I Wonder How Big the Panic in the Oil Market Will Be?

By the time you read this, oil futures will have traded post the drone attack on Saudi oil facilities that occurred on Sunday.

The Wall Street Journal reports:

Saudi Arabia raced Sunday to restore crude production knocked out by a weekend attack, but the blow at the heart of the kingdom’s oil industry threatens to boost prices and raise concerns about the security of supplies in the region. 

Analysts said they were looking ahead to the opening of futures-market trading Sunday evening to see how much oil prices would react, but that it was hard to assess without more details about the longer-term disruption to Saudi production.

Yep. Who knows how high prices will spike following this incident. You can bet there will be speculators aplenty piling in trying to make a buck from it.

But I would caution against trying to do the same by buying energy stocks on the ASX this morning. Or if you do, know that it is a punt that could unravel quickly.

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I am always wary of markets spiking based on emotional factors like concerns over energy supply. Especially when the extent of the damage, and the reasons behind it, are unclear. It just opens you up to the risk of a reversal if everything calms down in a few days or weeks.

And on the surface, the impact on the oil market doesn’t appear to be that bad. From the WSJ article again:

Saudi officials said they could return to normal levels of oil production by Monday, after an attack Saturday disabled a key processing plant and knocked out about five million barrels of production—about half of the country’s output and 5% of global supply.

Western capitals said they were ready to release emergency stocks if necessary, and Saudi officials discussed shipping their own extra inventory to meet short-term supply needs, according to people familiar with the matter.’

Having said that, we are talking about the Middle East here. This is not your ordinary supply disruption. This is potentially an act of aggression from Iran that could lead to war.

Zerohedge reports:

After the United States was quick to point the finger at Iran for the early Saturday explosions that rocked Abqaiq facility and the Khurais field — forcing production to be shut and with it 5.7 million barrels a day of oil production lost — Iran has warned it stands ready for a “full-fledged” war.

Iranian foreign ministry spokesman Abbas Mousavi slammed Washington for a “maximum pressure” strategy that has turned to “maximum lies,” saying that because of the former’s “failure [the US] is leaning toward maximum lies”. FM Javad Zarif also said these were a continuation of efforts to pressure and shame into compliance under US hegemony.

Iran and Saudi Arabia have been waging a proxy war in Yemen for years. Iran is one of the world’s largest sponsors of state terrorism. It funds these organisations while its citizens struggle day-to-day.

Under the Obama administration, Iran got a sweet deal. But the Trump administration has taken a much harder line. Whether this is the reason behind Iran’s increased belligerence, I don’t know.

But what is clear is that there will now be an increased geopolitical risk premium in the oil price. For how long is the question.

Let’s have a look at the Brent crude chart to see how the oil price looked before this incident…

Crude Oil Brent NYMEX - OILBR (WII)- 16-09-19

Source: Optuma

[Click to open in a new window]

It could all reverse very quickly

As you can see, after rallying from its late 2018 lows, the price of Brent peaked in April this year. It has been trending lower ever since. This reflects a slowing global economy where demand for energy is weak.

However, today’s trading is likely to change all that. A price spike will likely see the downward sloping green trend line broken. From there it will be a tug-of-war between the effects of slowing global growth and geopolitical risk.

Geopolitical risk is likely to win in the very short term, while slowing global growth will probably reassert itself after a month or so.

But who knows. If the drums of war get louder, all bets are off. So if you want to take a punt on energy stocks today, know that it could all reverse very quickly. But if you already own some, then hold on and see where the rally takes you.

The bigger question to ask is what this means for broader markets and economic growth.

The way I see it, this is just another added impost to global growth. Rising oil prices usually indicate a healthy global economy. But in this case, you’ve seen an oil price bear market develop since the price peaked around US$86 a barrel in Sept/Oct last year.

If prices were to jump US$5–10 a barrel based on geopolitical risks, it would effectively represent a new tax on global growth, out of the blue.

So this is a bad shock. I would expect equity prices to decline as a result (contingent upon our lunatic central bankers’ response), while gold and bond prices are likely to increase.

The prospect of a real war to accompany a trade war, at a time of already slowing global growth, should be bearish for markets in general.

For investors, this is a time to be extremely picky about what you buy. Having exposure to gold is a must. I’ve been banging on about that for a while now.



Greg Canavan,
Editor, The Rum Rebellion

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