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Schork Oil Outlook: Duration and Contagion Supporting Higher Oil

Keeping in mind that markets abhor uncertainty, the most significant (and obvious) driver supporting oil prices today are the two big unknowns related to the Middle East; namely, duration and contagion.

1. Duration

  • Egypt… coup d’état with military now calling the shots

Concern: there is no organized democratic group ready to step in to fill the void. The only established group that appears able to assume leadership (at least in some form) is the Muslim Brotherhood… and that is not a good thing for the region, especially in regard to Israel.

  • Libya… civil war with the potential to escalate

Concern: both pro-Gaddafi and anti-Gaddafi forces appear unable to seize control. Thus, we face the specter of a prolonged conflict there and potential that the violence escalates beyond Libya’s borders.

This brings us to the second unknown:

2. Contagion

Concern: Sunni/Shia conflict escalates with Shia Iran instigating upheaval amongst the Shia minority in Sunni majority Arab oil producer countries (i.e. Saudi Arabia, Kuwait and U.A.E.).

Of course, the other major concern is the role of the speculator.

We spoke about this on Friday and it warrants an update following the latest CFTC report (see Chart of the Day in today’s issue of The Schork Report).

Managed money accounts on the NYMEX own a record 268,622 contracts (i.e. 269 MMbbls) of WTI crude oil. The storage capacity at the NYMEX hub in Cushing, OK is only around 45 MMbbls. In other words, speculators own nearly 6× the capacity currently available at Cushing. It does not get any clearer which way Wall Street is trying to take oil.

Bottom line, NYMEX WTI aside, light sweet crude oils (e.g. LLS, Brent, and Bonny Light) are trading comfortably above $115 a barrel. At this level retail gasoline works out to around $3.70 a gallon. The national average for gasoline as of last Monday was $3.39 a gallon. Thus, at the current rate Americans face the prospect of another 30 cent increase at the pump this summer.

We know from recent history that demand inelasticity, be it in the U.S., Europe and yes, even China, begin to wane at these retail prices.

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Stephen Schork is the Editor of The Schork Reportand has more than 17 years experience in physical commodity and derivatives trading, risk systems modeling and structured commodity finance.

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