I'll be on the air again this afternoon, shortly after 2 p.m. Eastern, talking to Brian Sullivan of FOX Business Network. Brian wants my views on events in the Mideast and the continuing surge in oil prices.
But I thought I would fill you in first on what I plan to tell him … and what I won't tell him about how investors should play triple-digit oil.
The Risk Factor Is Taking Center Stage
We are now looking at the prospect of significant and sustained instability in the region of the world that's home to two-thirds of the known crude oil reserves.
It has already sent shivers through the international energy sector, and the problems are likely to be getting worse.
Brent crude prices in London are closing in on $110; there is no reason to suspect they will retreat anytime soon. Meanwhile, in the U.S., the March futures contract for West Texas Intermediate (WTI) – the benchmark for New York traded futures – closes today, and the April contract is already $97 at market open this morning (it breached $98 overnight). Both Brent and WTI opened today at two-and-a-half year highs.
The futures contract curve reveals that traders do not regard this as a short-term problem.
We have an escalating and contango market – one in which each month further out has a higher price than earlier months. In addition to the uncertainty spiking prices, traders will have to unwind shorts immediately. The market holiday yesterday will make that an even more essential move today. They were betting on the crude oil price declining, and they were absolutely wrong.
If ever there were doubts that exogenous (outside of the market) forces could dictate trade, the current events will push them aside. The volatility will now kick in big-time … and that will further unnerve the trading environment.
A Protracted – and Violent – Struggle Is Underway
Tunisia and Egypt were disconcerting. But the events in Cairo may end up being the exception to the rule.
The unrest in Bahrain and Libya is far more dangerous. The unraveling of autocratic rule in the Middle East and North Africa (MENA) will not be a peaceful event.
With Libya, we have a major source – and one of the last sources – of light, sweet (low-sulfur) crude. This is most prized by refiners because it requires the least processing expense. There is one other source. Unfortunately, that happens to be Nigeria – a place not particularly known for its stability either.
Libya is descending into civil war; the foreign oil companies have stopped activities and have begun pulling out most of their personnel. As of 9 a.m. this morning, 6% of production in the country is offline… and that number is growing.
Europe is directly in the path of this interruption, since it is the end user for about 80% of all Libyan exports.
The bodies in the streets of Tripoli and Benghazi are a harbinger of what is to come. Unlike the army in Egypt, which served as a restraining influence, the army in both Tripoli and Bahrain is a weapon against the crowds and a virtual guarantee of further bloodshed. Neither Gaddafi nor the ruling family in Bahrain will be leaving voluntarily.
And that means a protracted struggle is underway.
In Bahrain, however, something perhaps far worse is on the horizon.
The Perfect Storm That Everybody Wanted to Avoid
In Bahrain, there is oil, but there is also the incendiary religious division – a Sunni minority ruling class against a majority of Shiites. Combine that with the acute economic problems experienced by average people throughout the region, and frustration is leading to rage.
Bahrain is also located, strategically speaking, in the worst place for such an uprising.
Yes, the U.S. bases its Fifth Fleet there, and that has been a primary ingredient in American Persian Gulf policy. If the fleet needs to leave, that will provide another ingredient in rising regional instability.
However, the real problem is this.
Bahrain is a 665-square-kilometer archipelago directly across the water from Iran and connected to Saudi Arabia by a causeway. Tehran has almost certainly started to provide support to a Shiite uprising; but the Saudis will do everything they can to prevent one.
This is because Bahrain connects directly to the eastern province in Saudi Arabia that contains its principal oil production. That province also has a Shiite majority. When Ayatollah Khomeini led the Shiite revolution in Iran back in 1979, the Saudis had to use the military to put down a revolution in its own province. This time around, Riyadh will not wait for that to happen.
The concern over contagion – the spread of unrest throughout the region – is certainly genuine.
That means the volatility prompted in futures oil prices will be figured into the unfolding dynamic for some time.
Now for what I will not be telling the anchor on FOX Business this afternoon …
How to Play Triple-Digit Oil
There are three overarching considerations here, and we are seeing these moves already this morning.
First, the primary hit will be taken by those oil majors with exposure to the region and the impact the region's events are having on the broader oil market.
The big boys will survive, but they will have to counterbalance developments in places like Libya with production from other areas. That will take some time.
Watch the well-focused medium and smaller-sized companies, especially North American operations. They will be the primary beneficiaries.
Second, this will generate at least a short-term impetus for the transition from crude oil to natural gas. Expect primary natural gas producers to experience a pop. The longer the crisis remains, the more the transition between these fuels will gather steam.
This should also be the case with high-grade coal holdings and alternative energy. However, there are other factors at work in both sectors. In the first instance, there's the unwinding of the global coal picture, with Australian volume slowly coming back online after severe flooding; and in the second, there's the length of time needed to move significant renewable and alternative energy capacity into those sectors where rising crude oil prices would dictate a switch.
Yes, this is another reminder that ultimately means a move away from crude as the energy source of choice. But crises demand more immediate solutions; they rarely allow for a period of R&D.
Finally, at these prices, all sources of unconventional and synthetic oil become attractive, especially if they are not in the region coming unglued.
For North America, that means Canadian oil sands and American or Canadian oil shale are back on the front burner. As the MENA sourcing for conventional crude becomes a rising issue, these alternatives already producing closer to home are a ready substitute.
It used to be a problem of price. But at triple-digit levels for crude on both sides of the Atlantic, that is no longer an issue.