Crude Oil Seeks Iranian Black Swan

The recent week has seen crude oil soar through $140 onwards and upwards to a new record high of $146. Much of this gain has been attributed to the growing tension in the middle east with regards a possible Israeli strike on Iranian nuclear infrastructure and the drop in US oil stockpiles.The rise has been accompanied by investors dumping stocks as highly inflationary oil prices continue to contribute towards the destruction of economic activity that pushed the major US indices into technical bear markets (20% down from Oct 07 highs).

Technical Outlook

My original target for crude oil for 2008 is $150. The rally to date has been far stronger than expected and on face value is signaling much higher prices. Despite crude oil having reached an overbought state since late May, oil prices have stubbornly refused to embark on a significant correction.

Charts Courtesy of stockcharts.com

On a short-term basis, crude oil is moving in an up channel with an current upper boundary at $147, the temptation exists for crude oil to clearly to continue snaking along the upper channel line in a very dangerously overbought state until oil prices hit $150. This is thus suggesting a continuing trend higher despite the overbought state for another $3 to $4 to try and hit the psychological $150 level. Following which the short-term chart is targeting a swift downtrend towards the support channel at $135 to unwind the short-term overbought state.

On the longer term weekly chart crude oil is critically overbought, the chart implies on a technical basis that a correction is imminent and again confirms a target of $135, which if breached would target a similarly swift move towards $110. However the technical's are at the mercy of BLACK SWAN events, primarily an attack on Iran which WOULD result in a SPIKE higher, how high ? That's something outside of technical analysis.

Another factor that could result in a crude oil spike higher against the bearish technical picture would be if the US Dollar PLUNGED to new lows.

Consequences and Probability of an Attack Against Iran

The US intelligence agencies concluded in December 07 that Iran was many years away from building nuclear weapons, possibly by 2015 at the earliest. However the problem here is the lack of confidence in the accuracy of US intelligence given a string of huge intelligence failures. A strike against Iran would not require extensive military hardware, and given the eagerness of Israel, may not involve US air forces at all. However an attack against Iran would result in retaliation that would spike crude oil much higher. The obvious immediate target for Iranian retaliation would be to try and stop oil shipments through the gulf of hormuz through which 17 million barrels per day flow or about 19% of the worlds supply.

This would result in a prolonged campaign and not something that would go away in a few weeks, therefore the risk is for crude oil not only spiking higher but remaining at elevated levels for the duration of the crisis, even in the face of economic contraction in the US and elsewhere, this would be disastrous for the distressed financial system and global economies, even the emerging powerhouses would feel the impact that would nudge up already excessive inflation rates of 10%+ many notches higher.

Even if the Iranians failed to stop most of the oil flowing through the gulf straits, a shortfall of even 2 or 3 million barrels per day would be enough to tip the precariously balanced world supply/demand into oil shortages, which would result in panic buying and hoarding thus exacerbating the situation.

Therefore this suggests an attack against Iran has to be a low probability of less than 20%, that is unless the White House is gripped by madness in its final days, hell bent on delivering a scorched earth economy to the Democrats in Novembers election.

In Summary: The technical picture is bearish, suggesting an imminent significant correction, but black swan events such as a strike on Iran or a US Dollar collapse would lead to a spike much higher with dire economic consequences.

Comments

[David White:]

We are currently seeing a cutback in usage by consumers as the price of oil (gasoline) has risen recently. Since most people expect oil prices to stay relatively high throughout the summer, analysts seem to be expecting a drop in oil prices afterwards. The summer is vacation driving time. It is hurricane season for the Gulf of Mexico. This all sounds like a plausible scenario. It may just play out this way. I have heard more than one analyst call for oil in the $130-$140 range throughout the summer. It does seem likely that we will reach the psychological $150/barrel figure though. The geopolitical speculations could easily account for that.

2008 Jul 07 09:12 AM

[David White:]

I should add that I personally have given some thought to how much I am spending on gasoline. Now I spend about $70 to fill up my tank (or 80-90% fill it). Two years ago that figure was in the $20-$30 range. I remember gas was about $1.50/gallon then. Now its $4.50+. I think a lot of people will start to look at their gasoline expenditures seriously in the near future. Since the U.S. is the greatest glutton, we can probably cut back the most easily. I am looking for data to say this is happening by the fall of this year. Oil prices may finally drop then.

2008 Jul 07 09:19 AM

[hook:]

what huge intelligence failures? please state your political affiliation nadeem so I can sort through your anti-Bush rhetoric and get at the real analysis here.

2008 Jul 07 09:24 AM

[selene:]

Uh, Hook. The official line of the Bush administration is that "huge intelligence failures" are what caused the US to go to war in Iraq even though Saddam had no WMD. One might debate the merits of this claim, but calling it "anti-Bush rhetoric" is just woefully uninformed.

2008 Jul 07 09:44 AM

[Chubbs:]

anti-Bush or pro-reality?

2008 Jul 07 10:17 AM

[cashsa4:]

An attack an Iran would not be constituted as a Black Swan event. Although highly impactful and having the trait of being able to explained after the fact, it is not highly improbable.

You don't know Black Swans are coming. This is a good example of a gray swan.

2008 Jul 07 11:56 AM

[Sophisse:]

I definitely agree that black swan thinking applies to oil pricing. With spare supply capacity at an extreme low, oil is very vulnerable to negative swans (black or grey). And unfortunately, it is very easy to imagine a variety of negative events, so easy that when you put them all together there is a material chance of at least one of them happening.

On the flip side, it is definitely possible to imagine a large positive black swan like a huge oil discovery somewhere. But the asymmetry is, the negative events can stop oil flowing overnight, whereas the positive ones start oil flowing after 3-6 years.

2008 Jul 07 12:14 PM

[Urbane Gori...:]

China became a net importer of oil in 2007 and they increase the number of vehicles on their roads by 25% a year. This doesn't even take into account other industrializing or emerging markets... That would be my take on why oil prices are where they are today and clearly where they are heading in the future. It's unlikely that our minor reductions in usage will impact future oil consumption. (as an aside, I don't fault any other country for their consumption.. It is what it is... )

The handwriting is on the wall ... **We** need to do something about this problem...And I don't mean the fact that gas is over $4 a gallon. I bothers me to see CNBC run documentaries on "America's Gas Problem". In fact we aren't suffering much yet and in no way are we approaching the $9 to $10 a gallon price that Europe is dealing with. Sure makes us seem like a bunch of whiners, doesn't it! Particularly when we still consume more oil than any other country in the world.

An interesting note is our local drop in gas prices just before the 4th. We went from $4.67 a gallon here in the California foothills, to $4.57 and the next town over was selling at $4.41. Odd as it seems to be the pattern to run up prices over the 4th and drop after. I noticed that prices seem to be up again today.

Thx jegan ;-)

2008 Jul 07 01:31 PM

[E.D.Hart:]

Black swan events are highly improbable events, but it is not impossible to take them into account--it is just against human nature to consider them. In other words, you can take into consideration in your investment process the need to expect the unexpected--though you may not know the cause.



Hurricanes, war, nuclear strike, terrorist hit on major shipping lane or pipeline...who knows where the next spike is going to come from?


The fact is, global oil supply constrints are near critical levels, and spare capacity is very tight, much less than weve been told by the Suadis.

Dollar depreciation explains about 20% of the oil price rise, but the other 80% is related to a new scarcity psychology taking root: end users are getting nervous that they wont be able to get crude when they need it. This is primarily due to very limited spare capacity.

The oil market is ripe for a spike above todays levels...but then again, no one knows.

I can't predict the specific cause...but I agree with Sophisse above that there is a corresponding asymmetrical positive black swan that might mitigate global oil constraints to spare capacity...however the time delay of oil to market makes this less impactful.

Demenad destruction is occurring in the US with higher prices, yet in no way is this a way to lower prices over the mid to long term. The reason is that gasoline doesn't trade in a free market, if one takes into account the numerous markets around the world with gasoline subsidies.

Chinese subsidies resulted in gas shortages in China because the refineries were not willing to supply all the gas the market needed at a loss to their bottom line. (even after government paybacks).

The counterintuitive result is that as subsidies in China and other countries are gradually rolled back, gasoline consumption will likely increase, not decrease.

Summary: Higher prices in subsidized markets= higher consumption due to much wider availability of the product. This is not included in most economic models.

Moreover, the revaluation of currencies around the world that are linked to the dollar will result in much higher buying power, and will mitigate against the higher prices of fuel. Some authors say that the yuan is primed to appreciate 1 to 2 times against the dollar.

The Chinese and others will see much slower rises in fuel costs if and when they revalue their currencies. Demand destruction in emerging economies is apt to be a very minor occurrence in the medium to long term. We may see some over the near term.

In summary, higher oil prices are hear to stay. Much of the cause is from the new appreciation of severely limited spare capacity which introduces a fear factor that was heretofore not present in the main.

The second, lesser cause, is dollar depreciation and corresponding yuan (and other currencies) appreciation coupled with emerging economic growth.

Finally, as there is not a free market in gasoline in much of the world, atypical consequences result from higher prices in subsidized gas markets, resulting in greater gasoline use, and greater demand for crude.

P.S.--Huge intelligence failures are well documented, and widely known. Both parties, and many military, and intelligence leaders have written well documented books on the Iraq intelligence fiasco. There has not been a greater intelligence failure in my lifetime, and several generals have said this.

2008 Jul 07 04:01 PM

[xander:]

no wmd plans by saddam? really - well how come we just removed 550 tons of yellowcake from irag?

2008 Jul 08 02:08 AM

[john s. gordon:]

need more pipelines from east arabia over to the red sea or around the hormuz strait overland.
> jack

2008 Jul 08 11:14 AM

[OKMONEY:]

Tell us all about this yellowcake removed from Iraq, Xander. Sure you're not talking about the birdshot still emerging from Harry Worthington's face after his brush with sharpshooter Cheney.

2008 Jul 08 11:26 AM

[David Lentz:]

xander, check out:
crooksandliars.com/200.../

It was not weapons grade uranium.

While doubtless Saddam had dreams of developing the infrastructure to make it weapons grade, it would have taken decades for him to achieve that, and even longer to turn the dreamed-of weapons grade uranium into a bomb.

There was no threat, and it was not a secret, it was registered and tracked by the UN and every intelligence agency under the sun.

Repeat -- NOT A THREAT.

Bush remains a clueless idiot.

2008 Jul 08 01:09 PM

[CaptBob:]

To Us it's the price of pump gas, to Israel it's survival!!
I can remember the bay of pigs and the Cuba missile crisis, It's funny how much more we try when it's our A$$ on the line. This is not lost on Israel I'm sure.
The rest of it may rate a Dirty Duck, or you haven't seen the Iranian Navy in action--their pucker factor isn't up to closing the straights with a Carrier force looking at them.
The Mullahs are giving the orders there, and Martyrdom & Virgins are for the peons, when the going gets tough they go to Paris.
As long as we don't use ground forces, just use Bosnia tactics, a month with no electric, roads,water or food, living off the land and the Mullahs will get tossed out for trial just like Mileshnikoff (Sp)?

2008 Jul 08 04:23 PM

[Secure Ener...:]

Of course, the UN and IAEA have been telling for years that Iran and North Korea don't have nuclear weapons either, but then, oops, they do.

Of course, we can count on the North Koreans not to sell uranium to terrorist states, right?

Let's not re-write history guys. We all know there were no WMD in Iraq. But we also know that Iraq had the ability to produce chemical weapons in a matter of months. We also know that Saddam trained and sheltered any number of terrorists, and contrary to the revisionism the Left keeps feeding us, Iraq had high-level contacts with international terrorists including Al Qaeda. Or did the bipartisan 9/11 commission fabricate that as well?

So go ahead and run in circles for a few more years telling us Iran won't make a nuclear weapon. Just be sure you apologize and every Iran-appeasing liberal resigns from government when Iran does test (or use) a nuclear weapon.

2008 Jul 08 09:02 PM

[Secure Ener...:]

Of course, the UN and IAEA have been telling for years that Iran and North Korea don't have nuclear weapons either, but then, oops, they do.

Of course, we can count on the North Koreans not to sell uranium to terrorist states, right?

Let's not re-write history guys. We all know there were no WMD in Iraq. But we also know that Iraq had the ability to produce chemical weapons in a matter of months. We also know that Saddam trained and sheltered any number of terrorists, and contrary to the revisionism the Left keeps feeding us, Iraq had high-level contacts with international terrorists including Al Qaeda. Or did the bipartisan 9/11 commission fabricate that as well?

So go ahead and run in circles for a few more years telling us Iran won't make a nuclear weapon. Just be sure you apologize and every Iran-appeasing liberal resigns from government when Iran does test (or use) a nuclear weapon.

2008 Jul 08 09:02 PM

[alpha24seven:]

Here's what you do. Open Google Earth and go to the Straight of Hormuz. Look at that landscape and envision the targetability of the US weapon systems.

There is NO way the Iranians can even put a modicum of a decent fight. I'm sorry but game over within 24 hours.

Of course the CL contract will skyrocket but the reality is the Iranians cannot block the straight of Hormuz. No way.

2008 Jul 09 08:38 PM

[Old Trader:]

Hmmm...regarding the ability of Iran to block the Straits of Hormuz. Its my understanding that there are a number of tankers full of Iranian oil, acting as temporary storage facilities (something on the order of 19, the last I read).

I've no doubt our Navy could/would make short work of any Iranian naval attempt to block the Straits....but a couple of tankers...setting sail with a skeleton crew of the "faithful", explosive charges strategically placed....doesn't sound like blocking the Straits is all that hard....imho.

jan

2008 Jul 09 11:47 PM