I’ve finally had enough time to catch up on the latest disasters in the Middle East. Let me hit on some topics to give some perspective that I hope makes sense. In no particular order:No-Fly Zones:
In a perfect world, stopping all military flights in Libya would be a nice humanitarian thing to do. In reality, a feasible no-fly zone requires the elimination of ground anti-aircraft defenses. After the first Gulf war, a no-fly zone was easy. We'd already bombed enough out of Iraq. There was no anti-aircraft defense left. Starting a no-fly zone in Libya without elimination of defenses would probably result in everybody shooting at US planes. Bombing Libya first is not going to happen. Forget the no-fly zone.Bahrain:
Bahrain is this little island sitting off the coast of Saudi Arabia. After how much oil Bahrain controls, the next most important question is the Sunni/Shiite ratio. The answer: not enough oil to matter, but the Sunni/Shiite ratio is critical. Bahrain is the last remaining country with a population that is a majority of Shiite, but ruled by Sunnis. To make matters worse, Iran (majority Shiite) had Bahrain as a province until 1783. They would like it back.
Saudi Arabia built a 16-mile “Friendship” causeway to Bahrain so that their “Friendship” tanks and troops can be there in 30 minutes or less. There is no way Saudi Arabia will let an Iranian-controlled island happen just off their coast, and there is no way the US would try to stop a Saudi takeover. Take Bahrain off your radar screen.Libya:
One of these days, Moammar Gadhafi is either going to take a bullet or bolt the country. Either way, the price of oil will spike down. From what I can tell, Libya really isn’t a country. It’s just a hunk of land occupied by a bunch of tribes that hate each other going back thousands of years. With possible oil revenue of $150 million a day, a new central government is going to form? Peacefully? There’s no way. Civil war is the only likely outcome, and realistically that is probably what we are seeing on a day-to-day basis now. It’s all about the oil. The chances of oil shipments resuming to “normal” output is years away. Here's a good background
on the realities of Libya. Oil:
With all this “bullish” oil news it should be obvious that being long oil is the simple way to sleep at night. Futures traders sure believe that. Look at the number of speculators
long the April crude oil contract. In my opinion, if it’s that obvious, it’s obviously wrong. Here’s the reason why. In addition to a Gadhafi event, an ETF, United States Oil
(USO), is now the 800-pound gorilla in the room. USO is supposed to track the daily price of crude oil. At first glance, that seems relatively harmless, but the reality is that USO, as of March 4, had about 19,000 oil future contracts that expire in late March. USO has to sell all 19,000 contracts. The USO portfolio managers will start this week.
Unlike stock futures and other casino-like futures, crude oil futures trade as a real commodity, meaning that you can take physical delivery of the actual commodity. The place that physical delivery of a West Texas Intermediate futures contact takes place is Cushing, Oklahoma. It has to happen somewhere, and this place is a lot easier than downtown Chicago or New York. Cushing was selected because it was at the intersection of several crude oil pipelines. To fully understand the importance of Cushing, let’s assume that the futures price of oil was higher than the current price. A smart buyer could buy oil at this month’s price, sell a futures contract to lock in next month's higher price, and store the oil for month. The only problem was where to store it for a month. Surprise, surprise, the market sensed a need, and huge storage tanks were built in Cushing. Go to Google maps and check out Cushing.
So much for the Cushing background. The reality of this USO rollover to the next futures contract is that there is almost no additional storage capacity left at Cushing. Therefore, the normal arbitrage buyers of USO‘s forced contract sales have no place to put the oil. Conventional arbitrage doesn’t look like it will perform normally on this USO rollover. Dian Chu discusses this rollover
in greater detail.
My thinking is that a downside surprise is more likely than upside in the next couple of weeks. I’m keeping buying power available for my favorite domestic oil play, Continental Resources
(CLR), in case the downside surprise does develop.
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