Call (866) 878-2881 to learn more about our investment strategies.

Commentaries & market updates.

There is no “war premium” in the price of oil!

There is no “war premium” in the price of oil!

Many economists, energy analysts and investors have attributed the recent
rise in crude oil prices to a “war premium.” However, such a belief
may be nothing more than wishful thinking. In order for a war premium to exist
in advance of the war itself, two elements must be present:

1. There must be a general belief that oil prices will rise in the event of

2. There must be either an active accumulation of inventories as individuals,
companies, traders, etc stockpile oil now (with the intention of either selling
it or using it during the war, when prices will presumably be higher), or producers
must scale back current production, preferring to sell later at higher prices.
(It is either this increase in excess inventory or the decrease in production,
relative to current demand, that causes a war premium.)

However, neither of these elements are now present.

In fact, the consensus opinion is that oil prices will fall after the war
breaks out. If so, why would anyone of that opinion stockpile oil now? In fact,
given the consensus, one would expect a depletion of inventories as oil users
purchase as little oil as possible, preferring to wait for the lower prices
which will presumably prevail after the invasion. This, of course, is exactly
what is happening. This week the department of energy reported that U.S. crude
inventories fell to a 28 year low. Considering how much more oil we consume
daily than we did 28 years ago, that figure is even more startling.

What these low inventory levels actually reveal is a “war discount” in
the price of oil. Because of the widespread belief that oil prices will fall
after the war, inventory levels are being depleted, resulting in oil prices
being lower than they otherwise would be under normal inventory levels. However,
once the war breaks out, these low inventory levels will need to be replenished,
putting additional upward pressure on prices. In fact, the belief that oil
prices will fall is so prevalent that even with the current high prices, exploration
has been sharply reduced, and the share prices of oil and oil service companies
have been falling. And all this is taking place during a period when OPEC members
are producing at maximum capacity. What’s worse, given the low inventory levels,
if there is actually any disruption of supply as a result of the war, oil prices
could soar, perhaps as high as $50 – $100 per barrel. Now that would be a war
premium- and, given the lack of exploration, it could be a long time before
prices come back down.

Just because oil prices happen to be rising prior to war with Iraq does not
in and of itself create a direct relationship between the two. It is my opinion
that these two events, while reminiscent of the Gulf War experience, are independent.
Despite the temptation, comparisons to the first Gulf War are not appropriate.
Prior to Iraq’s invasion of Kuwait oil prices had been fluctuating around 20
dollars per barrel for the prior 4 years. Immediately following the invasions
speculative buying caused oil prices to spike to 40 per barrel. Within a few
short months oil prices had declined back to the $20 per barrel level, where,
despite a momentary drop following Desert Strom, they remained for the following
two years. Contrast that to the current period were oil prices have been rising
steadily for the past year and a half from just under $20 per barrel in November
of 1991 to close to $40 this week.

In conclusion, current oil prices are not rising because of a “war premium,” but
are in fact rising despite the existence of what in reality is a “war
discount.” Anyone counting on a quick drop in prices (after the bombs
start falling) to help the economy or the stock market is going to be profoundly

Sign up for our Free Reports & Market Updates.

You are now leaving

We are providing a link to the third party's website solely as a convenience to you, because we believe that website may provide useful content. We do not control the content on the third-party website; we do not guarantee any claims made on it; nor do we endorse the website, its sponsor, or any of the content, policies, activities, products or services offered on the website or by any advertiser on the site. We disclaim any responsibility for the website’s performance or interaction with your computer, its security and privacy policies and practices, and any consequences that may result from visiting it. The link is not intended to create an offer to sell, or a solicitation of an offer to buy or hold, any securities.

You will be redirected to
in 3 seconds...

Click the link above to continue or CANCEL