Energy Investing Amid Iran’s Military Threats

by Aaron Levitt | January 5, 2012 7:00 am

The latest bellicose rhetoric coming out of Iran has the world’s energy markets in a tizzy. Tensions between the West and Tehran about its nuclear program could be coming to a head with Iran’s repeated threats to close the Persian Gulf’s vital Strait of Hormuz. A series of economic sanctions have finally begun taking a toll on the OPEC member, and Iran has just completed a several days of naval military drills in the Persian Gulf.

For energy investors, the potential for military conflict is increasing every day and could have far-reaching implications for your  portfolio.

As the U.S. and its allies prepare to impose tough new financial sanctions, including banning dealings with Iran’s central bank and limiting the ability of service firms to provide Iran with equipment necessary to run its oil and chemical industries, Iran has fired back, literally.

“Not a Single Drop”

On Tuesday, it shot off a test surface-to-air missile during naval exercises that took place in a 1,250 mile stretch of water beyond the Strait of Hormuz at the mouth of the Persian Gulf. These maneuvers where part Tehran’s saber-rattling response to the West’s sanctions. Speaking through Iran’s State News Agency,  First Vice President Mohammad Reza Rahimi[1] said of the actions: “If Iran oil is banned, not a single drop of oil will pass through Hormuz Strait.”

While Iran exports only around 2 million barrels of oil a day, the Strait of Hormuz is a critical shipping way for the world’s energy market. The U.S. Energy Information Agency estimates that around 17 million barrels of oil per day passed through the Strait in 2011. This is nearly one-sixth of total global oil production and nearly 35% of the world’s seaborne traded oil.

The majority of this oil flows into emerging Asia, Japan and India. Any escalating hostility in the region could seriously dampen economic growth and drive oil up prices further[2].

While energy analysts predict that Iran won’t take military action, the potential remains for it to occur. The U.S. Navy has vowed to keep the Strait open, and there’s no way of telling where any hostilities might lead. With so much of world’s oil moving through the Strait, any closure would have a serious impact on prices.

Morgan Stanley predicts that a blockage would cause a $40-a-barrel increase in the price of crude. This echoes similar predictions by other energy analysts, which show prices reaching between $120 and $150 a barrel. Already, oil has surged in the wake of Iran’s threat. The price of Brent crude jumped[3] by roughly $5 to land $111.65 a barrel, while the U.S. benchmark WTI rose to $103 on Wednesday.

Playing the Threat

While the softening global economy should keep oil prices below the highest predictions, investors in the energy sector should prepare themselves for a bumpy ride. The US Brent Oil ETF (NYSE:BNO[4]), allows investors to track the pricing of Brent crude. The fund will be the major winner if the Strait is closed because Brent is the de facto oil pricing measure for the world. The ETF surged 4.4% the day Iran made its missile test.

Perhaps the biggest benefactors will be North American energy producers. Canada is already becoming a major oil supplier to China, and with the Asian Dragon receiving about 550,000 barrels of oil per day from Iran, Canada could get the call to replace the lost oil.

In addition, the U.S.’s vast shale revolution is revitalizing the industry and creating a glut of oil domestically, ready for export. Both the iShares Dow Jones US Energy (NYSE:IYE[5]) and Guggenheim Canadian Energy Income (NYSE:ENY[6]) provide a wide net of North American energy producers, including Cenovus (NYSE:CVE[7]) and ConocoPhillips (NYSE:COP[8]). These two funds make a great short-term play on the Iranian news as well as great long-term options for rising energy demand.

With tensions continuing to rise in the Middle East, both consumers and investors could be seeing higher oil prices on the horizon. Saber-rattling or not, Iran’s threats to close the Strait of Hormuz will keep the upward pressure on energy pricing. For investors, these three ETFs offer a way to stay ahead of the unfolding conflict and potentially hedge one’s own energy costs.

Disclosure: Aaron Levitt is long IYE

Endnotes:
  1. First Vice President Mohammad Reza Rahimi: http://money.cnn.com/2012/01/03/markets/oil_iran/?hpt=hp_t1
  2. drive oil up prices further: http://www.csmonitor.com/USA/2012/0103/Oil-prices-What-happens-if-Iran-shuts-down-the-Strait-of-Hormuz
  3. The price of Brent crude jumped: http://money.cnn.com/galleries/2011/news/1112/gallery.2012-financial-apocalypse/2.html
  4. BNO: http://studio-5.financialcontent.com/investplace/quote?Symbol=BNO
  5. IYE: http://studio-5.financialcontent.com/investplace/quote?Symbol=IYE
  6. ENY: http://studio-5.financialcontent.com/investplace/quote?Symbol=ENY
  7. CVE: http://studio-5.financialcontent.com/investplace/quote?Symbol=CVE
  8. COP: http://studio-5.financialcontent.com/investplace/quote?Symbol=COP

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