Kilduff: Is Oil Heading To $200?
Partner, Again Capital LLC
The attention of investors has been rightly focused on a solid earnings season, employment data, and the Federal Open Market Committeemeeting on Tuesday.
Unfortunately, the elements that constitute so-called risk or geopolitical premium in oil prices suffer from no distractions. Several newsworthy events, recently, represent the dots that the oil market may begin to connect to produce a significant event driven price spike in prices - potentially driving crude oil prices upwards of $200 per barrel.
The most recent dot was news on Sunday that Iran inaugurated into service four new small submarines into its naval fleet, whose design and purpose are to maneuver in the shallow waters off the coast of Iran into the vital oil shipping lanes of the Strait of Hormuz, through which 40% of the world's traded oil flows.
Make no mistake: these submarines are to be used to attack western shipping interests in the Strait, thereby shutting it down.
It is not well understood that the Strait is merely two, one-mile wide shipping lanes.
In testimony before Congress, the U.S. military has acknowledged Iran's ability to shut the Strait; however, with reassuring bravado, in the same testimony and almost the same breath, the U.S. military asserted its ability to "unblock" the Strait, as well.
An attack is assumed to come as a response to an attack by the United States and/or Israel or others on Iran's nuclear facilities, but other attack-inducing scenarios exist. The latest round of sanctions against Iran from the United Nations, European Union, and the United States seem to be squeezing the regime more than I would have expected. Imports of gasoline are being impacted, and financial restrictions are hampering commerce.
So what is an increasingly desperate, isolated, and squeezed regime to do? If North Korea is any guide, one idea would be to sink a ship or several ships. I have long maintained that Iran could be pushed to the point where they seek to take us all down with them.
The vulnerability of the Strait of Hormuz does not lie solely with an attack by the Iranians.
There was a notable terrorist attack in the Strait last week.
The attack was the equivalent of coming out the supermarket to see your car with a big dent in the bumper and no note. A Japanese supertanker transiting the Strait suffered a bomb attack in its stern. This was confirmed by the U.A.E. on Monday, and the attackers, an Al Qaeda linked group, did leave a note by taking responsibility on their website. The ship was able to sail to port under its own power with little damage.
The terrorists clearly have oil installations, pipelines, and shipping interests in their sights.
They are aware of the economic dislocation that could be wrought through an energy price spike.
On this score, victory is theirs, if they are able to create an atmosphere of instability surrounding the supply chain. We have seen these attempts, previously, most notably the aborted attack on the Abqaiq export facility near Ras Tanura in Saudi Arabia in 2006, which is the world's oil aorta. The oil that flows through the Strait is oil that western countries count on for secure supply: Saudi Arabia, Kuwait, Southern Iraq, and U.A.E. More troubling, the country that has several million barrels of spare capacity to fill any void: Saudi Arabia is the most vulnerable.
As the situation percolates, investors need to monitor the stories out of the region. There is inherent event-risk that is substantial. If news were to hit the tape that there was an attack in the Strait of Hormuz, traders are going to buy oil first and ask questions later. The initial surge would likely involve a doubling of prices with further gains ensuing as details emerge about the severity of the attack and the status of navigability. Sophisticated investors routinely buy some energy price spike protection as a portfolio hedge.
Thankfully, for now, the situation is not on the boil. But the region remains a tinder box. The small stories that I have noted here may turn out to be the precursor to the big story later.
John P. Kilduff is a Partner with Again Capital LLC. He's also a CNBC contributor.