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Yesterday, I advised my Energy Advantage and Energy Inner Circle subscribers about the reasons behind the recent plunge in crude oil prices.
This morning, I released a longer version of that in Money Morning (“The Shocking Role of Iranian Sanctions in Crude Oil’s Plunge.”).
Now, I want to fill in Oil and Energy Investor readers on the latest developments in this unfolding situation.
A behind-the-scenes look, if you will.
This is a market plunge the likes of which we haven’t seen in the oil industry since 2015 – nearly three years.
As expected, market pundits have been flying into a frenzy about the state of the markets, yelling that the sky is falling and the world is ending.
However, there’s no reason to get too worked up about this.
Analyzing the Cause of Oil’s Plunge
In part, today’s Money Morning release reads as follows:
The collapse in oil prices has now reached historic levels.
Tuesday’s 7% plunge in West Texas Intermediate (WTI) – the largest slump in more than 30 years of futures contracts – marked the 12th consecutive daily loss for the New York benchmark. Before rebounding slightly, crude was down more than 22% in less than a month.
Now, we’ve spoken many times before about the numerous reasons why crude prices can plunge: artificial manipulation from short sellers and institutional monkeyshines, geopolitical tensions, distortions in supply and demand, even outright oversupply – we’ve seen it all before.
In this present case, some of this current decline is warranted, given the market’s overestimation of Iranian sanction impacts and, to a far lesser extent, some weakening in underlying fundamentals.
But to be sure, the leading cause of the plunge has been a combination of what I have called the “lemming fixation” (a penchant for jumping off the cliff en masse) and some outright market manipulation.
But it’s the completely counterintuitive – yet entirely predictable – effect of the recently re-imposed sanctions on the Islamic Republic that I want to explore today…
Trump Has Undermined His Ultimate Goal in Iran
One of the administration’s stated aims in slapping sanctions on the Teheran regime is to choke off their avenues for selling crude oil on the global markets.
Economics 101 tells us, all other things being equal, a reduction in supply would lead to a rise in prices.
But much of the expected effect from Iranian sanctions has been delayed, even blunted, by a last-minute decision on the part of the Trump administration to exempt the eight largest importers of Iranian crude.
This makes the short-term impact of the sanctions effectively nil, and advances a direction question: Why was the decision to remove the U.S. from the Joint Comprehensive Plan of Action – the “nuclear deal” treaty signed by the United States, France, the United Kingdom, Germany, China, Russia, the European Union, and Iran in 2015 – and reintroduce sanctions even made?
At the moment, it seems merely another political move, utterly devoid of substance, by an increasingly beleaguered White House.
We’re witnessing the result, at least in the short term: WTI has been cut by almost $20 a barrel since Oct. 1. The more widely used London benchmark, Brent, is down $20.63 a barrel since Oct. 3.
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The market is now more oversold and undervalued than at any time I have witnessed in the last three decades.
That’s no idle claim: As you may recall, several years ago I developed an analytical technique to determine the effective market value for oil. The intent was to determine what effect artificial moves (especially those short contracts) had on the market value so we could see, in essence, the truth.
By the close of trade Tuesday, my calculations put the effective market value of WTI at $65.80 a barrel; Brent was at $74.75.
Respectively, those prices would be $10.11 and $8.91 higher than Tuesday’s closing prices.
Meanwhile, the spread between Brent and WTI, calculated as a percentage of WTI (the more accurate way of determining the difference between the two benchmarks) has expanded to 15.4%.
That is a wider spread than at any point since the turbulent depths of the global crude bear market in late March of 2015.
Anyone who’s long crude right now should be out; we need the dust to settle and for a “floor” to emerge here before moving back in. There’s not even a pretense of market equilibrium right now.
But rest assured that, when that floor becomes apparent, there will be some very big money to be made. Manipulation has a way of snapping back like an elastic band, and there’s massive profit potential in the “snapping.”
President Trump Has Backed Himself into a Corner
Okay, so here’s what’s happening now.
Yesterday, both West Texas Intermediate (WTI) and Brent, the two benchmarks for oil prices, bounced back, a process that is slowly continuing this morning.
Of real import, however, is what’s emerging elsewhere in this grant scheme of manipulation.
My research team is moving ahead with a more comprehensive strategy, but there is one additional element in this that is hitting as I write this. And it is geopolitically explosive.
The strange last-minute decision by the White House to provide a six-month exemption to the eight largest importers of Iranian oil appears to fly in the face of the sanctions’ stated objectives.
But it had a basic domestic political objective.
As I have noted on several occasions, the impact of full Iranian sanctions (in other words, what the White House had repeatedly – and very publicly – assured was the policy objective) would combine with already declining exports from Venezuela, Libya, and Nigeria to produce marked pressure on supply.
That was never a positive result for Trump, since the rise in oil prices would translate into higher costs for refined oil products like gasoline, low sulfur content diesel, and heating fuel as a contentious mid-term election hit.
Crude oil markets may be an academic subject for most Americans. But gasoline votes.
The blatant political objective largely succeeded.
The decision was to “jaw-bone” Saudi Arabia – thereby OPEC as a whole and Russia as well – to raise production in anticipation of lower supply from Iran. However, by providing eleventh-hour exemptions, the Trump Administration succeeded in driving down oil prices just before the U.S. vote.
Short contracts exacerbating the decline has merely added to the political manipulation.
But the charade is over.
Multiple sources are telling me that Riyadh and Moscow are livid over the Trump chicanery.
In response, a cut in both production and exports is coming to offset the U.S. political ruse; the Saudis have already announced a unilateral export cut for December.
As one of my Saudi contacts put it: “At best, Trump bought himself some temporary reductions in oil prices. But this is hardly more than a short-term move. Our supply cuts will offset the Washington move. And in a few months, when the exemptions either expire or the [Iranian] sanctions collapse, the situation will be even more acute.”
A Russian source had an even less charitable read. “Such a political stunt guarantees reprisals in a global market where a significant rise in U.S. crude exports to offset are limited.” The reference here is to the export ceiling approaching due to American port capacity.
“This isn’t even good reality TV,” he added.
The elections are over. Trump has painted himself into a policy corner. The Iranians are still exporting oil, and supply cuts by the Saudis and the Russians are now assured.
All of which means we are in short order going to have a lot of profitable moves emerging.
So be sure to watch out for them.
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