3 Reasons Oil Prices Are Gushing (USO, UCO, XLE, ERY, ERX, SCO)

Diane Alter: Oil prices have taken a backseat lately to the turmoil in Europe and Obamacare. But investors and consumers are starting to take notice again.

For the first time in three weeks, oil staged a noticeable rally. Brent crude oil topped $100 a barrel on Tuesday and crude for August delivery jumped $3.80 to $87.57 a barrel.

Tuesday’s rise in oil came off Monday’s 1.4% decline and follows a selloff that has pushed oil down some 22% from its 2012 peak of $128.40 on March 1. In the second quarter, oil prices experienced their biggest quarterly drop since the financial crisis of 2008.

Moving oil prices higher on Tuesday was a trio of factors: Iran tensions, dwindling inventories, and a wager that further policy action to shore up global growth is on the horizon.

Oil Prices and Iran Tensions
Concerns about Iran had calmed over the past month along with the sagging worldwide oil prices, but those worries were stoked Tuesday by an army general in Iran.

The general reportedly said that the country wouldn’t “sit idly by” as the U.S. and Europe built a missile-defense shield program that could target Iran.

Late Monday, Iranian authorities staged missile drills to test weapons reportedly capable of hitting targets as far away as Israel. Iran officials also announced possible legislation targeted at closing the Strait of Hormuz, one of the world’s most important choke points. Approximately 20% of the world’s oil, nearly 17 million barrels a day, passes through the narrow strait.

Iran’s move came on the heels of the European Union’s full embargo on Iranian oil that went into effect Sunday. The EU embargo halts the vast majority of imports into Europe, ending exemptions for contracts signed before 2012, and barring insurance for Iranian oil shipments.

“Iran is always a factor and it has the potential to have a dramatic impact on oil prices,” Ben Le Brun, a markets analyst at OptionsXpress in Sydney, told Reuters.

While Iran was the biggest catalyst behind oil’s ascent Tuesday, it wasn’t the only factor moving oil upwards.

Oil Inventory

Another reason oil was fueled higher Tuesday was a decrease in supply.

A handful of reports out this week, including data from the American Petroleum Institute, are expected to show a further drop in U.S. crude inventories due to production cuts in the Gulf of Mexico, a result from Tropical Storm Debby.

Analysts in a preliminary Reuters poll forecast a 2.2 million barrel drop in supply.

This is in sharp contrast to recent reports of record production in North America which had helped bring oil prices down. That surge in production can only hold oil down for so long before other factors kick in.

More Stimulus, More Demand

Fresh hopes that more economic stimulus is on the very near horizon is another major oil price catalyst. More central bank action is expected in the U.S., Europe, and China.

While some worry that Europe’s debt mess will derail oil demand, Europe actually accounts for a small part of global oil consumption.

As Money Morning Chief Investment Strategist Keith Fitz-Gerald explained, Europe’s largest economies don’t even comprise 11% of global oil consumption. That means even if oil consumption dropped 20% in Germany, France, Italy, the U.K., and Spain, it would only push consumption down by an insignificant 1.9 million barrels a day.

Instead, said Fitz-Gerald, the key lies in the United States and China.

“The United States and China together account for roughly 32.5% (or roughly 28.26 million barrels a day) of global oil consumption,” Fitz-Gerald wrote Tuesday to subscribers of his Geiger Index service. “Both countries are still growing, albeit more slowly than we’d like to see. A 2% increase in the U.S. economy (median forecast) could translate into an additional 373,800 barrels a day of demand. A 7% increase in China’s economy (also a median forecast) could translate into an additional 574,000 barrels a day. Factor in Russia, India, Japan, along with emerging economies in Latin America and the Pacific Rim, and you get back to a hefty and very probable increase in global oil demand.”

The Wall Street Journal corroborates this, noting that global demand is expected to increase 1.2% in 2012 and another 1.5% in 2013, which would bring global oil demand to 90.33 million barrels a day,” Fitz-Gerald added.

While oil has taken a beating over the last few months, it appears overdone and Tuesday’s rally was warranted.

Fitz-Gerald noted, “Traders are overreacting. They’ve priced oil (and its related options) as if the world is going to stop turning tomorrow.”

Related Tickers: Direxion Energy Bear 3X Shares ETF (NYSEARCA:ERY), Direxion Energy Bull 3X Shares ETF (NYSEARCA:ERX), SPDR Select Sector Fund (NYSEARCA:XLE), ProShares UltraShort DJ-UBS Crude Oil ETF (NYSEARCA:SCO), ProShares Ultra DJ-UBS Crude Oil (NYSEARCA:UCO), United States Oil Fund LP (NYSEARCA:USO).

Written By Diane Alter For Money Morning

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