Option Investor
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Smoke and Mirrors

HAVING TROUBLE PRINTING?
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Condeleezza Rice launches into a tirade against Iran and Iran launches a new flurry of missiles as a warning that severe retaliation will fall upon any country stupid enough to attack Iran. Is that really what happened? More and more reports are surfacing suggesting those missiles may have been tested several years ago and those were just old videos.

Iran already admitted one of the videos had been altered to show four missiles being fired instead of three that actually took off. The fourth one was a dud but was added back into the picture later.

Missiles are expensive and even more so when a country is accumulating debt faster than blowing sand. Getting spare parts is another problem. Why waste several million dollars worth of missiles when you might actually need them for a future war? U.S. intelligence experts claim these were old and outdated missiles and did not have the range Iran was claiming. Obviously this is just speculation on my part and others on why Iran chose to release those videos. Whatever the reason oil prices benefited.

I have been speculating all week that Iran was more concerned about jacking up the price of oil than deterring anyone from attacking them. I have listened to several retired generals this week who claim there will be no attack. First because the distance and logistics are too far and too tough for Israel and second because the U.S. will not let them attack. The U.S. is trying to wind down violence in Iraq and an attack on Iran by Israel or the U.S. would increase the intensity of Iran's involvement in Iraq exponentially. Iran has threatened the U.S. with this escalation and this is not an idle threat. Bush may not want Iran to have a nuclear weapon but there have been some recent discrepancies come to light on the Israeli intelligence claiming Iran will have weapons capability as early as 2009. If the intelligence was credible Dick Cheney would be leading the attack himself.

While the U.S. is not cooling its vocal attack on Iran as evidenced by the Rice speech this week they are still trying to use peaceful means to shutdown Iran's nuclear ambitions. That does not include allowing Israeli planes to use Iraq as a staging area for an attack as the Jerusalem Post claimed on Thursday.

The post said Israeli planes were using an airbase in Iraq to stage supplies and for Israeli pilots to practice tactical missions in identical terrain as they would find in Iran. The Israeli government, Iraq government and the U.S. government said this claim was utterly baseless. It was however another strong psychological attack aimed at keeping Iran off guard regardless of who actually planted the story. The rumors sent oil prices soaring to a new high on Friday at $147.27 before multiple denials ended the rally.

I believe all the thrust and parry maneuvers by the U.S. and Israel are meant to keep Iran guessing. Iran's propaganda is meant to push oil prices higher. Do you really think anyone is going to be scared off from attacking Iran just because of video of some outdated missiles that didn't even launch reliably? I doubt it. If they wanted to scare off attackers they would have shown their jets with the new high technology missiles they got from Russia or the extremely high tech antiaircraft missiles they have ringing the nuclear installations. If you want to threaten someone you need to have something they would be afraid of. It is all smoke and mirrors and I doubt they will have anything to do for an encore next week.

A more important problem for oil supplies is the cancellation of the cease-fire in Nigeria as of midnight on Friday. The cease-fire lasted only about three weeks before the MEND rebels became upset about Britain's backing of the government in the conflict. You can expect some more violence directed at the energy infrastructure next week just to prove they are back on the attack. The MEND rebels have kept over one-third of Nigeria's crude off the market for most of the last year. Nigeria's crude is the light sweet variety and the kind in high demand.

Petrobras said their workers on 42 offshore platforms in the Campos region were going to strike for five days next week. The workers are trying to get an extra day off every work cycle. Currently they work two weeks on and three weeks off. What a deal and they are whining about another day. Get a life! The workers said they would let a minimal amount of oil through as long as Petrobras did not try to replace them with alternate crews. If Petrobras brings in new crews the striking workers said they would disable the system. This area produces 1.8 mbpd for Petrobras. The actual impact on the world demand will be minimal as long as the strike is peaceful.

The following paragraph is reprinted from this weekend's Option Investor commentary.

Matthew Simmons was interviewed on CNBC again on Friday and was again adamant that this price hike was just another step higher towards $200 oil and higher. He said as long as so many people continue to expect a return to lower prices nothing will really change. Consumers will drive less in the short term but not really change their consumption habits. He thinks the government should be worried about how to limit consumption and increase production rather than focusing on a witch-hunt for whatever demon caused the problem. He believes the U.S. is on a dangerous spiral where inventory levels continue to decline until some geopolitical event causes a severe shortfall in imports. When that happens there will be a shortage of gasoline and diesel and the country will see severe civil unrest from the lack of fuel and food. I know this sounds dire but I have been preaching this for several years. All of my predictions have come true as many of our readers know. This is just another step in the process of peak oil and while we have not seen the top in production yet it is expected to be in 2009. Once that occurs there will be a serious downward economic spiral not just in the U.S. but around the world. Peak oil does not mean the end of oil, just the end of cheap oil. Every barrel from that point forward will be fought over either by bidding or shooting or both.

Crude oil inventories dropped -5.8 million barrels last week making the combined drop for the last eight weeks nearly 32 million barrels. There was a substantial decline in crude imports and refiner consumption rose slightly ahead of the July-4th weekend. Analysts believe the emergence of Hurricane Bertha off the coast of Africa and progressing towards the U.S. disrupted the flow of oil from that direction. This suggests we could see a large jump in inventories in two weeks now that Bertha has moved north and out of the tanker path. I also believe refiners and pipeline companies are reluctant to buy oil for inventory at these high prices. With the crack spread at $5 a barrel the risk is too great. With crude prices swinging $5 a day it could be significantly lower by the time you actually got delivery and it would be impossible to refine it for a profit.

Oil and Gas Inventories

The $9 drop in oil prices on Mon/Tue knocked us out of four positions (NE, NOV, PDE, PBR) but gave us entry points in four new positions. (ANR, MOS, FLR, TS, SD) If the bear market continues or we get another swoon in oil prices we could lose some more. It is amazing to me that oil can be trading within reach of $150 but many of the oil stocks are at multi month lows. Actually quite a few of the S&P-500 are at new lows simply because investors are moving to the sidelines rather than fight the market volatility. It is not just energy but almost every sector. Heck, RIMM hit $109 on Friday and well off the $148 high just a couple weeks ago. Their business model did not change and they received several high profile upgrades over the last couple weeks. It is just a bear market and all stocks go down. I am actually rather pleased that many of our positions this posted gains.

Jim Brown


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