Maintaining A Long Bias On Oil

The timing of these pieces, coming at the end of the week, is sometimes a frustration, but often a blessing. There are times when I want to give you a “hot take” on something in the news. After all, as somebody who made a living in a dealing room for a couple of decades, reacting is kind of what I do. However, my inability to react immediately to this week’s big news, Trump’s decision on the Iran deal, was probably a good thing.

On the surface, the market implications of the decision were obvious. Even those who believe that the original deal was a bad one would struggle to argue that unilaterally withdrawing from it left the Middle East more stable than it was before, and instability in the region always pushes oil prices up. Because of the potential significance of the announcement in that regard, my own hot take was that oil was about to fly. WTI did indeed jump, but as you can see from the chart below, on the initial reaction, futures only made back the ground lost earlier in the morning, when a rumor surfaced that Trump would stay in the deal. I did manage to get long shortly after the announcement and made money on the trade, but it was a long way from the home run I envisaged.

(Click to enlarge)

After that muted initial reaction we have continued a little higher, but still not nearly as much as many people expected. What I and many others forgot in our enthusiastic bullishness when the news came on Tuesday was something that I preach about here regularly. When trading in front of or in reaction to news of any kind, the most important consideration for traders should not be the news itself, but how the market had positioned itself going into the release. In this case, given that Trump had been signaling his intentions with regard to the agreement since the campaign, traders had been betting on a withdrawal for about a month. Other factors had also driven oil higher, but by Tuesday just about everybody was already long.

Little wonder then that the initial reaction was not what was expected. More careful consideration hardly lit a fire under the market either, as in Trump’s speech on the matter he made it clear that the withdrawal and the accompanying sanctions would be phased in over a long period of time, potentially reducing the disruption.

Still, looking at the withdrawal now with the benefit of hindsight, it still looks to me that, probably because of all the advanced positioning, the market is underestimating the long-term effects of Trump’s decision. For evidence I would point to what has already transpired. A now unrestrained Iran and a newly emboldened Israel have clashed already, with the prospect of all-out, open warfare in Syria raising its ugly head. Given the tribal and historical enmity between the Saudis and the Iranians that could lead to an unlikely, convenient alliance between Israel and Saudi Arabia and a conflict that engulfs the whole region.

Of course, all of this is speculation and one could argue that the prospect of disruption in the Middle East is nothing new. However, the immediacy of the escalation of conflict following the announcement makes this seem different. Even if things do die down though, there will be upward pressure on oil. The two big winners in oil terms are Saudi Arabia and Russia. Both of those countries are signatories to the OPEC et al agreement to cut production, and both are on the hawkish side, looking to push oil even higher than current levels. This makes it more likely that they will get their way.

However you look at it, despite the weak initial reaction to the news, the U.S. exiting the Iran nuclear agreement will push oil higher. That may not happen all at once or in a straight line but maintaining a long bias in oil looks sensible for the foreseeable future.