Iran: How Middle Eastern Woes Will Impact Crude Oil (USO, XOM, DBO, ERY, ERX)

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January 16, 2012 12:37pm NYSE:DBO NYSE:ERX

Jared Cummans: Crude oil is arguably the most widely-traded commodity on the market and it is also one of the most significant. Much of the past year saw crude sway violently back in forth much like general equities, but oil prices have recently been enjoying a nice upward momentum that began in early

October. With prices now broken through the triple digit barrier once again, investors look to the price drivers for crude to see if the commodity is overvalued or if now may be a good time to buy in. Perhaps the most important factor to consider in trading crude today is the tensions and issues revolving around Iran [see also 12 High-Yielding Commodities For 2012].

The past year dealt with a widespread revolution through out Africa and the Middle East, halting the crude production of some of the most powerful producers on the globe. This sent prices up to $115/barrel, levels not seen since the recession. However, once the dust settled crude plummeted to $75/barrel, illustrating losses of roughly 34.8%. After the death of dictator Muammar Gaddafi, many had hoped that Middle Eastern tensions would finally subdue. But recent weeks have seen issues flare up in a far more significant nation, Iran. As one of the global superpowers of crude, the uncertain future surrounding Iran has many fearful for future crude production and consumption, while investors are scrambling to figure out what will happen to its price [see also Crude Oil Guide: Brent Vs. WTI, What’s The Difference?].

The Facts

According to the CIA factbook, Iran is the fifth largest producer of oil in the world, with an average output of 4.2 million barrels per day, roughly 5% of the world’s crude production. For reference, the U.S. ranks as number three with about 9.7 million bbl/day and Suadi Arabia comes in as number one with more than 10.5 million bbl/day. From a reserves standpoint, Iran is also a key player with enough oil to continue current production for roughly a century. With massive figures like that, the tensions mounting could have a significant impact [see also 25 Ways To Invest In Crude Oil].

The trouble stems from Iranian nuclear policies where the U.S. and others aren’t exactly thrilled about Iran’s testing and use of nuclear facilities. Then came the threats. First came the threat of Iran to close the Strait of Hormuz, a small body of water through which nearly 40% of the world’s oil passes. The U.S. responded by saying that we will not allow for such a vital passageway to be closed and that we would have to use force to uphold this statement. Iran was quick to respond with a direct threat. “I advise, recommend and warn them over the return of this carrier to the  Persian Gulf because we are not in the habit of warning more than once” said army chief Ataollah Salehi.

The U.S. has now responded with sanctions against Iranian oil, making it very difficult to purchase, and the European Union is also expected to follow suit in the next few weeks. Unfortunately, these sanctions did not hold in China, Iran’s largest consumer, as the nation refused to participate in the action. This issue has now turned into a massive global affair with neither side refusing to back down. It seems that crude oil is poised for volatility in the days ahead, but many are wondering what this could mean for their portfolios and crude investments [see also Crude Oil On Fire: Examining The Commodity’s Rise].

What It Means To You

While a dip in supply would often mean a jump in prices, that may not be the case in this instance. Goldman Sachs actually predicts a bearish trend for crude, stating that, “as oil producers and refiners  have reacted to the new U.S. sanctions against Iran and prepared for  the likely implementation of a European Union embargo of Iranian oil,  the escalating tensions between Iran and the West have likely been  exerting a near-term negative influence on crude oil prices”. Many investors assume that there is a premium embedded in current prices given the fear of the supply dip, but Goldman found “strikingly little evidence” of this being true. Instead, the EU and possibly the U.S. are likely to replace Iranian crude with more from Saudi Arabia [see also The Five Most Active Commodities of 2011].

Goldman was quick to note, however, that OPEC was very low spare capacity, which could leave crude subject to heavy volatility in the days to come. It seems that in the very short term, oil prices could experience a quick jump that would likely last for only a few days. Beyond that, it is important to note that Saudia Arabia has already pledged to offset any production losses from Iran on top of both Iraq and Libya increasing their production. For active traders, crude could make for a sweet play for a few days, but over the longer term, increased production from around the world points to relief from high oil prices [see also Three Commodity Plays For 2012].

Ways To Play

For those with a strong opinion on which way crude oil is headed, we outline several key investment vehicles below.

  • CL Light Sweet Crude (WTI): These optionable futures are some of the most popular on the NYMEX. Currently the most popular contracts expire in March and June though the options for investment span all the way out to 2020.
  • United States Oil Fund (NYSEARCA:USO): This ETF that tracks the very futures contracts offered on the NYMEX.  The  fund has  about $1.6 billion in assets and trades an average of 9.7   million times  each day.
  • Exxon Mobil (NYSE:XOM): The world’s largest company by market capitalization, XOM is an investor favorite with an average daily volume of over 20 million as well as a 2.2% dividend yield. For investors looking to make a long term play, this is one of your better options.

Related Tickers: PowerShares DB Oil Fund (NYSEARCA:DBO), Direxion Energy Bear 3X Shares ETF (NYSEARCA:ERY), Direxion Energy Bull 3X Shares ETF (NYSEARCA:ERX).

Written By Jared Cummans From CommodityHQ Disclosure: No positions at time of writing.

CommodityHQ offers educational content, analysis, and commentary on global commodity markets. Whether you’re looking to speculate on a short-term jump in crude or establish a long-term allocation to natural resources, CommodityHQ has the information you need.

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