You can thank Egypt for the recent rise in both Brent and West Texas Intermediate (WTI) crude oil prices.
The region continues to be a cluster of protest activity, as Egyptians have taken to the streets demanding the resignation of President Mohammed Morsi. Echoing the protests in 2011 — which begun the Arab Spring and ousted former leader Hosni Mubarak — tensions are rising fast as many Egyptian citizens are still fed up with the country’s economic inequality and troubling unemployment rate.
Those fears have now been heightened over the threat of military intervention, with the beginnings of a coup underway at time of writing.
Although Egypt isn’t a major producer of crude oil itself, its proximity to oil exporters such as Saudi Arabia is a big problem. Like we saw with Iran, the potential to close a major shipping channel can wreak havoc on the oil markets.
Instead of the Straits of Hormuz, Egypt controls the Suez Canal and the Suez-Mediterranean Pipeline (SUMED). Both are huge pieces of midstream infrastructure in the region for crude oil and other products. Linking the Red and the Mediterranean Seas, shipments of crude oil through the shipping channel grew to 140.8 million tons in 2012 — a 22.5% jump year-over-year. At the same time, liquefied natural gas transport from Qatar has increased six-fold since 2008.
Overall, the Suez Canal and the SUMED shipped a combined 2.24 million barrels a day from Red Sea to Europe and North America in 2011. That’s a lot of crude oil.
While Egypt’s military has made safeguarding the Suez Canal a priority during the protest, the threat of damage to the pipeline or closure of the critical waterway is a distinct possibility. So the elevated prices are certainly justified. This isn’t Iran saber-rattling.
Geopolitical Issues Aside …
Geopolitical events — in places like Egypt or Iran, or even Libya, for that matter — tend to cause oil prices to spike in the short term. But it’s rising demand that keeps moving the crude price floor upward.
Surprise surprise, the demand picture for crude oil is getting better as well.
Following one of the biggest drops in more than three year, Commerce Department data showed that U.S. consumer spending rebounded 0.3% in May. At the same time, weekly claims for unemployment benefits slid for the third time in a month and manufacturing seems to be getting its mojo back, with durable goods orders rising last month. Heck, Americans are even driving more, with gasoline stockpiles declining by 183,000 barrels last week.
Globally, it’s a similar outlook, with both manufacturing and consumer spending in Europe finally regaining some footing. Even with China slowing down a bit, it’s still drinking crude oil like it’s going out of style.
All in all, that paints a pretty rosy picture for crude oil demand
Then there is infrastructure to consider. As the U.S. shale boom unearthed massive amounts of oil in places like the Bakken, infrastructure bottlenecks rendered that crude virtually useless. Essentially, it was stuck in the middle of the country. But America’s oil infrastructure is finally starting to reconfigure around new oil hot spots in such places as North Dakota, Oklahoma and Texas. New pipelines are relieving constraints, and crude-by-rail/crude-by-barge are moving more energy than ever before. Finally, U.S. oil has started making its way to refining hubs along the coasts.
However, that’s kind of a problem.
WTI-priced crude now has access to the global markets; previously, when it was trapped in Cushing, it was insulated. That means it’s now subject to the whims of global demand and geopolitical events rather than the simple supply-demand fundamentals of the U.S.
In other words, prices are headed higher.
Making a Play
Given that Egypt is the spark and better fundamentals are the gunpowder, investors could see some fireworks in the energy sector this summer and beyond. While we probably won’t hit the $150-a-barrel highs anytime soon, the march for higher oil prices is on.
So you could stand to have a dose of energy stocks in your portfolio.
My favorite funds in this sector continue to be the equal-weighted SPDR S&P Oil & Gas Equipment & Services (XES), the broad and cheap Vanguard Energy ETF (VDE) and U.S.-focused iShares Dow Jones US Energy (IYE). These funds have all the necessary characteristics to profit in the short-term, but they’re also built to be long-term winners.
At the same time, both the United States Brent Oil Fund (BNO) and the United States Oil Fund (USO), which tracks WTI, can be used for short-term trades for those wanting to play the spikes and valleys in the oil market. While over the longer-term, both ETFs suffer big time from contango, they are acceptable ways to play short-term “hiccups” caused by things such as Egyptian unrest or other events.
Bottom line: Higher crude oil prices are around the corner. Plan accordingly.
As of this writing, Aaron Levitt was long XES.