Will This 25-Page IAEA Report Send Crude Oil To $200 per Barrel? (USO, UCO, OIH, ERX, ERY)

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November 10, 2011 5:33pm NYSE:ERX NYSE:ERY

Justice Litle: A new report from the International Atomic Energy Agency contains unsettling accusations — and increases the odds of a crude oil spike to $200 per barrel.

Could a 25-page report send the price of crude oil to $200 per barrel?

The International Atomic Energy Agency, or IAEA, released its findings on Iran this week. Their 25-page report accuses Iran of developing miniaturized nuclear warheads, built for delivery by medium-range missiles. Iran could have enough fissile material, if enriched to weapons grade, for four nuclear bombs.

Fallout from the report is spreading (no pun intended). The United States could push for new sanctions on Iran… Israel is on high alert… and harsh threats are flying.

Benjamin Netanyahu, the prime minister of Israel, is said to be reviewing Israel’s options for a military strike. Iran did not mince words on hearing the news.

Iranian officials said an Israeli attack on its infrastructure would be suicidal. “If a military challenge is started against Iran in the region, the Zionist regime will definitely be faced with a hell,” said a member of Iran’s national security commission.

Israel has a history of nuclear intervention. In 2007, the Israeli military destroyed a potential nuclear site in Syria. In 1981, Israel preemptively struck Osirak, a nuclear facility outside of Baghdad.

In terms of crude oil, the major risk comes down to the Strait of Hormuz, a key export gateway for multiple OPEC producers: Iran, Iraq, Kuwait, Saudi Arabia and others.

A third of all seaborne-traded oil passes through Hormuz every day, or roughly 15.5 million barrels. Were Israel to attack Iran, the Strait would potentially be shut down.

Oil consultant Phillip Verleger calls it “the $200-a-barrel scenario.” Even more aggressive estimates put the war price at $290 per barrel. The risk is heightened by production bottlenecks in Libya and Syria, aggravated by civil unrest.

What would be the fallout from a Strait of Hormuz shutdown?

The consequences would hit like a one-two punch. First, a vicious spike in the price of oil would be massively deflationary. Energy-dependent economies around the world would seize up as prices rose. The weak recoveries of the U.S. and Europe, already in doubt, would be vaporized by price shocks.

The follow-on impact would come courtesy of world governments. New waves of stimulus would flood the United States, China and Europe. Central banks would go into instant emergency mode. Liquidity injections would be justified as adrenaline shots for a patient (the economy) in cardiac arrest.

Unfortunately, the central bank medicine would fail — just as all previous injections failed. Rather than smoothing over price shocks, the excess liquidity would make things worse (without solving the real problem). Fears would intensify over rising debt, paper currency destruction, unstable commodity pricing and precious metals hoarding.

The big winners in this scenario would be inflation-protective assets. The oil spike would crush economic activity — which is deflationary — but the global government response would push in the exact opposite direction. Traders would anticipate this, and act accordingly. Industrial metals like copper and aluminum might be hit… but gold and silver would soar.

An Israel attack will not come with advance warning (other than the vague signs already present). A $200 oil spike is thus another instance of “headline risk” to consider in these incredibly volatile markets.

In terms of investor positioning, this possibility further favors precious metals. If the attack and shutdown occurs on a random Tuesday morning, there will be no time to scramble. Those already positioned will be glad they acted in advance.

Related: United States Oil ETF (NYSEARCA: USO),  ProShares Ultra DJ-UBS Crude (NYSEARCA: UCO), Oil Services HOLDRs  (NYSEARCA: OIH), Direxion Daily Energy Bull 3X Shares (NYSEARCA: ERX), Direxion  Daily Energy Bear 3X Shares (NYSEARCA: ERY).

Written By Justice Litle From Taipan Publishing Group

Justice Litle is the Editorial Director of Taipan Publishing Group, Editor of Justice Litle’s Macro Trader and Managing Editor of the free financial market news e-letter Taipan Daily. Justice began his career by pursuing a Ph.D. in literature and philosophy at Oxford University in England, and continued his education at Pulacki University in Olomouc, Czech Republic, and Macquarie University in Sydney, Australia.

Article brought to you by Taipan Publishing Group, www.taipanpublishinggroup.com.

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