Oil! The price forecasts vary. Why?

David R. Kotok co-founded Cumberland Advisors in 1973 and has been its Chief Investment Officer since inception. He holds a B.S. in Economics from The Wharton School of the University of Pennsylvania, an M.S. in Organizational Dynamics from The School of Arts and Sciences at the University of Pennsylvania, and a Masters in Philosophy from the University of Pennsylvania. Mr. Kotok’s articles and financial market commentary have appeared in The New York Times, The Wall Street Journal, Barron’s, and other publications. He is a frequent contributor to CNBC programs.

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Oil! The price forecasts vary. Why?
August 23, 2009

Oil flirts with $75 dollars a barrel. Forecasts range from a low in the $40s to $85-90 before the end of the year. Inventories on or off the water, futures and ETF-driven trading forces derived from dollar strength or weakness, China’s and other emerging market countries’ demand, mature countries’ economic recoveries, fuel substitutions when natural gas prices are so low relative to oil – these are some of the crosscurrents that make the oil price so difficult to determine.

One oil price driving force that has been more obscure lately is the geopolitical risk in the Persian Gulf at the Straits of Hormuz. This body of water, situated between Iran and Saudi Arabia, is what Stratfor’s George Freidman has described as Iran’s “true nuclear option.” The details of that analysis are found in the last several discussions at www.stratfor.com. Cumberland is a subscriber; readers may wish to try the free subscription available on their website and see if they like the service. It will give you an opportunity to read the Iran and Persian Gulf analysis.

Stratfor disclosed some intricate and little-known intelligence items this week while market agents were busy with Bernanke at Jackson Hole. At the end of August, it takes shocks to pry folks out of vacation mode and away from the Kansas City Fed meeting. For us, some long plane rides and two days’ work in Salt Lake City gave us a reading opportunity. We immediately asked for and obtained permission to republish the last Iran situation analysis for our readers. It follows below.

Friday, August 21, 2009

Mixed Signals From Tehran, by Stratfor, www.stratfor.com .

“THE IRANIAN GOVERNMENT’S BEHAVIOR has grown a bit more bizarre over the past several days — as to be expected, with a September deadline looming for negotiations with the West over its nuclear program.

U.N. officials revealed Thursday that Iran had allowed International Atomic Energy Agency (IAEA) inspectors access last week to its nearly completed Arak heavy water reactor for the first time in a year. Iran also agreed to allow expanded IAEA monitoring of the Natanz uranium enrichment site, which produces material for nuclear fuel that potentially could be enriched further for use in nuclear warheads.

In addition to these confidence-building measures, the Iranians also appear to be using private channels to dilute the U.S. perception of an Iranian threat. After Israeli President Shimon Peres left a meeting with Russian President Dmitri Medvedev in Sochi on Tuesday, STRATFOR received word from an Iranian diplomatic source that Russia has flatly refused to sell Iran the S-300 strategic air defense system. Iranian Defense Minister Mostafa Mohammad Najjar (nominated by President Mahmoud Ahmadinejad to be the new interior minister) was rebuffed by his Russian counterpart when he visited Moscow in February and, despite his attempts, has not since been invited back. The Russians allegedly told the Iranians that as long as concerns remain over Iran’s nuclear ambitions, they can pretty much forget about the S-300.

The timing of this message is interesting, especially as Russia, in recent weeks, has been the one to draw attention to possible weapons sales to Iran. Even after the Israeli president traveled to Sochi to warn the Russians against arming Iran, state arms exporter Rosoboronexport announced that it would consider Iranian requests to buy front-line fighters and bombers. Peres claimed that Medvedev promised to reconsider the matter of S-300 sales to Iran, but the Kremlin has not confirmed making such a pledge. With Russia’s negotiations with the United States currently in a flux, the Russians want to remind Washington of the upset they could cause in the already shaky state of affairs in the Middle East should their demands be ignored.

“The Iranians evidently are nervous enough about this September deadline that they feel the need to give the West at least some assurances that they are willing to cooperate.”

But the Iranians evidently are nervous enough about this September deadline that they feel the need to give the West at least some assurances that they are willing to cooperate. While trying to soften up its image, Iran also might be seeking to want to give Washington the impression that, in light of the domestic political turmoil that followed presidential elections in June, the regime simply isn’t prepared or capable of committing to serious negotiations in the near term.

This was the kind of mixed message that came across Tuesday, when Iran’s envoy to the IAEA, Ali Asghar Soltanieh, said on state television said that Iran was ready to resume negotiations with the West over its nuclear program — as long as the talks were held without preconditions and based on mutual respect. Several hours later, Soltanieh publicly claimed he’d never said anything about Iran’s readiness for negotiations; he attributed his earlier comments to a letter he had sent to the United Nations, calling for a ban on armed attacks against nuclear facilities around the world. The lag between the first statement on state TV and Soltaniehs odd retraction gave the impression that there were competing opinions among the regime elites over how to negotiate with the West, and that Soltanieh had spoken prematurely. There was enough confusion that day that Washington didn’t bother responding to the statement either way.

Between threats of crippling sanctions on Iranian gasoline imports and hinting at military action, the U.S. administration has insisted that this September deadline would not come and go without consequences if Iran defies demands to curb its uranium enrichment programs. There are methods to getting around sanctions, but the Iranians don’t seem to be in the mood to take many chances on the military threat. As we have recently noted, the real nuclear option that Iran holds against the United States is the threat of mining the Strait of Hormuz. This is an option of last resort, however — and while Iran’s leadership is playing out all the options, it has a need to make itself appear as confused and benign as possible.”

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We again thank Stratfor for permission to share these views.

Stratfor’s analysis reminds us of previous periods when oil prices firmed. We reach back into history to the time when the Egypt closed the Red Sea to Israeli shipping and triggered a war in 1967. We recall the 1973 invasion of Israel on the Jewish holy day of Yom Kippur. We remember the Iraqi belligerency of Saddam Hussein. In many instances there was a firming of oil prices that preceded some hostile action in the Middle East.

Those price hikes had no apparent explanation at the time. The clarity came after the events. There are oil-trading companies linked quietly to Middle Eastern governments; many are owned or controlled by the rulers of those countries or their neighbors. They know that oil prices will spike on geopolitical risks. They take long positions prior to actions that will cause those prices to spike. At the time preceding the outbreak of violence, the markets don’t have a clear explanation for the rising price. That is the pattern of the last 50 years.

Having followed Stratfor’s details on the developments in Iran, we speculate as to whether this is another one of those developing instances. Our primary rule about the Middle East is simple: when it is too quiet and there is no apparent violence, the situation is temporary and will soon change for the worse.

Is there going to be a September surprise? As Stratfor notes, September is a key month for Iran and for the US. The same is true for oil

David R. Kotok, Chairman and Chief Investment Officer, email: david.kotok@cumber.com