Oil gains as violence continues in Middle East

If today was the day you were finally going to win, did you show up?

Daniel Waldschmidt

Unrest in the Middle East, a view that Yemen may slip into civil war, ongoing operations in Libya, a view that the fighting will last for an extended period of time in Libya, rising consumption in China and a smaller than originally expected decline in Japanese oil consumption has all contributed to pushing oil prices back to levels not seen for a few weeks. Now that the spot WTI contract is back over the $103/bbl market the next technical stopping point is around the $110/bbl level. That said the oil market is not a technically driven market rather it is being driven by the geopolitics of the North Africa & greater Middle East region and will continue to drive prices until both the commercial and non-commercial sectors are convinced that there will not be a supply disruption of significance down the road.

I say down the road because even with Libyan production mostly shut-in there is still not a shortage of oil anyplace in the world due to supply issues (Japan is the exception due to shut-down of refining capacity from the earthquake). The market is well bid as participants from all ends of the infrastructure view the drive to democracy eventually working its way to Saudi Arabia which could then result in a very significant impact on the flow of oil from the region. That is why prices are where they are today and that is why prices are likely to move higher if the tensions in the region continue to grow resulting in an increase in the fear side of the oil equation. Oil prices are driven by two main factors…supply & demand (over various timeframes) and fear. Today it is fear that is the main driver and it is attracting buyers into the complex. Things like the huge decline in gasoline inventories (see below for more detail) reported by the API in tier report on Tuesday evening only contribute further to the fear factor as we get closer to the summer driving season.

So where do oil prices go from here? Over the medium-term I would expect to see higher oil prices as a result of either a significant supply disruption (lower probability) and/or just an increase in demand as the global economy continues on its road to recovery. Supply and demand balances are slowly returning to pre-recession levels as demand continues to outstrip current supply flows. Although total stocks are still above normal, the overhang is now only marginal compared to where it was about a year or so ago. So even without a significant supply disruption I would expect prices to gradually rise over the next three to six months. If the unrest spreads to the larger oil producers in the Gulf, than all bets are off as oil prices will surge irrespective of what the current supply & demand balance looks like. If stability emerges quickly in Libya, Yemen and Bahrain, then I would expect oil prices to retrace strongly in the short-term with WTI likely falling back below the $100/bbl mark for a period of time. IF it does I would strongly suggest that it would be a buying opportunity as we now seem to be in the mode of buying the dips rather than selling the rallies.

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