Current oil prices seem to be throwing many analysts for a loop. And there’s no question that with price spikes and flash crashes, stimulus efforts in the United States and Europe, and turmoil in the Middle East, there’s an awful lot to digest.
But when you boil everything down, all we have is a good old-fashioned tug-of-war – one that the bulls are winning… at least for now.
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Then and Now
West Texas Intermediate (WTI) crude, traded on the NYMEX, peaked at $109 in February. This was largely the result of the West’s political clash with Iran, which threatened to close a vital shipping passage, the Strait of Hormuz.
However, by the end of May, economic uncertainty, overabundant supplies and a stronger dollar had knocked the wind out of oil prices. WTI crude fell to the low $80s, leading many analysts to bemoan the “oil bear market.”
Of course, Wall Street Daily readers were too smart to buy into that. We knew oil prices would bounce back. And bounce back they did, hitting a four-month high of $99 a barrel last week.
Now, with the Federal Reserve acting to buttress the U.S. economy, Germany stepping up to the plate in Europe and hostilities in Iran once again at a fevered pitch, it seemed like oil prices should head even higher.
But so far, that hasn’t been the case. To the contrary, oil prices have pulled back slightly – and in some cases, dramatically.
In fact, on Monday, the most actively traded November ICE Brent crude contract shed 2.35% in a matter of minutes.
Trading volume soared, with turnover flying from 152 contracts a minute to an extraordinary 10,246 a minute. Since each contract is worth 1,000 barrels of oil, the market traded futures contracts equivalent to 10.25 million barrels of crude – more than the entire daily output of Saudi Arabia – in just 60 seconds’ time.
In this day and age, that’s not uncommon. Remember, we’ve seen similar “flash crashes” before in both oil and stocks over the past few years.
But there has yet to be a definitive explanation as to what caused those market blips. And no one’s coming forward to take responsibility for this one.
It could have been something as simple as a hedge fund liquidation, or something as elaborate as a conspiracy among investment banks to manipulate oil prices.
Either way, it doesn’t really matter. It was a short-lived anomaly, and there’s nothing the average investor can do about it.
All you can do is to keep looking forward. And here’s what you’re going to see when you do.
What Lies Ahead
As it stands now, WTI crude is trading at about $95 a barrel and Brent is at $115. These prices are at the high end of the historical range, and they’re going to stay there for a while.
The two main catalysts will continue to be the situation in Iran and global efforts to stimulate the world economy.
Israeli Prime Minister Benjamin Netanyahu has been blasting the United States for not doing more to thwart Iran. Netanyahu wants a military strike against Iran, but he wants the United States to do the dirty work. So he’s been pushing for the United States to adopt a “red line,” or a boundary that would result in an immediate U.S. military strike should Iran cross it.
However, neither President Obama nor candidate Mitt Romney have shown any willingness to indulge Netanyahu’s demand. (Another military operation in the Middle East is nothing either candidate has seen fit to support in an election season.)
Of course, if Netanyahu does get his way, you can count on oil prices launching into the stratosphere. They’ll work their way to $150 a barrel in a relatively short time, and maybe even $200 if the Strait of Hormuz is, in fact, jeopardized. The threat to supplies, infrastructure and shipping would be too great to keep oil prices contained.
Now, the reason oil prices have stalled is that this risk premium (for the most part) has already been priced into the oil market. The same way the Fed’s recent stimulus announcement didn’t have a major impact, since traders had been anticipating it for months.
We’re essentially back to where we were in April. Oil prices have been moved by external political factors – not fundamentals. Supply and demand do not warrant prices this high.
So if the crisis in Iran magically comes to a non-confrontational resolution, we’ll see oil prices plunge just like we did in May – Bernanke’s inflationary policies notwithstanding.
But that’s not going to happen.
What’s going to happen is a tug-of-war between oil bulls and oil bears.
The bears will bet that the situation in Iran won’t jeopardize supplies, that it will be resolved relatively peacefully. They’ll cling to any negative data they can find as evidence that the global economy is weakening, that demand can’t be sustained and supplies are too abundant. And finally, they’ll point to high oil prices themselves as a headwind to economic growth.
That’s a fair case. But it won’t be enough to weigh significantly on oil prices. There’s too much working in the bulls’ favor right now.
Namely, the bulls will argue that Iran is a powder keg that’s ready to blow at any moment, and seize on any evidence of political unrest in the volatile Middle East. Furthermore, bulls have the added tailwinds of the Fed’s stimulus.
For the bulls, Bernanke’s policies will boost the lagging recovery, at best. And at worst, it will spur inflation, which would drive oil prices higher anyway.
And remember, the global economy withstood high oil prices at the beginning of this year and demand proved resilient. It could be months before we see the economy start to balk again – and even longer if the stimulus proves effective.
That’s why we’ve seen more bullish activity from hedge funds lately.
Hedge funds have raised bullish bets on oil to a four-month high, increasing net-long positions by 5% in the week ended September 11. Meanwhile, crude holdings rose for a fourth straight week to 203,324 contracts, the longest stretch of increases since February.
So now’s not the time to be shorting oil. Instead, just keep a close eye on these developments, and we’ll keep you abreast of any new investment opportunities that result from the volatility.