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Energy Insights: Energy News: When the dust settles, oil prices decline

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When the dust settles, oil prices decline


Desert Storm

©AP  A US Army manual states that “dust and sand in the air may be the single most destructive environmental element to military equipment” (Hoock, 1984).

By John Dizard

Dust and Sand Forecasting in Iraq and Adjoining Countries, MSgt Walter Wilkerson, Air Weather Service, November 1991

Let us say you were interested in determining the optimum time of year for a country to be conducting major air operations in some country that adjoins Iraq. You’d be consulting reference sources such as MSgt Wilkerson’s work, wouldn’t you? It turns out that there is a certain seasonality to dust storm frequency and severity, and that if you are making a decision on this sort of activity some time around the end of January, sooner is better than later if you want to reduce the risk of engine damage.

I know, it all seems a little obscure, even by my standards. Unless, perhaps, you are exposed in some way to the price of oil. Then, maybe not so obscure. And what pile of money is not, in some way, exposed to the price of oil?

Perhaps you should relax, though. The Israeli Knesset (parliament) elections are almost two weeks off, so you have time to think about whether those flatlined volatility prices are really the best measure of how macro risks to the portfolio will play out over the course of the year. After the elections are over, it may in turn take some days to get all the cabinet positions allocated. Then you can start to worry.
I’ve also been following the stock price of Alliant Techsystems, normally a boring activity, except that the stock price has been on a tear since August, up about 30 per cent. ATK is the major supplier of munitions to the US Defense Department and other approved customers. Before you ask, no, you can’t buy its products for your own use.

Put all this together, and I think that the volatility of most traded securities and commodities is underpriced, and the price of oil is ... overpriced. This may seem counterintuitive, but while an Israeli strike on Iran’s nuclear facilities would undoubtedly lead to an immediate spike in the price of oil, it seems most likely that the price increase would be temporary.

Thanks in part to international sanctions, as well as to the Iranian government’s mismanagement of its economy, the ability of the country to sustain a prolonged war or cut-off of critical imports and oil exports is limited.

Furthermore, even the most hawkish Israelis (or anti-Shia Sunnis) don’t seek to entirely destroy the Iranian economy, or its ability to produce oil. They just want to destroy, or very severely damage, its nuclear facilities. If an angered Iranian government and people want to retaliate on a large scale, the Israelis might point to the essential, and vulnerable, refining facilities in Abadan and comment that those will not have been destroyed – yet. The Iranian economy and society would not function without that fuel.

So after the dust (the forms of which were ably described by MSgt Wilkerson) settles, the world will have an open Strait of Hormuz, an Iran that will probably have regained access to the world’s oil markets, and a lot of oil in the hands of cash-strapped governments, along with speculators and hedgers with interest and storage charges to pay. They’ve been holding on to abnormally high inventories for years, and may be open to selling some of what they have. On the initial news of any strike, the oil price will have jumped up to some huge premium, but then, as the saying goes in the business, the cure for high prices is high prices.

This wouldn’t mean that there will be a crash back to the 1940s or 1950s in the per-barrel price, but would a decline over several months to, say, $70 be an impossibility? I don’t think so. That’s an economic price for a lot of projects, even though you’d have some unhappy oligarchs and London property agents. And, of course, Israel would not be popular in the Muslim world. But then it’s not that popular now, is it?

I’m not sure any US government denunciations of the irresponsible and premature actions of Israel would be an adequate defence against accusations of hypocrisy.

The problem with actions such as a strike on Iranian nuclear facilities is that it’s not possible to foresee the long-term consequences.

There would be significant civilian casualties, much bitterness, some immediate, though limited, retaliatory measures against Israel, international sanctions, and possibly an indefinite extension of the political life of the Iranian regime. For those reasons, many thoughtful and well-informed Israelis are opposed to a strike. That group may not comprise a majority in the next cabinet.

What we’re considering here, though, is the effect of a strike on oil prices in the following months, and I believe that there’s a more compelling case for a decline after an initial spike rather than a semi-permanent move far above $100 per barrel.

Any portfolio manager should keep that in mind when looking at any dramatic televised images and fast-blinking price screens. This event, or series of events, isn’t a certainty, but it’s a lot more probable than the volatility series are forecasting.

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