2 Reasons to Expect More Oil Volatility

02/20/2013 9:15 am EST


Political pressures always play a role in oil prices, but two long-simmering hotbeds could reach their flashpoints in the coming months, writes Dr. Kent Moors of Money Morning.

A combination of rising demand and tension in the Middle East means oil prices will continue to climb. How this plays out in the short term will have a primary impact on the profitability of oil investments.

One conclusion is already clear: This will once again be a volatile market. And this time, volatility will be pointed upward.

Both the International Energy Agency (IEA) and OPEC have raised demand projections for the near term, to levels approaching less than 3 million barrels per day of global supply. Meanwhile, we are not going to have a crude shortage anytime soon, although there may be some regional constrictions on the horizon.

Ample supplies are available for quick pumping to meet rising demand. Nonetheless, there will be a greater use of unconventional production (tight, shale, heavy, oil sands). And that means the oil coming on market will be more expensive.

Knee-jerk reactions to global events will again pull on demand sentiment. That, in turn, will spike the volatility. Yet, this is likely to be more subdued on the downside than at any time in the last year.

The likelihood of a recession is rapidly dissipating, and the prospects of these fear tactics are declining along with that reality. So reversals, while still inevitable, will be short in nature so long as the current underlying dynamics remain. Those are now pointing up.

My ten indicators of oil prices are designed to estimate the actual composition, strength, and direction of pricing movements. For the past month, six of them have been pointing positive. The upward pressure is building, reflecting the overall higher revisions in forecasted demand by IEA and OPEC.

Yet we are once again reminded that the oil market hardly operates in a vacuum. As the new round of American sanctions designed to limit global financial access kicks in against Iran, Tehran is once again showing its defiance. A test balloon on bilateral discussions with the US has been shot down.

Apart from the latest statement of Iranian defiance, the recent ripple affecting oil sentiment is internal.

Already, the path to the country’s June presidential election is becoming more difficult. After two consecutive four-year terms, President Mahmoud Ahmadinejad is ineligible to run and the frontrunner appears to be Majlis (parliament) Speaker Ali Larijani.

Larijani has been an outspoken critic of the current president, while at the same time he has a much better relationship to the real power in Iran—Ayatollah Ali Khamenei.

Ahmadinejad retains significant support among one group comprising some of the leaders in the Revolutionary Guard—the most powerful group of Iranian puppet masters. They will not cede that power to anybody having any appearance of being a reformer.

Such uncertainty enhances the concern over violence and instability as the election approaches. Since the Guard also controls the military, there is an added fear. It is these developments that are factors likely to increase global oil prices.

The second factor is Europe, which will likely pressure prices lower. The situation really has not changed that much, although perceptions of pending improvements had pushed it to the back burner of late. Concerns over Italian elections and a developing Spanish scandal introduce again the question of whether the European Union and the European Central Bank can meet the ongoing credit crisis.

The vacillations of the oil market will continue. Nonetheless, the price is still likely to gain strength. Just avoid getting caught in the crossfire.

Read more from Money Morning here...

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