#$olo

Oil prices have fallen over 50% in the last year or so, and all the focus seems to be on when prices may or may not rebound. As I wrote a few months back, the price of crude is notoriously finicky, and supply and demand forces can create sweeping shifts in prices very quickly. It’s not bullish or bearish – it just is.

In my view, however, the biggest story relating to crude oil is the one not being told: Why does the U.S. still have a 40-year old ban on exporting it? Many people aren’t aware of this, but by law the U.S. cannot export crude oil even though we are the world’s largest crude oil producer. Indeed, with the shale boom, the U.S. has overtaken Russia and Saudi Arabia as the world’s largest oil (and natural gas) producer, yet virtually all of that supply stays domestic. Why?

The 1973 Arab Oil Embargo

In 1973, Saudi Arabia cut off export oil to the U.S. in direct protest of American military support of Israel’s war with Egypt and Syria. Many of you may remember the drastic impact felt as a result – long lines at filling stations, a rush to pass new fuel efficiency standards, the feeling that your energy had to be rationed. It was a difficult time, indeed, that ultimately contributed to a major economic downturn in the U.S.

The embargo made the U.S. acutely aware – and wary of – their dependence on Middle Eastern oil. The ban on exports followed so the U.S. could protect its domestic supply.

This also served as a catalyst for exploring new resources – drilling in Alaska, the Gulf of Mexico and a slew of shale discoveries and technologies resulting in the product which we see today.

So while the supply dynamic and the market landscape have changed dramatically, the laws have not.

Pros and Cons of Lifting the Export Ban

Let’s start with the most important pro: lifting the export ban will likely help consumers. The price consumers pay for gasoline is set by the world price of oil, not by the U.S. price. And since the U.S. is over-supplied, our prices are lower than global prices (at one point even by $20 a barrel). Read: we’re paying even more for gas than is potentially required.

Another potential positive is that, with the U.S. being a bigger player in the global market, there could be more influence over global prices. This could mean an end to the times of OPEC - ramping production up or down to puppeteer prices for their own benefit.

On the flip side, there are tangible negatives to exporting more oil. From an environmental standpoint, cheaper oil and gas could be a disincentive for development of energy efficient technologies and dilute the urgency in creating alternative power sources. It could also mean becoming even more entangled with the Middle East and Russia, and risking more chess matches with already volatile areas of the world.

There’s a lot to be considered and I don’t think there is a firm right or wrong answer here. If both sides of the debate are considered thoughtfully though, I think there is a happy medium that can provide economic benefit while keeping environmental and national security interests in mind.  

Times They Are a Changin’?

The catalyst for this topic was the recent announcement that the U.S. will almost certainly approve a 100,000 barrel swap of light sweet crude with Mexico for heavy crude. This would be the first swap since the 90's and would move the U.S. an inch closer to reconsidering/ending the 40-year ban on crude exports.

There are plenty of non-U.S. refineries that can handle our light sweet crude, and countries such as Mexico, South Korea, and Greater Europe are keen to import our oil. With our production and supply running at historic levels, it could make some sense to revisit the export ban and open up our market — at least to a degree. It rarely makes sense to argue against freer trade and, in this case, it could be good for longer-term energy prices which helps the consumer.

In the U.S., there’s one thing we know for sure: what helps the consumer helps the economy. Something we can all agree is a desired outcome.

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How many people do you know that have this trade on right now. I tell people I like this pair trade and they look at me like I have six heads. We love that.First of all, let me start out by saying how weird it feels to be short treasury bonds. I’ve loved these guys for so long that it’s crazy (see Dec 16 2013, Jan 6 2014  & March 24 2014). But hey, when the data changes you have to change your stance right? I preach constantly how important it is to keep an open, so I guess I’m taking my own advice. Here’s what I see. I think it’s simple: Our upside target in Bonds was $TLT back up to $132 which were the 2012 highs. This was a logical target for me. We finally hit that in January and I backed off the bonds trade. I didn’t get short, but it was no longer for me. We kept rallying a bit after that for a couple of weeks and then it came crashing down.

After a nice little bounce last month, bonds rallied back up to that original $132 target. That’s the brick wall I see. If prices remain below that, I think this is an easy short. Meanwhile, look at interest rates. This is the 10-year yield falling back down but holding on to the October lows. This is the big level for me. If rates remain above that 1.87% area I think they mean revert back towards 2.2%:

As far as Crude Oil goes, it has been well publicized that I’ve liked it since they originally broke out last month (see Here and Here). Nothing has changed since then and everything we hoped for as far as confirmation was concerned, we’ve seen happen very nicely. So no reason to go over it again.Finally, here is the chart of the pair itself. I think there is a ton of upside mean reversion here. It just makes sense. Look at the bullish momentum divergences and brief failed breakdown on the pair below the late February lows:

How many people do you know think that bonds get crushed and Oil rips? I don’t know many…

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