Still Bullish on Oil

By Steve Belmont
Friday, May 19th, 2006

[Editor's Note: I wanted to share with you today an editorial by my good friend Steve Belmont. Steve is the Senior Market Strategist for the Rutsen Meier Belmont Group LLC in Chicago. His insights into the oil market are bar none. I hope you enjoy today's Energy and Capital -- Mike Schaefer]

We are pretty sure you've heard most of the bullish arguments for crude oil by now. We know we have. And yes, our contrarian instincts make us want to short this market in the worst sort of way.

High prices have made new sources of energy profitable. These new sources will eventually start cutting into demand with enough oomph to cause the price of crude oil to fall.

Saudi oil minister Ali al-Naimi predicted as much four days ago. This is, after all, the way markets work. Nevertheless, we doubt that this is going to happen tomorrow or the next day.

New technologies take time to develop. Lots of things could go wrong in the interim. Consequently, we cannot ignore the continued compelling evidence for higher prices.


China is home to 1.2 billion people. India is home to another billion. Both these economies are growing fast - China at just below 10% and India at slightly below 7.

Global production capacity is roughly 85 million barrels per day, when hitting on all cylinders. Just last week the Paris-based International Energy Agency (IEA) reduced its estimate of global demand by 15%.

Even with this substantial reduction, the IEA estimated total global demand at 84.8 million barrels per day. High prices may have reduced demand, but even so, supply can barely keep pace. There is still very little room for supply disruptions bought about by weather, geopolitics, equipment failure or any combination thereof.

The five largest suppliers of crude oil to the US are Canada, Mexico, Venezuela, Saudi Arabia and Nigeria. Four are in an area of the world author and analyst Rick Maybury calls "Chaostan" -- which translates as "the land of Chaos."

Rick believes incompetent US meddling in Chaostan has ignited World War III and that we are still in the war's early stages. Sound farfetched? So did $70 crude oil a year ago. Considering the US War in Iraq has lasted nearly as long as the US involvement in World War II, Mr. Maybury may be proven right. If so, $200 crude oil is not out of the question.

Indeed, one could make the argument that everything needs to run perfectly in order for crude not to climb over $100 per barrel. That means no storms, political or otherwise, from now until the end of the year.

Hurricane season doesn't officially begin until next month, but crude oil has already exceeded last year's Katrina high by $5.00 per barrel. One can imagine what would happen to prices should another big storm hit or even threaten the Gulf Coast.

Things are far from perfect on the geopolitical side as well. Iran is becoming more belligerent and closer to a nuclear weapon by the day. So far the overwhelming consensus is the US - entangled in an unpopular war in Iraq - will not result to military means to stop Iran from getting the Bomb. However, this consensus ignores the Bush Administration's sense of divine mission.

The neoconservatives went to war because they wanted to democratize the world. Now that they have created an even bigger mess, who is to say they won't "double down" on Iran in an attempt to salvage their Iraq mistake?

With the president's ratings about as low as they can go and Republicans in danger of losing Congress, George Bush has a lot less to lose politically by attacking Iran. The fear card worked wonders in the last election, why not now? We admit this is a long shot, but it absolutely could happen.

Let's say the US doesn't attack Iran. That doesn't mean Israel -- the one nation directly threatened by a nuclear Iran -- won't. How would Iran respond to such an attack? No one knows, but you can bet it will not be pretty. Iran has purchased a number of Chinese-made "silkworm" missiles which can skim nearly undetected over the water, striking unsuspecting ships right at the waterline.

Iran is also located on the Strait of Homuz which puts Iran in a perfect position to block it, potentially stranding 20 million barrels per day or ¼ of the world's oil demand. All it would take is a few strategically sunken tankers and oil prices would skyrocket.

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Last year, a group of former high-ranking US officials -- including former members of the CIA and the military --sat down and ran a simulated "war game." They created a hypothetical scenario in which three relatively minor supply disruptions unfolded at the same time.

These events were: 1) Ethnic unrest and attacks on oil facilities in Nigeria, 2) successful attacks by Al Qaeda on the Valdez oil terminal in Alaska and natural gas facilities in Saudi Arabia, and 3) an exodus of foreign oil workers from Saudi Arabia due to Al Qaeda attacks on foreigners. These three hypothetical factors caused the price of crude oil to spike to $150 per barrel overnight.

Two of these "hypothetical" events have already occurred. Nigerian militants attacked oil facilities and took oil workers hostage in March, effectively shutting off 455,000 barrels per day of Nigerian production. They have vowed to keep attacking until they shut down an additional million barrels.

At the same time, Al Qaeda staged an attack on Saudi Arabia's massive Abqiaq oil processing facility. That attack was unsuccessful, so crude oil prices fell back after spiking over $2.00 per barrel on the news. Given Al Queda's persistence, as evident on 9-11, you can assume they will try again, either in Saudi Arabia or some other key oil hub.

Oil is expensive right now. So are crude oil options and energy stocks. We have delayed entering this market precisely because the options are so expensive.

However, with hurricane season approaching and events continuing to deteriorate in the Mideast, we have decided we need some exposure.

Our ultimate target is the old inflation-adjusted high of $97 per barrel. Any major supply disruption could send prices much higher.

-- Steve Belmont

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