Black Swan Events In 2012 Could Push Oil To $200

Includes: DBO, OIL, OLO, USL, USO
by: Hard Assets Investor

by Amine Bouchentouf

Oil prices throughout 2011 experienced volatility, while maintaining an upward trend. In 2012, oil prices will remain in that uptrend, but with even more volatility.

Tight Supply

The International Energy Agency estimates oil demand at 89.5 million barrels per day for 2012; oil supply is estimated at 88.3 million barrels per day. This tight situation means that any disruption will send prices much higher very quickly.

In 2011, we saw Brent prices increase dramatically during the political upheaval in the Middle East, especially when Libya went offline. If there are other such disruptions, this can render an already tight market even tighter — and send prices to new records.

In 2012, I’m going to be keeping a very close watch on any events that could cause supply-side disruptions, such as political upheavals and military conflicts.

Emerging Market Demand

One of the biggest shifts in the global oil markets over the last decade has been the increasing importance of emerging markets in the oil markets. Throughout much of the post-World War II period, demand was driven mainly by the United States and Europe. However, beginning in 2000, most of the demand growth in oil has been driven by emerging-market demand, primarily in Asia.

A case in point is demand for oil products and derivatives, such as gasoline and jet fuel, which has grown dramatically in the last five years. Oil product demand has more than doubled over the last five years, from 3 million barrels a day to more than 7 million barrels a day.

More than 50 percent of that demand growth came from emerging markets. Expect this trend to continue.

OPEC And Oil

Many market observers tend to forget how important a role OPEC plays in the global markets. In addition to being the global organization that has the most oil reserves in the world (more than 50 percent), OPEC is also important because it accounts for almost 40 percent of daily global oil production.

When Libya, an OPEC member, went offline due to political turmoil last spring, OPEC countries stepped up to the plate and increased supply in order to make up for the reduced output. This action helped calm markets and prevented prices from spiraling out of control. OPEC has a close handle on the oil price lever and it isn’t afraid to deploy it in order to serve the interests of its members.

OPEC is currently incentivized to keep oil prices in the triple-digit range, and the oil cartel has stated so publicly. OPEC has a number of tools at its disposal to maintain prices in this range, such as output quotas, which it will deploy at the right time.

Black Swan Events

There are certain black swan events that could cause prices to go through the roof. One is if there’s some sort of military altercation with Iran. Most of the world’s oil crosses the strategically located Strait of Hormuz in the Arabian Gulf. In case of a standoff between the United States and its allies and Iran and its allies, there’s a large risk that some of the oil transitioning through the Arabian Gulf will be trapped.

In this scenario, oil prices would experience the same effect as during the Arab oil embargo of the 1970s. Prices could skyrocket to $200/bbl or more with gas lines similar to those seen in America 40 years ago. A military confrontation with Iran that spills into the Arabian Gulf could send prices spiraling out of control.

Another scenario to keep an eye on is the euro-debt crisis. If the crisis isn’t resolved and the eurozone implodes economically, it could have an unpredictable impact on prices.

On the one hand, reduced economic growth should be bearish for prices; on the other hand, oil is a highly inelastic commodity and will be one of the last consumables to be reduced. Even in a case of a slowdown, it is not certain that oil prices will be reduced significantly. What is certain is that this will create more price volatility globally.

Next year is shaping up to be pivotal both in the global commodities markets and in the financial markets. We’re in the process of seeing a major shift in the global economic center of gravity, away from traditional oil-consuming countries like America and eurozone members toward Asia and emerging markets. This is manifesting itself in a number of forms, including in the oil markets.

Currently the majority of oil produced in Middle Eastern OPEC countries isn’t destined for Europe, but for Asia. This will continue.

Expect oil in 2012 to trend higher, but with plenty of volatility along the way; in the meantime, keep an eye out for black swan events that could send prices to uncharted levels.

Disclosure: The Author doesn’t have any positions in the stocks mentioned.