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Mon, September 21 at 4:00PM ET

Strikes Push Oil Prices Higher, Dow Lower

Over the weekend, drones disrupted half of Saudi Arabia’s oil production. Here’s how to play it

The single worst, sudden oil disruption ever …

That’s the outcome of this weekend’s Iranian drone strikes on Saudi Arabian oil fields, which forced the kingdom to shut down half of its daily crude production, roughly 5.7 million barrels. That’s about 5% of the world’s oil supply.

The volume of oil production affected surpasses the loss following the invasion of Kuwait and the Iranian Revolution.

While this is a significant hit, Saudi Arabia has enough oil in reserves to cover production for approximately 30 days as it tries to restore its damaged facilities.

That said, an official familiar with the matter told news reporters, “The more information we are getting on the extent of the damage, the clearer it is becoming this is really serious and would take longer than anticipated to see things back to normal.”

For the moment, however, other OPEC nations will not increase their output to offset the decline in Saudi production. If production does become a problem, Trump has authorized the release of oil from the U.S. Strategic Petroleum Reserve to stabilize energy markets.


***What’s the broader effect on the energy markets?

Master income investor, Neil George is the editor of Profitable Investing. Since the energy sector is home to abundant income investments (most notably, MLPs and select energy stocks with high dividends), Neil regularly monitors what’s happening in this corner of the market.

Given this, I reached out to Neil this morning for his thoughts. Here’s Neil for a broad overview of the impact of the attack:

Crude prices for Brent and West Texas Intermediate (WTI) are up significantly even after calming a bit from initial spikes in the first trading hours of futures trading.

This will leave uncertainty in supplies as futures and forward contracts are also becoming volatile on speculation of delivery issues.

OPEC+ has limited turn-key abilities to bring enough oil to the market particularly with Iranian sanctions which will for now be ratcheted up as stories of Iran being behind the drone attacks. And whether Iran did the launch or aided others inside the Kingdom or Yemen — uncertainty is a big factor in the market.

More so are the ramped-up concerns of other attacks on other facilities or fields including terminal facilities at export ports.


***As Neil points out, “who’s behind the attack?” is an important question, and the answer could point toward greater tension and market volatility in coming weeks

Yemen’s Houthi rebels have claimed credit for the attack. However, U.S. officials are eyeing Iran as the real source. Houthi’s are often backed by Iran.

Last night Trump tweeted:

Saudi Arabia oil supply was attacked. There is reason to believe that we know the culprit, are locked and loaded depending on verification, but are waiting to hear from the Kingdom as to who they believe was the cause of this attack, and under what terms we would proceed!

Though Trump didn’t name Iran specifically, Secretary of State Mike Pompeo blamed Iran for the attack on Saudi oil facilities and argued there is “no evidence the attacks came from Yemen.” Satellite imagery shows the oil facilities were hit from the northwest, which suggests an attack from Iraq or Iran.

Beyond the direction of attacks, the numbers of points of impact suggests it’s unlikely the attacks were carried out by Yemen. Specifically, the 19 Saudi targets that were hit suggests the attack could not be accomplished by the 10 drones the Houthis claimed to have used.

If tensions continue building, leading to an escalation in conflict, it stands to have a far more profound impact on the overall investment markets, not just the energy sector. This fear is in part why the Dow is down 128 points mid-afternoon Monday, on track to end a win-streak of eight consecutive days.

***Returning to the investing implications for energy investors, who’s likely to benefit from the production disruption?

Back to Neil:

U.S. shale and Canadian producers (remember the U.S. is the largest producer and Canada is the 6th largest and is the 5th largest exporter) are benefitting near term. But with the uncertainty in Saudi Arabia — they should benefit from an increase in contracted demand from much more secure production sources.

I see that U.S. producers which have been sliding in share price represent better value for their security of supply. And if tensions further rise with Iran and in the Middle East — prices will be supported aiding margins and the discount of WTI to Brent.

The U.S. shale fields companies are benefitting including my royalty company Viper Energy (VNOM). As are major integrated companies such as ExxonMobil (XOM) and others due to their off-shore assets and other ex-Middle East assets.

Interestingly, Neil has had the overall energy market sector on hold in the Profitable Investing portfolios, though there are a handful of plays he continues to recommend. Here’s how he views the most attractive opportunities today:

U.S. pipeline companies — particular with marine terminal assets should continue to be bought. The larger Enterprise Product Partners (EPD) and Plains GP Holdings (PAGP) are prime to benefit now and in the future.

The October issue of Profitable Investing due out next week will be all about oil. Neil will be discussing which energy positions he’ll continue to hold in his portfolios versus which need to go. If you’re an energy investor with a substantial portion of your portfolio exposed to oil, this is a must-read issue. To learn more, click here.

***What if you want to play oil itself in the wake of this attack? And what should we expect from oil prices?

For that answer, let’s turn to our resident quant investor, John Jagerson, editor of Strategic Trader.

Regular Digest readers know that we frequently ask John to run market studies for us. In doing this, John accesses historical market data to identify patterns and trends. Then he uses that information to help make well-informed predictions as to what might happen in the markets going forward.

Given the attacks, over the weekend, John decided to look into what usually happens to oil prices when there is a disruption to supply. If you’re an oil investor, knowing how long the disruption might last, as well as the typical affect on oil prices is important information.

Here’s John on this note:

For example, Hurricane Katrina led to a decline in global oil supply of -1.2% and oil prices rose 9% in the short-term. Hurricane Harvey cut -.6% of global supply in 2017 and prices immediately rose 6%. The collapse of Libyan supplies in 2011 cut -.7% from global supply and oil rallied more than 20% over the next six weeks.

To look at the historical effect of production disruptions, John ran a study of 24 such events that resulted in a spike in oil prices of at least 5% in the ensuing week (John limited his study to events happening within the last 12 years). This included OPEC supply constraints, civil war, terrorist attacks, accidents, and storms.

Overall, he found that the average move in oil prices in the first two weeks was 7.2%, but the length of the rally was usually short-lived.

Here’s John for more:

If I exclude a few of the extreme outliers, the typical length of time for oil prices to hit a top following the disruption was 22 trading sessions — or about a month. Following the top, oil prices returned to within 3% of pre-spike levels 82% of the time.

***So, how might an oil trader play this event?

Back to John:

Each situation is unique. However, history can help us create some estimates. Most of the time, the initial price-spike in oil following a disruption ends and returns to its prior levels within two months. Most of the gains are realized within a few days of the disruption and a top is formed within a month.

Investors looking for long-term bullish momentum after a disruption are better off waiting for the top to form and oil to come back to support before entering a new position. Traders who already had exposure to oil prices or oil stocks should find ways to protect their gains either by taking profits off the table or buying long puts against their long positions.

The bottom line is that although the news is dramatic, if we consider today’s disruption within the historical context, this spike is far more likely to fade in the short-term which should be good for market stability.

***Looking big-picture, Trump wasted little time in using the strikes as an opportunity to attack the Fed, once again pushing for a cut in rates

In two tweets this morning, Trump questioned whether the Fed would “ever get into the game.” He went on to say the Fed and Powell “don’t have a clue.”

After pointing toward the strong dollar’s harmful effect on U.S. exporters, he turned toward the oil attack, writing: “And now, on top of it all, the Oil hit. Big Interest Rate Drop, Stimulus!”


And let’s not forget Trump’s tweet from last week:

The Federal Reserve should get our interest rates down to ZERO, or less, and we should then start to refinance our debt.

As a reminder, the FOMC meets tomorrow and Wednesday. As I write Monday, the CME Group’s FedWatch tools puts the odds of a quarter-point rate reduction at 68.1%.

We’ll continue to keep you up to speed on developments in the energy sector, as well as the FOMC outcome.

Have a good evening,

Jeff Remsburg

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