Impossible to Short Crude

 | Dec 05, 2011 | 10:00 AM EST  | Comments
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Stock quotes in this article:

vlo

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tso

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cvi

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hfc

Oil markets are experiencing upward pressure again, most recently from events in Iran. Despite the fundamentally bad outlook for crude, this latest rally in oil shows why the financial oil markets are basically impossible to short. For retail investors it is better focus on stock sectors that can take advantage of what are basically broken oil markets. 

The International Atomic Energy Agency (IAEA) reported last week something most of us already knew, that Iran's nuclear development program has not been entirely "humanitarian," as it claimed. Much of their research and development has been undertaken to develop a nuclear device. 

The British joined the US in more stringent sanctions against Iran, followed by the Iranian students invasion of the British embassy in Tehran, closely again followed by British expulsion of Iranian diplomats and talk of a full-scale European boycott of Iranian crude imports and a reprise of possible Israeli and/or Western military action against the Iranian nuclear complex.

With daily exports of 2.4 million barrels, Iran represents the third-largest exporter of crude, behind Russia and Saudi Arabia. 

Still, the truth behind all the threats are not fundamentally nearly so bullish as they sound. But it is how they sound that often matters most in these financially interconnected markets.

A threat of military action from Israel has been a long-standing overhang in the oil markets, dating back at least for the last four years. Whatever premium there is from this threat, it has been in the price for quite a while. Even the threat of a full-fledged European ban on Iranian crude is relatively toothless. More than 70% of Iranian crude heads for Asia to begin with, with most European imports headed towards Turkey and Greece, both of whom have much different relationships with the Iranians than with their other European brethren.  In the global oil markets, petrodollars always trump politics, meaning that Iranian exports are unlikely to drop much even with the most draconian import ban.

But for the markets, not much of that really matters. Headline risks from an Iranian flare-up are all that are needed to get the hedge funds, algorithmic black boxes, index speculators and long-short managers to hit the buy button right away. It's practically impossible to be short crude.

But we can take advantage of the almost sure, if short-term, spiking in the oil markets. One area where a quick spike in European crude prices will hurt is in refining stocks, whether that spike is artificial or not. 

That is because while crude markets will readily rally on the merest news, gasoline and distillate markets are more likely to adhere more closely to the fundamentals.  Margins on refining get slashed when crude price are going up quicker than their associated refined products. Even as cheap as many of the refiners are trading, I still don't like their associated stocks, including Valero (VLO), Tesoro (TSO), CVR Energy (CVI) and Holly Frontier (HFC), among others.

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