Why The Latest Rally Needs To Be Sold

Oil prices breached the $50 mark on Thursday as Saudi Arabia and other Gulf states deployed airstrikes into Yemen in defense of the Sunni leadership and against the Shiite Houthi rebels. While oil has moved upwards rapidly after retesting old lows in the low 40's last week, this latest 4% move in oil is counterintuitive and needs to be sold.

Oil has been laboring under very deep stockpile gluts and projections from virtually every American E+P that production is not yet ready to decrease. With surpluses of more than 30 days here in the US, we've reached historic records on storage. Yet storage levels, as important a fundamental as they are, are hardly alone in determining the price for a barrel of oil. In the last week, the dollar finally took a break from its one-way drive to parity with the Euro, allowing oil to recover quickly after testing the January $43 low.

And throughout this downturn in oil, geopolitical events have been mostly ignored. It used to be that a good dustup in the civil war that continues in Libya would translate into at least a $3-$5 rally in the price of crude. But in February, when supplies again collapsed in Libya, the market seemingly didn't care.

But it can't be equally dismissive about military action in Yemen. The 'success' of Houthi rebels in destabilizing Yemen, along with a brutal suicide attack on a mosque in Sanaa killing 137 on March 20 has motivated the Saudis to strike back with air raids inside Yemen. Sunni leaders inside Saudi Arabia, and in other key Gulf states, are also striking directly against Iran, the supporters of Houthi rebels, and protecting the sovereignty of Sunni-controlled regions against the Shiite inroads being made in Iraq and elsewhere in the Middle East. The battle between Shiite and Sunni continues, but the important point is that the Saudis are now frightened enough of an Iranian threat to deploy military force without the aid or consent of the United States.

Oil is reacting to the possibility of further destabilizing military action or a response from the Iranians, both possibilities I think unlikely. The Iranians have already publicly dismissed military action as a possible response, knowing that would almost surely lead to a US showdown.

This action is Saudi in its origin and Saudi in its purpose and in both I think it is ultimately bearish for oil prices. First, the Saudis are reminding the Middle East and the United States that they retain control of the Gulf region and continue to be disturbed by US negotiations with Iran on a nuclear deal and connections between the two in their fight against ISIS in Iraq. Ultimately, the US-Saudi military connection is unbreakable and the Saudis will use that to protect themselves.

And with oil, the Saudis will also use the tools they have to thwart Iran. That means a full-scale continuation of full-throttle pumping, where lower energy prices hurt the cash-strapped Iranian economy many times more than the very rich Saudis and other Sunni states. In my upcoming book, “Shale boom, Shale bust”, I opine that the opportunity the Saudis saw in 2014's oil price disaster is much more about economically castrating the Iranians as it is about thinning out production here in the US.

With new military action against Iran-sponsored terrorists in Yemen, you can expect that any Saudi or OPEC production cut that might have been rumored for 2015 or even much of 2016 is now way off the table. The Saudis are getting serious about their rival to the North. I expect some geopolitical knee-jerk rallying of crude to come of this military action, but ultimately expect to continue to see large buildups and surpluses in production, both here in the US and globally – led by the Saudis.

And that will lead to a still depressed price for oil.