As I expected, oil has been rallying with the deteriorating news flow out of Libya, along with other problematic headlines from the Middle East.
While there is a lot of oil on the U.S. market right now, this rally is not about the present equilibrium of supply and demand — it is about the future likely disequilibrium if this turns into a protracted civil war that spills over into other countries.
Watching senior Libyan government ministers, diplomats and military personnel defect to the opposition is a clear sign of the popularity of Qaddafi. However, it is surprising to see how fast they were able to organize on a big scale. While statements from both sides are highly conflicting, some experts suggest that neither side has the military might for a quick end of the fighting. The situation might require a coalition-style military intervention in Libya like we had in the first Gulf War.
What Escalation Means for Oil Prices
It is all about oil now with front-month futures making consecutive new highs in the past several days. This situation negates the otherwise clearly improving U.S. economic data until more clarity is introduced into the equation.
There is something going on in Saudi Arabia, too, although there the secret police force is very strong. I think the Saudis are misrepresenting their ability to pump more oil on short notice as such statements have done little to calm the market in the past. Tapping into the USPR will do little to solve the bigger problems in North Africa; it looks to me that we will see much higher oil prices before this is over.
The call options I suggested on the U.S. Oil Fund (NYSE: USO) have been handsomely rewarding, and any put credit spreads will be in due course. When my first article on how to trade the oil panic was written, USO traded below $38. On Monday, it rose almost to $43.
At the time, I didn’t suggest an exact strike and expiration as only experienced traders that know how to manage their own risk should be making such a trade. Looking at the trade now, I think it would be prudent to take half of the originally suggested position off the table and let the other half run and/or roll into April calls.