The Trouble with Oil & Egypt
07/10/2013 7:00 am EST
Political tension in Egypt has raised fears of skyrocketing oil prices, writes John Nyaradi of Wall Street Sector Selector, and significant profit opportunities could be available as the crisis deepens.
By Wednesday, July 3, the price of oil topped $102 per barrel, reaching its highest level in over a year. Although Egypt is not a significant producer of oil, it has control over the Suez Canal and pipeline, accounting for a daily flow of roughly four million barrels of oil. An oil price disruption is the last thing the world needs as it attempts to thread the needle of economic recovery.
One might have assumed that once Mohamed Morsi was deposed, the situation would cool and the price of oil would fall. Unfortunately, such is not the case. While tensions continue to brew in Egypt, with pro-Morsi demonstrators venting their outrage in Nasr City, Turkish Prime Minister Recep Tayyip Erdogan has also voiced his complaints about the Morsi ouster, fearing the same fate for his own regime. Meanwhile, Syria’s Bashar Assad gleefully declares the end of “political Islam.”
In Tunisia, a similar transition process is underway. In both Egypt and Tunisia, Islamist regimes managed to get elected while eventually failing to hold power. Since early January, a good deal of discussion was focused on a “second Arab spring” led by the young people of Egypt and Tunis who started the Arab spring movement. The Islamists who assumed power have cranked-up their authoritarianism and ideology as a substitute for socio-economic development. The pushback against this tyranny has now found its way to Turkey, an ally of the United States.
Will the anti-Islamist wave reach oil-producing nations, escalating the risk of oil price disruptions?
Against this backdrop, the price of Brent crude futures for September delivery reached $107.31 per barrel on the ICE Exchange in London. WTI crude futures for August delivery reached $103.95 per barrel on the ICE.
Because the American economy is 70% consumer-driven, a spike in oil prices could threaten our slow-moving economic recovery. Many fear that the combination of rising oil prices and escalating interest rates could put a severe dent in third quarter GDP—which is already facing headwinds from the budget sequester. How high can oil prices go and how much is too much? Consider that the 50-day moving average for the spot price of WTI crude on the Chicago Mercantile Exchange is $95.49 per barrel. On Friday it closed at $103.63.
In the chart of United States Oil Fund (USO), the recent uptick in prices is clearly visible and the ETF has formed a “golden cross” buy signal as the 50-day average has crossed above the 200-day moving average.
Concerns about the energy supply give traders an opportunity to benefit from a highly-volatile market. There are a number of ETFs available to provide investors the opportunity to take advantage of movements in either direction.
Investors seeking to profit from increasing oil prices may want to consider one or more of the following ETFs:
United States Oil (USO) – This ETF is designed to obtain investment results, which correspond to the performance of the spot price of West Texas Intermediate (WTI) light, sweet crude oil. The fund will invest in futures contracts for WTI light, sweet crude oil, other types of crude oil, heating oil, gasoline, natural gas and other petroleum based-fuels that are traded on exchanges.
United States 12-Month Oil (USL) – This ETF is designed to replicate the changes in percentage terms of the price of light, sweet crude oil delivered to Cushing, Oklahoma, as measured by the changes in the average of the prices of 12 futures contracts on crude oil traded on the NYMEX. USL will consist of the near-month contract to expire and the contracts for the following 11 months, for a total of 12 consecutive months’ contracts. When calculating the daily movement of the average price of the 12 contracts each contract month is equally weighted.
Energy Select Sector SPDR ETF (XLE) – This ETF is designed to obtain investment results, which correspond to the price and yield performance of publicly traded equity securities of companies in the energy select sector index. In seeking to track the performance of the index, the fund employs a replication strategy. It generally invests substantially all, but at least 95%, of its total assets in the securities comprising the energy select sector index. The index includes companies from the following industries: oil, gas & consumable fuels; and energy equipment & services.
Investors seeking to profit from declining oil prices may want to consider one or more of the following ETFs:
United States Short Oil (DNO) – This ETF is designed to replicate the inverse percentage changes of the spot price of light, sweet crude oil delivered to Cushing, Oklahoma. It will be measured by the changes in the price of the futures contract on light, sweet crude oil as traded on the NYMEX that is the near-month contract to expire, except when the near-month contract is within two weeks of expiration, in which case the futures contract will be the next month contract to expire.
ProShares Short Oil & Gas ETF (DDG) – This ETF is designed to obtain daily investment results, which correspond to the inverse (-1x) of the daily performance of the Dow Jones US Oil & Gas Index. DDG invests in derivatives, which ProShares Advisors believes, in combination, should have similar daily return characteristics as the inverse (-1x) of the daily return of the Dow Jones US Oil & Gas Index. The index measures the performance of the oil and gas sector of the US equity market. Component companies include, among others, exploration and production, integrated oil and gas, oil equipment and services, pipelines, renewable energy equipment companies and alternative fuel producers.
ProShares UltraShort Dow Jones-UBS Crude Oil ETF (SCO) – This ETF is designed to obtain investment results, which correspond to twice (200%) the inverse of the daily performance of the Dow Jones-UBS Crude Oil Sub-Index. SCO invests in any one of or combinations of the financial instruments (swap agreements, futures contracts, forward contracts, option contracts) with respect to the applicable fund’s benchmark to the extent determined appropriate by the Sponsor.
Bottom line: The political situation in Egypt remains in disarray and instability here can lead to soaring oil prices around the world. Instability breeds opportunity and oil is currently in a bull market driven by fears in the Middle East. Expect oil to remain volatile in the days ahead.
By John Nyaradi, Publisher, Wall Street Sector Selector