Crude oil prices have seen an upward movement due to the increased tension in the Middle East, with Israel threatening to bomb Iran to delay its acquisition of nuclear weapons, and a reduction in the crude oil inventory in the U.S.
Also, the economic data from China is alarming, as a slowdown in the economy is set to have an adverse impact on crude oil prices.
The Middle East produces about one-third of the total oil production in the world; Saudi Arabia is the largest producer of crude oil, followed by Iran. The production of crude oil, which is a major portion of the gross domestic product of Iran, has been adversely affected by the economic sanctions imposed by the U.S. and the E.U. in June. The purpose of the economic sanctions was to discourage Iran from its pursuit of nuclear weapons. Post the economic sanctions, the production of crude oil from Iran has dropped from 3.4 million barrels per day to around 2.4 million barrels per day. To counter the supply disruption, Saudi Arabia increased its output of crude oil to meet any shortfalls being created by the imposition of sanctions on Iran.
However, the economic sanctions have failed to have the desired effect, as Iran has continued with its nuclear program, insisting that it is for civil use only.
Israel Strike on Iran's Nuclear Plants being Considered
Israel has declared that it is currently considering a strike on Iran's nuclear facilities to delay the country from acquiring nuclear weapons, if not eliminate its chances all together. Such a strike would have severe repercussions on peace in the Middle East, and would hamper the supply of crude from one of the most important crude oil production regions in the world; and prices will increase drastically.
Inventory of Crude Oil
The inventory of crude oil (without SPR) in the U.S. slipped by 3.7 million barrels to reach 366 million barrels on August 10, 2012, as per yesterday's announcement by the Energy Information Agency (EIA). The crude oil inventory reached levels last achieved in April 2012.
Economic Slowdown in China
The recent economic slowdown in China is a cause for concern, as the downturn in the second-largest economy in the world would exert negative pressure on crude oil prices. China did not continue with its stimulus plan by not reducing the reserve requirement ratios of banks from 20%. The investment, industrial production and loan growth has slowed down, which added to the expectations of a cut in the reserve ratio. China has reduced its discount rate twice since June 2012 in order to stimulate growth.
Debt Crisis in E.U.
Another factor contributing to the low crude oil prices is the debt crisis engulfing the E.U., and any solution will have a positive impact on crude oil prices.
Outlook for Crude Oil
Given the factors mentioned above, we have a bullish view on crude oil prices given that the crude oil inventory levels continue to follow a downward path, a possible economic recovery in China, and a resolution of the European debt crisis.
A persistence of tensions in the Middle East, which would be fueled further by an Israeli air strike on Iran's nuclear facilities, would disrupt crude oil supplies, hence increasing crude oil prices.
Beneficiaries of an Increase in Crude Oil Prices
The beneficiaries of an increase in crude oil prices include:
- Integrated companies like Exxon Mobil Corp (XOM), Chevron Corp (CVX) and Total SA (TOT).
- Independent exploration and production (E&P) companies like ConocoPhillips (COP), Apache Corp (APA), through higher realizations.
- Refineries like HollyFrontier Corp (HFC), Tesoro Corp (TSO) and Phillips 66 (PSX), through higher gross refinery margins.
- Midstream companies like Kinder Morgan Partners LP (KMP) and Targa Resources Partners LP (NGLS), through higher revenue for transporting petroleum products and crude oil.
Exxon Mobil Corp : We have a bullish stance on XOM, due to its strong business model, its global presence, and its dividend yield of 2.6%. For a detailed analysis view our reports "Buy Exxon Mobil: High Dividend Yield And Cheap Valuations" and "Exxon To Benefit From Strong Financial Position, Economic Recovery."
Chevron Corp : We have a bullish stance on CVX due to its strong business model, its valuations and its high-dividend yield of 3.2%. For a detailed analysis view our report "Hedge Chevron By Selling Oil ETF."
Total SA : We are bullish on TOT due to its dividend yield of 4.8%, one of the highest amongst its peers. For a detailed analysis, view our report "Buy Total: Highest Dividend Yield Among Peers, Cheap Valuations."
ConocoPhillips : We have a bullish stance on COP due to its strong market presence, its business model and its dividend yield of 4.6%. For a detailed analysis, view our report "Buy ConocoPhillips: A Dividend Gem In The E&P Industry."
HollyFrontier Corpc : We have a bullish stance on HFC due to its high gross refinery margins and better refinery locations. For a detailed analysis, view our report "Increased Domestic Oil Supply Favors HollyFrontier Corp."