What Happened to Oil Prices and the Middle Eastern Put?

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Over the last few months, we’ve witnessed oil prices drop by about 60%. While they’ve recently rebounded to the $50 mark, they are still a long way from their previous lofty peaks.

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Continually rising production — thanks to U.S. shale drilling — amid relatively low demand has crimped the outlook for higher oil prices in the near term.

Aside from the new supply/demand environment, there is another factor at work with regards to lower oil prices — a constant element that has been a major factor in helping support higher oil prices.

I’m talking about what we can call the “Middle Eastern put.”

A Defused Powder Keg? Not So Fast.

For the global energy sector, one of the major constants with regards to pricing has been conflict in the Middle East. From the tensions with Iran over its nuclear ambitions to uprisings in Libya and Bahrain, the Middle East has been powder keg for decades.

And amid the pressure, oil prices have been subject to sort of a price floor. Basically — to use an option trader’s phrase — Wall Street created a “put” underneath oil prices that prevented them from going lower.

For example, three years ago when Iran was threatening to close the critical Strait of Hormuz over sanctions about its nuclear program, West Texas Intermediate benchmark crude oil was almost $110 per barrel, while Brent was even higher. And yet, the sheer abundance of shale drilling in United States prompted many analysts to forecast that WTI should be in the $80 to $85 range.

The threat of geopolitical violence kept the oil machine right on moving higher and higher.

On the surface, the so-called Middle Eastern put has been missing for months — Wall Street’s focus has been on U.S. shale drilling, not Middle East tensions. But rest assured, it’s still there. And when it finally resurfaces we could finally see oil prices move higher.

Certainly, oil supplies are much greater than few years ago. But the Middle East is no safer today than it was back then. In fact, it’s actually more dangerous.

Originally, the Islamic State — also known as the Islamic State of Iraq and Syria, or ISIS — emerged as group bent on toppling Syria’s leader Bashar al-Assad. The group has taken on a life of its own and now has become huge destabilizing threat to the entire region, including the oil sector.

Islamic State fighters have continually attacked and captured various oil fields, refineries and other pieces of energy infrastructure. While those attacks have centered on installations in Iraq and Syria, nations such as Saudi Arabia, the UAE and Jordan are estimated to be next on the terrorist group’s hit list.

Global powers are also affected — the U.S. and NATO countries are weighing military options as IS terrorists abduct and execute Western citizens. And Russia’s unpredictable president, Vladimir Putin, is under increasing pressure as cratering oil prices coupled with Western sanctions have sent Russia’s economy into a downward spiral.

And IS isn’t the only threat in Middle East.

At the start of the year, Yemen has turned into a civil war zone — with rebels taking over the government and the U.S. abandoning its embassy in the nation. The Houthis uprising has the potential to undermine the United States’ security detail in the Middle East and spill over into neighboring nations.

Meanwhile, Libya remains in a constant state of turmoil, Egypt’s volatile economy has led to continued protests and Lebanon is without leadership.

As if that wasn’t enough, lower oil prices have the potential to undermine things even further in the region. Analysts estimate that that Gulf Cooperation Council (GCC) group of nations will see their economies shrink by about 17% this year on the back of lower oil prices. Residents in these nations will see their incomes drop by an average of $9,800. One of the main reasons for the Arab Spring in the first place was a dwindling in social programs, economic opportunity and incomes.

The Middle Eastern Put is Very Much Alive

As long as investors are focused on fracking as the source of the rising oil supplies, the Middle Eastern oil put will remain below the surface. That makes the potential for a huge snapback in oil prices even larger should volatility increase in the Mideast.

It never takes much to light the powder keg in the Middle East. And when it does light, we could see much higher oil prices.

So where does that leave investors?

Any dip could be seen as an opportunity to load up on quality energy stocks. Firms such as Exxon Mobil Corporation (NYSE:XOM) or Continental Resources, Inc. (NYSE:CLR) can still make hay with oil prices this low. As a result, their margins will be that much higher when it rises.

That makes them a good bet for any price environment.

All in all, the market seems to be dismissing the growing problems in the Middle East when it comes to oil prices. However, those problems will likely be impossible to ignore much longer.

As of this writing, Aaron Levitt did not hold a position in any of the aforementioned securities.

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Aaron Levitt is an investment journalist living in Ohio. With nearly two decades of experience, his work appears in several high-profile publications in both print and on the web. Also likes a good Reuben sandwich. Follow his picks and pans on Twitter at @AaronLevitt.


Article printed from InvestorPlace Media, https://investorplace.com/2015/03/happened-oil-prices-middle-eastern-put/.

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