The Energy Report: The Fed's fickle finger of fate.

Phil Flynn

First Energy Financial

Jun 22, 2009

The Fed's fickle finger of fate.

We can talk about the way the oil market has run out of steam or how the futures market seems to indicate that gasoline prices have topped for the season. We can talk about the way oil seems to be failing going into today’s contract expiration. We should talk about what oil has ignored such as threats to global supply in Iran and Nigeria. We can talk about how the market ignored increasing oil imports to China because some feel China has bought more oil than it needs. We can talk about the seasonality of the market and how often we see oil top this time of year. But what may actually happen to oil and its fortunes may come down to the Feds fickle finger of fate.

Once again the Fed has the power to determine whether this sell off in oil and the products is just a minor setback in a secular bull market or the beginning of a major top. The main driver of oil has gone beyond traditional measures of just supply and demand and has metamorphisized into a macro economic force that at times measures the state of the global recovery and other times becomes a safe haven from the dollar or inflation or systemic risk. Oil has been driven in large part by the Fed's efforts to save the economy using quantitative easing (printing money) and by historic simulative activity. The Fed has the power by what it does this week to seal the market's fate.

My buddy trilby Lundberg of the Lundberg Survey writes in a new report called “Stimuli" Or Not” the flood of dollars causing oil price spikes that, “Crude oil's dramatic price climb from $33.98 in mid-February this year to $71.03 on June 17 comes not from the world economy, a surge in demand, or lack of supply, but from the weaker U.S. dollar and the market's view of future demand growth. In Euros and in gold, the price of oil also has risen, but less so than it has in dollars."

Even today oil is responding to the value of the dollar that seems to be gaining strength due to rising economic tension as well as the hope that the Federal Reserve will finally give us some type of exit strategy from this unprecedented and historic economic stimulus. Dow Jones Newswires wrote that, "when Federal Reserve officials meet this week, they will spend a lot of time discussing exit strategies. When should they start unwinding their efforts to stimulate the economy? How should they go about doing it? It's easy to answer the first question: not soon.”

Dow Jones says that, “The economy and financial markets have stabilized in recent weeks, but Fed officials want more evidence a recovery is for real. The economy is on track to contract at about a 1% annual rate in the second quarter, according to forecasters Macroeconomic Advisers. That would be the fourth straight quarterly contraction.” If the Fed feels that it is too soon to talk about an exit strategy and wants the market to back off in predicting that we will see rate increases this year, then oil will make new highs soon. If on the other hand the Fed starts showing unease at the way the globe has questioned the strength of the dollar and its policies, then oil can fall dramatically. Most feel the Fed will tread lightly and not give us encouragement that the printing presses will go idle soon.

Another weekend of violence and drama in Iran and oil is lower. The Supreme Leader is not looking supreme as the people rise up in Iran. Still oil is lower. Many want to know why. Well first of all, as Dow Jones news report, Iran's oil industry has been unaffected by the recent unrest citing state-run Press TV reports, citing the country's OPEC governor. Do we believe anything the state run Iranian new network runs? In this case yes. "The recent developments in the country have had no impact on the oil industry or crude exports. The national oil industry is 100% normal," Mohammad Ali Khatibi said. He put Iran's oil production capacity at 4.3 million barrels a day, according to the report and said Iran has cut production in line with the Organization of Petroleum Exporting Countries directive.

Brendan Coffey wrote this weekend that, “One year ago, when oil was $140 a barrel and gasoline averaged $4.10 a gallon, what is going on in Iran today would have been the apocalyptic capper to a doom and gloom start to the summer. If you can recall (and strangely isn’t it hard to? It’s just one year) about one year to the day Congressmen were calling for an investigation into oil prices and the LA Times was soberly detailing what would happen if oil hit $200 a barrel.Today, there is upheaval in a nation of 70 million people that is a member of OPEC, and which exports a large portion of the oil the United States needs to import. The market’s reaction? Yawn.

“We’re living in a new world of spare oil capacity,” Phil Flynn, energy analyst for futures brokerage Alaron Trading told me midday Friday. “There was a time when President Ahmadinejad giving a tirade would rally oil $5 because the world was so concerned of the ability to meet demand - OPEC couldn’t keep up, guys were worried Peak Oil had arrived - everything was just a panic.”

Now, the market is paying some attention, but just to pass the time: "Unless they take over the oil fields and cut off supply, then maybe there would be a problem.” But probably not. A year ago, “the market would have been up $10, $12 - or more - immediately,” on simple fears of a disruption, Flynn says.

Last year, OPEC was churning out record oil of around 32 million barrels a day to try and meet demand not just from the U.S., which imports 12 million barrels a day, but also a go-go Chinese economy. Today, the cartel has been forced to cut back to just 26 million barrels and even that is too much for slackened demand caused by the economic recession. The current oil price of $72 many feel is too high given the state of the world economy and the significant amount of oil in storage. One potential result of the global excess of oil supply is that the U.S. may not be as hesitant to apply a little more pressure on Iran than it would be if we were in a state of high oil prices. Iran isn’t even high on the list of market worries: in recent months the market has lost more oil supply from upheaval in Nigeria than Iran even exports, so the action of the Ayatollah may mean a lot for democracy and even regional security, but not for the gas pump. Kind of nice, for a change.

If you need a change try the Fox Business Network where you can see me every day! Also if you need to change your broker call me at 800-935-6487 or email me at pflynn@alaron.com to open your account.