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February 24th, 2011 by

Oil Bubble

Up, up and away, buy oil, buy energy – when I look at a XLE, IYE, OIH I see an almost perfectly trending up straight line. It looks beautiful, it looks like a sure thing. With the political turmoil in the Middle East and North Africa this looks like the right place to be.

Nope, wrong, that’s my opinion! Now why would I say that? Can’t I see the obvious?

Tunisia was the first voice, we did not really pay too much attention – one off. Then it moved East to its big brother Egypt. That got things noticed, but we were holding steady. Why? We all did our analysis and it did not seem that what was happening in those countries on the political front would have a major impact on stock price in general, remember it kept going up, and on energy and oil sector in particular.

Now with Libya, things become more interesting, in a bad way of course, because Libya produces oil and the “crazy one, Gadhafi that is, threatened to burn the productions sites. Crude oil prices are already up to $100 a barrel. And Libya conflict has not even at its peak yet. There is more of course, Bahrain is still very much in play, Jordan is nervous, Iran is not missing an opportunity to push its agenda through provocations and stirring trouble with its neighbors. Then who knows who goes next and where and how it will affect the energy sector.

So we still have a way to go, we probably not even in out of the first half. But I think we should look at things more clearly and we need to put things in perspective.

I don’t want to make it a political discussion, but I do want to connect the dots between what is happening in the Middle East and North Africa and what is happening next to my office, down on Wall Street. I want to connect the economic dots of it all.

On the political front, and although some spoiler countries are trying to prove me otherwise, it is not in any one’s interest for the energy prices to go up. The economy is bad in the US and worse other places. Simple supply and demand discussion will tell us that higher energy prices will push our (meek) recovery, according to the WSJ, towards a Double Dip. The “rational” oil producing countries learned that lesson well and want to avoid it.

Look at the Saudi Arabia’s King Abdullah, he is back home from medical treatments and the first thing he does he announces a massive social and economic programs to minimize any kind of political upheavals in his country. And although he could not save Mubarak (he tried), he is going to do all he can to save Bahrain, and he will. Although Mubarak’s Egypt is a heavyweight, it is less economically, although more politically, important than Bahrain. Bahrain is just too close to home for King Abdullah, it stations our US Fifth Fleet, it is a significant oil producer, as well a regional financial center. Just think for a second what would happen if the government in Bahrain changes and our Fifth Fleet is forced out of the area…to say it mildly, that would be a major destabilizing factor for the oil and energy sector and crude transport out of the area.

Now let’s look at the purely economic side of the oil and energy demand. Yes, the US economy is “kind of” growing, but significant driver of rise in energy prices was demand from China. In my opinion, yes here I go again throwing out opinions, China is basically done with high growth. I believe that China bubble will be upon us soon, for many internal, overexpansion, labor and inflationary reasons.

So the bottom line is that the overall energy demand is slowing down, that means crude will not sustain its growth and the current political issues are a spike. I don’t know how long this spike will last, but it will peter out and we will be back to the slower world energy consumption.

With that in mind, unless you are a day trader, I would not recommend going long energy or oil.

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