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Unsettled Mid-East demonstrations took their toll on the equity markets yesterday. Regime changes in Tunisia and Egypt are unsettling, a threat to the instability of the area, but not nearly as important as an unstable Libya. There Muammar Gadhafi's forty plus year grip on this country is being challenged.

As a producer and exporter of 1.7 million barrels/day of oil destined primarily to Europe, markets are unnerved with just cause. Sparsely populated Libya, population about 6.5M, is estimated to have the largest oil and natural gas reserves of any African country. Most of the oil is located deep in the sandy interior, which borders on the Sahara desert, and is transported to Tripoli and other ports by pipeline.

To remain in power, Gadhafi has resorted to use of military forces against the civilian rioters, in an effort to quell the uprising. Opposition to Gadhafi's rule seems to have originated in Benghazi, the second largest city and has worked west to Tripoli. Adding to the complexity, there are tribal rivalries between Gadhafi and the one-million-man-strong Warfalla tribe, who have recently been joined by the half-million-strong Saharan Touaregs.

Most of those working in the oil fields in Libya are foreign technical experts needed to keep the oil flowing. The threat of civil war in Libya is real. Some tribes, in an attempt to sabotage Gadhafi's rule, have threatened to disrupt the oil production. These threats have resulted in a steady exodus of foreign workers, a situation that is bound to reduce the oil flow, even without sabotage in the oil fields. Already production is slowing, as the technocrats exit from harm's way and go home.

Libya crude is a desirable light low sulfur crude that is easy to refine. Italy, France, Germany and Spain are all big consumers of this crude, and will be quick to feel the shortage. There is now a report that Libya is declaring force majeure on oil shipments, so unsettled conditions will continue. Eventually, look for the Saudis to increase production unilaterally should OPEC fail to increase quotas, but the markets are first going to suffer.

So far this week the euro has had about a 190 pip range. Monday we failed on the top side backing off from a high of 1.3713, and yesterday morning sold off to 1.3525 prior to bouncing back to 1.3650. Part of the euro rally may have been caused by a banker saying interest rates in the Euro Zone would likely increase. Of course, raising rates after a $10/20 increase in the oil price sounds like a great idea, one that could only come from a central banker.

There is probably no quick fix for the chaos in Libya, and its effect on markets, and there is a chance this unrest will spread. So how will this affect the money flow?

In currencies there has been a timid movement to the yen and the SF, perceived to be safe havens, but the big money in currencies is long the A$, C$, pound and the euro, and short the USD. Should some of the money be taken out of the market we think this might help the very unpopular USD. Let's try to sell the EUR/USD if there is a minor rally back to the 1.37 area risking 100 points, with a target down in the 1.34 area. Click to enlarge:




Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Source: Mid-East Turmoil Weighs on Forex Markets