Oil – Tom Keene’s Question

June 19, 2014

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“Why is the oil price not rising more?” asked Tom Keene during his interviews on this morning’s Bloomberg Surveillance.

Our answer: we are witnessing the early, still-evolving stage of the extreme, destructive Islamic militant breakout in Iraq and Syria. It is spreading in the region. Hence the oil price is in an upward trend. In our view, the trend has only just begun.

The Ned Davis database is helpful here. Ned Davis published an analysis on June 13. It covered 21 different crisis events in the Middle East and how they have affected the Brent Crude oil price.

The database demonstrates that some crisis events triggered very small movements in the price of oil. The bombing of the USS Cole on October 12, 2000, is an example. The oil price was up 10 percent about three months prior to that bombing. It was flat one month before the event and fell at the one-month and three-month intervals after the bombing.

On the other hand, the Gulf War and Operation Desert Storm raised the price of oil robustly for many months before and after the event. The price volatility was huge.

This list of 21 events spans nearly 40 years. It shows that volatility in oil price movements can be extreme and lasting. Each of the events is different, but there are some general characteristics that are important. Three months before a Middle East crisis event, the median oil price rise was up over 8 percent on average. That price was up an average of 4.5 percent one month before the event. After the event it was up an average of 5 percent in one month. Three months after the event, the price was up over 3 percent.

Those were the median percentage gains at each of the milestones. It is very important to distinguish between the median and the mean when doing this exercise.

The means were higher than the medians. That shows how violent and volatile oil price spikes can be when they reach extremes. In other words, this is not a smooth curve. There is huge risk in the “tails.”

We do not believe the median numbers are helpful. They do not give us guidance as to what should be done in a portfolio, though they do help identify an upward bias in the oil price. The mean numbers suggest that when oil price spikes occur and become robust, they reach real extremes.

Percentage moves in the oil price over a period of several months can be as much as 30 percent to 40 percent. A lot depends on how widespread and destructive the events are. For example, when Saddam Hussein was thwarted in his invasion of Kuwait, he set fire to Kuwait’s oil fields. It took months to put out the fires, rebuild and restore production. When the Libyan uprising began and Muammar al-Gaddafi’s government fell, the process raised the price of oil over a period of several months and by large amounts. So far, the world has not recovered from those events in Libya. The turmoil is ongoing.

We now see a very large, spreading, destructive, grisly, radical Islamic force at work in a number of sections of the region known as the Levant. We see a spreading infection of this force in other places in the world, including oil-producing Nigeria.

The upward bias in the oil price continues. We have yet to see it run its course. We have no idea how high the price may rise. We have no idea how much destruction lies ahead.

Cumberland Advisors remains overweight in the Energy sector. We watch the news continuously and think Tom Keene’s question is best answered by, “It is too soon to tell.”


The ideas and opinions expressed in this blog are those of the author, and they should not be perceived as investment advice or as any other kind of advice.

The preceding has been reposted with permission of the author. The original commentary is available at http://www.cumber.com/commentary.aspx?file=061714.asp.

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