The Oil That Sparked The Fire

Written by Christopher Nash.

 

 

In this article, we will discuss recent worldwide events, primarily in the Middle East where oil is a huge commodity, their impact on demand and supply of oil, expected stock prices in the future, and how to make some money (opinion of course).  We have a quick update located at the beginning of the article and will keep updating every so often, detailing changes and events which drive or have the possibility of driving the market.

 

 

1/18/16

Iran Sanctions lifted as soon as Oil seems to stabilize, allowing Iranians to reenter the global market, engendering fear that we may encounter even more oversupply as Iran possesses unfathomable stockpiles of oil. This and more.

 

At the moment, we are bearish on oil into the near future. However, we believe Q2 FY 2016, that will change.

1/6/16 

Revised 1/17/16.

The Fuel That Sparked The Fire

 

Let me explain what this all means.  If you take a few minutes to read this article, I promise you won’t regret it; in fact, you might even make a little money. Okay, let’s get to it: the fuel in the title here, which I’ve been blathering about here is oil.  Oil’s been steadily falling in value all year due to production far exceeding demand.  But, we might just see a change in that, especially if the escalating conflict boils over into Saudi Arabia’s domestic territory.  In the end, it depends what Saudi and Iran’s interests are and what are the benefits and costs of going to war.  Do the costs and benefits outweigh decreased supply and market share?

Energy is a long-term investment. Trading isn’t all about quick, voluminous transactions. Sometimes, we need to take time to speculate the market. Not to mention, playing the waiting game can pay off significantly.  

 

 

Saudi-Iranian Tensions

Something cataclysmic, yet monumental has just occurred.  Two of the largest oil producers and suppliers in the world have just made some very powerful moves, which has resulted in increased tensions and in the future, its acutely viable that Saudi Arabia and Iran could arrive at future war.  Actions speak louder than words my friends, and tonight there was no lack of action.

Saturday, the Saudi capital of  Riyadh ordered the execution of Shiite cleric Nimr al-Nimr.  Hours later, a retaliatory Iranian led Shiite attack consisting of Molotov cocktails on a Saudi embassy in Tehran resulted in severed diplomatic ties between the two nations, and has possibly opened Pandora’s box.  What I mean is there exists a very real possibility of war. Militant opportunity, ISIS involvement, etc. could tie up these countries for weeks, months, years; it is unknown at this point. And it is no secret that ISIS is a Sunni-based Muslim organization, and Iran has the largest Shiite population in the world.

Another point I have to make is that Iran and Saudi Arabia have been longtime enemies, which does have something to do with what seems like the “War of Cenuries”, Shiites vs. Sunnis.  Following the altercation, Saudis and Iranians severed any friendly diplomatic ties and/or relations, and closed the door on any friendly arrangements and/or agreements, especially a unique one involving working cooperatively to silence the conflict in Syria involving ISIS.  Remember, the last time Saudi Arabia broke off ties with Iran, after its embassy in Tehran was stormed by protesters in 1988, it took a swing in the regional power balance in the form of Saddam Hussein’s 1990 invasion of Kuwait to heal the rift.

IRAN-SOCIAL-EXECUTION-ISLAM
Balal, who killed Iranian youth Abdolah Hosseinzadeh in a street fight with a knife in 2007, is pictured blindfolded next to a noose during his execution ceremony in the northern city of Noor on April 15, 2014.  Iranian Shiite cleric Al-Nimr was also similarly executed by the Saudis last weekend, who are primarily Sunni, igniting prompt retaliation from Iranian Shiites.

Saudi Foreign Minister Adel al-Jubeir told Reuters on Monday, signaling Riyadh would not back down,”We will not allow Iran to destabilize our region. We will not allow Iran to do harm to our citizens or those of our allies and so we will react.”  But, remember these are just words, and if Iran really wants to dramatically overreact, I doubt the Saudi people and its capital city of Tehran will just be able to turn off the light switch like that.  Proof and point – two Sunni mosques were bombed over the weekend subsequent to the execution, signaling Iranian provocation.  How will Saudi Arabia respond? Will they respond? When will they respond?

The conflict was sparked by the execution of a prominent Shiite leader, a fervent opponent of the Sunni Saudi Royal Family.

 Choosing Sides

No matter what the policy of any country is or what they publicly disclose, I believe each country has a secret agenda and will make decisions that are of benefit to them in the situation. In this case, I believe that Sunnis will stick together in opposition of Shiites.

Other countries are also weighing in on the conflict between Saudi Arabia and Iran. Riyadh, has pushed allies to cut ties with Iran in recent days, which, and I’m being honest here, could prompt support from Syrian militant groups such as ISIS, a primarily Sunni terrorist organization.  Do I really need to explain who ISIS is; I mean, come on, they have been wreaking  havoc in the world and lately have dominated the media.  They’re a powerful, widespread organization, owning the strength and resources to be a huge asset to Saudi Arabia if the conflict does intensify.

“After the execution of Nimr, Iran’s Revolutionary Guard said a “harsh revenge” would strike Saudi’s ruling Al-Saud family in the near future.”

“The Revolutionary Guard is part of the Iranian government and their threats should be taken seriously because they control militia in Lebanon, Syria, Iraq and Yemen and I would not be surprised if they use it to act against the Saudis,” said Abdulaziz al-Sager, head of Jeddah-based Gulf Research Centre.” (Reuters).

I’m not sure why people are being dismissive of the disastrous events which recently took place, but this resembles a vintage start to a “Hussein Campaign”.  Yup, just coined that. No big deal.

Now, lets get move on to other nations. The Saudi Arabians are seeing swift support from Bahrain as well as The United Arab Emirates, who both made it clear a few days ago that they were “downgrading” relations with Iran.  African countries such as Sudan have also shown support for Saudi Arabia; they expelled the Iranian ambassador and the entire Iranian diplomatic mission in the country.  Sudan has also recalled its ambassador from Iran.

Other countries have also decided to remain neutral in the conflict such as Russia and China, two superpowers who hope the Middle East can resolve their differences.  The only reason I speak about all of this is because if war does occur between these two nations and supporting parties, oil supply will without a doubt be affected. And I don’t mean supply and production will increase when I say that.

I also just want to add something.  I have been following this conflict very closely, and I have seen nothing on any news outlet with any mention of nations like France or the United States, who have suffered attacks from either ISIS, ISIS affiliations, or groups inspired by ISIS.  In my opinion, ISIS could be a major piece of this dissension, and if war, short or long does take place, nations affected by ISIS may see this as an opportunity to weaken ISIS.

The list of nations affected include:

  1. France
  2. United States
  3. Canada
  4. Denmark
  5. England
  6. Algeria
  7. Libya
  8. Egypt
  9. Tunisia
  10. Yemen
  11. Turkey
  12. Italy
  13. Croatia
  14. Russia
  15. Lebanon
  16. Australia
  17. Afghanistan
  18. Bangladesh

 

Read more about the attacks here.

 

My Analysis

How do I see this, and how should we proceed, at least in relation to the markets? Because the execution was of Shiite leader al-Nimr, an aggressive opponent of the Sunni Muslim Saudi Royal Family, the Shiite territory has been significantly affected – disrupting normal life for these people.  Any fighting and disruption into domestic territories (which are full of oil), would mean decreased supply.  Oil consumption is also expected to rise by two percent this year, increasing demand further.  Basic economics tells us that when demand outweighs supply, price goes up. And when price goes up, so does income, profit, and consequently, associated share price. After consulting a few knowledgeable friends, I’ve even been told that we could see $20 a barrel early this year, and spikes of up to $70 per barrel. This could mean barrels of money for investors and those willing to take on some risk.

When do We Buy?

Not now, not yet.  The Middle East, particularly Saudi Arabia has been pumping huge excesses of oil in what seems like an effort to bankrupt foreign competition, and it seems to be working.  Because of increased shale fracking in the United States, other nations in competition have also kept up with their own production, maintaining a level of supply well above demand.

But, on the other hand, according to a Reuters poll of analysts, crude oil inventories have only increased by 439,000 barrels worldwide this week, which is not a good sign for output on a global scale.  Just to keep up with competition and increased exportation, reserve inventories have dropped to a staggering  5.1 million barrels in the United States, signaling a domestic shortage in the future.

Although many argue against a Saudi/Iran/Middle East instability theory, some do agree and believe it is possible: “Escalation between Iran and the Saudis is a potential threat to oil prices”, Kent Moors, Director of the Energy Policy Research Group, considers Bahrain to be the “flash point” for the Saudis.

“[Bahrain] is connected to the province in which they produce the majority of their oil,” he said. “It is also the only province in Saudi Arabia that has a majority Shiite population.”

I need to make note of the fact that the conflict may not result in less supply, however, we have seen escalation of the clash in the Middle East recently, with it seeming likely that other groups, and countries may decide to declare entry.  All I am saying is that this should be watched closely.

This is also imperative – we are likely to observe oil’s value demise for some time into the future; I believe we will see a bottom of about $20 a barrel at the end of March 2016; however, this is all speculation. OPEC will get back to work soon doing what they do, hopefully – regulate production and price.

Demand vs. Supply past and future forecast (below):

 

According to Market Realist, supply is expected to exceed demand over the Q1 of 2016.  However, as you see, supply and demand are likely to intersect soon, meaning market equilibrium.  If you look at the expected change in stock prices, it looks as if stocks will continue to fall in price and then begin to rebound around or shortly following March 31, 2016.

Short-Term

Short the stocks.  Saudi Arabia is pumping huge quantities of oil with the intention of putting the competition out of business.  However, this can’t last forever. OPEC should do something soon, jump in and regulate pricing, and not all nations oppose their mission.

Saudi Arabia and Iran both know what’s at stake here, they both are world leaders and have oil-dependent economies.

“Although Saudi oil costs as little as $10 per barrel to pull out of the ground, the government needs a break-even price of $95 per barrel in order to keep funding trouble abroad while keeping peace at home. Given today’s low oil prices, Saudi Arabia is spending $10 billion a month of its savings to keep the country afloat. According to the IMF, it will take 5 years of their current levels of deficit to send the country bankrupt.” (Oil Price, IMF)

I have to mention that I recently also was informed that other major exporters do not plan to cut their production and instead, we have enjoyed an increase in production from countries such as the United States.  According to CNBC, there has been a sharp rise in world oil inventories, and the United States added 10.1 million barrels last week following the escalation in Saudi Arabia and Iran.  The week before, the U.S. had only exported 900,000 barrels of crude oil. Folks, that’s an unfathomable increase of over 1,020 percent over a one week period.

“It’s the biggest increase in gasoline supply since 1993,” said John Kilduff, founding partner at Again Capital. “Gasoline prices are going to collapse.” (Courtesy of CNBC)

If that doesn’t get the message across to investors, then I don’t know what will.  Oil has also dipped below 34.00 a barrel, a 6 percent drop since the price of last week.  U.S. Crude Futures fell a little over 5.5 percent, while RBOB futures have also dropped a little over 7 percent since the events of last Saturday night.  We haven’t seen oil prices this low since 2009.  Finally, the turmoil in Saudi Arabia has ended any speculation that OPEC members would regulate production to increase prices.

Investor’s who have taken short positions on oil related securities have enjoyed marvelous returns over a week’s period. But the question remains; when do we buy again, when are we going to see an increase in demand over supply and will we?

Mid to Long-Term 

Long position.  This scenario may not even occur; it is actually somewhat dependent on war and international relations.  Maybe I should have consulted Shivani on this; after all she did study International Affairs.  If the rift escalates, IS gets involved, militants join the fight and oil-rich areas instead become war-rich areas, supply diminishes.  And like I said, demand is expected to increase by two percent in 2016.  After and if this occurs, do not hesitate and buy the relevant securities, speculate and monitor the conflict very closely.  This can be done when it looks as if the escalation is gaining momentum, or if you see a sudden increase in oil pricing.

There are always markers which can predict the future of the conflict; for example, militants beginning to pull out, peace talks, etc.  Oil prices is not only contingent upon the Saudi’s and the conflict however, but there is so much more involved.  Stick to the fundamentals; what I mean is that if the conflict and events do not drive the market or directly effect supply at all, ignore it.

Be sure to watch other players in the market, evaluate international ties, and take note of correlations between political events and their economic impact.  Something important to watch are the sanctions which were put on Iran, a large oil producing country.  I say this because those sanctions have been detrimental to Iran’s ecomomy – it has kept Iran from entering the global economy because of concerns over nuclear weapons.  Maintaining a supply and demand curve also doesn’t sound like a bad idea.

Long-term, Saudi Arabia also cannot continue pumping 1M barrels a day while pursuing other interests; according to the IMF, it will deplete their reserves as well as bankrupt the country.  It would also be beneficial for the world to see an increase in oil prices, it is part of the reason so many countries are currently in economic crises. 

In the end, it comes down to – what are the costs and benefits to Iran and Saudi Arabia in war, and what are the costs and benefits of not going to war, and which situation’s benefits and costs outweighs the other?  Think about that.  Let’s all just watch the news, evaluate both sides, the needs and the wants of nations involved, monitor other oil-producing countries, other nations (their comments and interests), and see what happens from there. 

 

Just keep this in your mind; in investing, if a stock is going to go up, you always want to be first in.  And if a stock is going to drop, you always want to sell first.  You always want to be the first to know, in order to maximize returns.

*All investment advice is opinion. Invest at your own risk.


 

Other Related & Interesting Articles:

http://oil-price.net/en/articles/syrian-war-oil-prices-and-paris-attacks.php

http://www.cnbc.com/2016/01/04/how-will-the-saudi-iranian-conflict-affect-oil.html

http://oilprice.com/Energy/Oil-Prices/War-Between-Saudi-Arabia-And-Iran-Could-Send-Oil-Prices-To-250.html

 

 

Here at The Economic Savant, we would love to hear your comments and feedback.

 

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