How Will the Iranian/US Tension Affect the Energy Complex?

This week crude bears were finally able to break support, taking near month crude futures out below short term trading ranges. Bulls came back into the market Friday defending the $65 support level. However, energy option put buying on HO, RBOB and CL, have dramatically increased, indicating fear of a continuing down trend. Will Iranian nuclear negotiations next month reverse these fears?

The G20 meetings this week ended on a sour note with President Obama coming forward with accusations Iran is producing enriched uranium at a previously undisclosed facility. The month of October will continue with back and forth verbal attacks, with little progress towards a resolution, unless China and France back Obama's call for stronger sanctions.

Since Iran is less than 3% of world crude production, current over supply will easily make up for any lost barrels on the market. The greater concern is a decrease in Nigerian low sulfur crude production.

Nigeria produces 13% of world low sulfur crude. Low sulfur or "sweet crude" is preferred by refiners as production costs are less than the more plentiful high sulfur crude or "sour crude". Many refiners are are not capable of cracking sour crude into petroleum products.
Nigerian sweet crude production is down one million barrels per day vs 2005 levels.

Refineries in Nigeria have been cutting production and closing facilities due to political unrest and lower demand. Any increased violence in this area will create a return to 2008 bottlenecks of world sweet crude supply resulting in increased prices for crude and petroleum products.

This is not to down play the seriousness of the tension in Iran. Should verbiage escalate into actual physical conflict, crude will be well on its way back to $100. The greater probability is for shortages of sweet crude keeping energy complex futures firm.

Event Anticipative Energy Trading

Successful energy traders maintain their edge by knowing what potential market moving events will occur during a particular week. Some will anticipate outcomes placing trades prior to the events. Others will wait until the results are known.

The market moving events scheduled for this week include Wednesday's Federal Reserve meeting and Thursday's and Friday's G20 meeting in Pittsburgh.

Should the Fed or G20 surprise with news that stimulative programs, including low interest rates, are no longer necessary, look for market participants to quickly sell out of long positions, taking the energy complex down quickly.

This scenario is highly unlikely to become reality as governments want to see unemployment numbers improving before even thinking about fighting inevitalbe future inflation.

In anticipation of this week's events, crude traders will likely begin the week hoping for a pull back to $70 and then begin putting on long positions for the ride to $75.

China's Liu Xinhua Assures Energy Markets

Liu Xinhua, Vice Chairman of China Securities Regulatory Commission, assured energy markets by saying China will seek to promote a stable and healthy market place. His comments alleviated concerns certain Chinese state owned companies would default on heavily out of the money hedge positions.

Free now from fear of counter party concerns, energy traders have been focused on US dollar weakness. The dollar is making almost daily lows vs the euro giving crude traders confidence in long positions.

With EIA inventories showing a large draw in US crude supplies last week, fewer traders will be comfortable on the short side.

Potential China Derivative Contract Defaults

Crude is having a swift fall from yearly highs. Investors looking for the reason are pointing to China owned commodity derivative contracts, currently deeply out of the money.

It was China's buying of commodities that led crude to its yearly highs. Rumours are now circulating that several state owned China entities may walk away from hedging bets put on prior to the collapse of the world wide economy.

The total amount of derivative contracts at jeopardy is not known, but counter parties at risk advise the dollar amount is substantial.

If the rumours turn out to be true, world banking will be in for another round of losses; crude and the refined products will continue to sink.