Oil shell shocked on Korean news

North Korea's shelling of a South Korean Island is raising fears of a global catastrophe and the impact on oil might be dramatic. Overnight, in what is being called the most aggressive attack since the Korean War Cease fire back in 1953, North Korea's shelling of South Korea is shaking up global commodity markets. Oil prices are falling with traders seeking safe haven in the US dollar as they wait and try to figure out just what the heck is behind North Korea's aggressive action. North Korea, without provocation, decided to shell a South Korean Island as reported by the New York Times. "North and South Korea exchanged artillery fire on Tuesday after dozens of shells fired from the North struck a South Korean Island near the countries' disputed maritime border. Two South Korean soldiers were killed, 15 were wounded and three civilians were injured", said Kiyheon Kwon, an official at the Defense Ministry.

Reuters News reported, "South Korea has warned North Korea it would ‘sternly retaliate’ to any further provocations.” There may be a lot of reasons for North Korea's action. Perhaps it is because their secret nuclear weapons facility was exposed. That led to reports that South Korea's defense minister saying that South Korea again might hoist US nuclear weapons. The other reason may be a power struggle. Reuters reports that the attack "follows moves by iron leader Kim Jong-il to make his youngest son heir apparent to the family dynasty. Experts say that for decades the Korean leadership has played a carefully calibrated game of provocations to win concessions from the international community and impress his own military." The risk is that the leadership transition has upset this balance and that events spin out of control.

If tensions heat up it can be a negative for oil demand as uncertainty in the region may slow economic activity. Major oil consumers like China and Japan might be impacted as economic activity might be slowed by uncertainty. At the same time, the flight to quality play would boost the dollar putting further downside pressure on price. Of course if this breaks out into a fully fledged war that in turn would be bullish for oil as demand from military would soar as well as insurance rates for tankers. Oil would also add a war risk premium that may add $5 to $10 a barrel to the price.

China is showing there is more than one way to cool inflation other than raising the reserve requirements for banks. They are trying to control inflation be releasing grain reserves. Grain prices and by default oil prices, fell on reports like one from Bloomberg that showed China's central and local governments have coordinated efforts to control inflation by increasing grain supply and drawing down government reserves. While that seemed successful in damping demand and export expectations in the short run, it might not actually slow demand. In fact the Chinese seem to get hungrier every year and may just take that extra food and eat it!

Corn and ethanol prices also got hit hard on news that the EPA would delay testing E15 on cars that were built between 2001 and 2006. E15 is gasoline that contains 15% ethanol and has been pushed by groups like "Growth Energy" championed by losing presidential candidate General Wesley Clark. The Energy Department said that the test were incomplete but also raise speculation that perhaps the cars just did not perform well with the higher concentrations of ethanol. If that is true, then the Chinese may gain even more weight with more grain to consume.

Another losing presidential candidate and former Vice President Al Gore as reported by Reuters said support for corn-based ethanol in the United States was "not a good policy" weeks before tax credits are up for renewal. In fact Gore alluded to the fact that his support for ethanol really was because it served his best interests. Mr. Gore said "One of the reasons I made that mistake is that I paid particular attention to the farmers in my home state of Tennessee, and I had a certain fondness for the farmers in the state of Iowa because I was about to run for president." I wonder if he is making that same mistake on climate change as his stance is lining his pockets with cold hard cash.

Phil Flynn is senior energy analyst for PFGBest Research and a Fox Business Network contributor. He can be reached at (800) 935-6487 or at pflynn@pfgbest.com.

About the Author
Phil Flynn

Senior energy analyst at The PRICE Futures Group and a Fox Business Network contributor. He is one of the world's leading market analysts, providing individual investors, professional traders, and institutions with up-to-the-minute investment and risk management insight into global petroleum, gasoline, and energy markets. His precise and timely forecasts have come to be in great demand by industry and media worldwide and his impressive career goes back almost three decades, gaining attention with his market calls and energetic personality as writer of The Energy Report. You can contact Phil by phone at (888) 264-5665 or by email at pflynn@pricegroup.com. Learn even more on our website at www.pricegroup.com.


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