, the economic recovery could be threatened.

"The risks would be very high," Mark Zandi, chief economist at Moody's Analytics, said earlier this month. "If it went up to $150 and stayed there for the rest of the year, then all the benefit of the tax cut deal would be wiped out."

Permanently high oil prices could devastate the U.S. economy. In late January, IHS Global Insight released a simulation that showed that if the price of a barrel of oil rose by $10.70 and stayed there for a year, higher fuel prices would rip 270,000 jobs from the U.S. economy. At that point, the price of Brent crude was around $100. In the space of weeks, it's risen to more than $108.

Since protests in the Middle East began, investors have feared that the supply of oil could be compromised. In Egypt, the worry was that the Suez Canal and the Sumed pipeline, which convey nearly 3 million barrels daily, would be blocked. As protests spread, investors' fears grew: If unrest were to hit an oil-producing country, the world's oil supply could suffer.

Amid nervousness, the Dow and the S&P 500 both dropped by about 1 percent Tuesday morning.

But at this point, the nightmare scenario hasn't come to pass. There are still significant forces standing in the way of economic catastrophe.

A disaster might only come, experts say, if protests threatened the government of Saudi Arabia, which controls backup oil reserves. In response to concerns, the Organization of Petroleum Exporting Countries has pledged to increase the world's oil supply if it is significantly constrained, a move that could alleviate the price climb.

"Saudi Arabia is considered the swing producer," Garten said. "It has faithfully played that role for a long time."

Even if all of Libya's oil supply is cut off, Saudi Arabia might be able to make up the difference, Garten said.

But unrest has been spreading at a surprising rate. After demonstrators took to the streets in Tunisia, protests erupted in Egypt, Yemen, Iran, Kuwait, Morocco, Bahrain and Libya.

"The big risk is geopolitical instability that's lasting and has widespread effects," Harvard economist Kenneth Rogoff said last week. "That's a much bigger issue than, say, short-term problems with oil."

UPDATE 4:04PM: At closing Tuesday, the Dow had dropped 1.7 percent, and the S&P 500 had dropped 2.05 percent.