Is the Liberation of Tripoli Good for the Oil Markets?

• Tweet
• Pin It

No doubt you have heard the surprising news last week that Libyan rebels were not only at the doorstep of the capital but that they actually appear to be in control.

This was indeed a major surprise since almost everyone thought the rebels were locked in a stalemate with Gaddafi's forces. The sudden freeing of the capital by the Libyan rebels should be viewed as a good thing in the long run for oil prices.

Yet, how these sudden events will affect the markets in the short term is causing understandable confusion.

In the long term, many believe that Gaddafi's fall will result in dropping oil prices due to increased production. This in turn should increase the value of the US Dollar.

So, the trading opportunity is to monitor the oil production of Libya. When it surpasses previous output, buy the US dollar against the EUR.

But in the near term, it is unrealistic that a new and inevitably shaky government will be able to get the Libyan oil fields back to full production levels anytime soon.

Instead, the more likely scenario is a drop in oil production. Economists might disagree on how long it will take for oil production in Libya to return to normal. Currently, it is clear the markets have already priced in an oil shortage.

This illustrates the wisdom of trading an uncertain situation like the Libyan revolution according to the maxim, "Buy the rumor (the revolution) and sell the news (liberation)."

In this case, you would have bought oil prices on the rumor of oil production shortages. Then, close out your position and sell when the news of liberation hit. Instead, the crowd will buy when news of the liberation hits and wonder why prices fall abruptly on supposedly good news.

Why does this happen?

When the media covers the liberation you'll hear a lot of doom and gloom about how Libya will face major problems bringing oil production back up.

The reality is that markets are 'forward looking' and over the last seven months the markets have already reacted to the rumored revolution. Therefore, the lesson is that the lower production numbers had already been figured into the current market value for the price of crude months ago.

If you want more evidence of this, take a look at market reactions upon the news that rebels captured Tripoli. Keep in mind this was a major surprise even to experts on the region, giving the news more power than usual to affect markets. In the short term oil prices did rise very slightly, going up only 41 cents per barrel before then losing 28 cents the next day. Brent crude for Europe was trading at around $107 a barrel, which was comparable to before the news.

In other words even with all the worries and projections on the market of Libya being slow to produce oil, there were no giant leaps in price. Economists as a whole seem to agree that the only market impact of Libya beginning to produce oil again will be that oil prices will eventually drop.

When you apply technical analysis to the markets this week, it becomes even clearer that the lack of oil production is already figured into the markets. The news driven effect from the liberation only lasted a few hours after the initial story break.

Market prices reflect the sum total of all trading decisions and insiders’ trades are invariably ahead of the crowd that jumps in when big news hits. This is especially true when a situation has developed over a longer period. Using technical analysis of the price chart measuring the retracement of price against an existing trend, you can get a measurement of the trend's health.

The US Dollar (USD) is still struggling to gain ground under what should be decent market conditions for a stronger dollar. Other technical trends that stick out to risk market traders is the 74.56 daily trend line in the USD Index which has traders looking for a breakout above that trend line, or below the daily trend line at 1.4200 in EUR/USD. Without these events confirming the short lived counter trend, the move in the markets lasted only hours on the Tripoli news.

So, if we get a break below 1.4200 in the EUR/USD it’s time to sell.

This should happen as the oil market drops. However, you need to watch out for other oil producing countries dropping their oil production for unseen reasons. This could cause oil to move higher and the US dollar to move lower.

This does not mean that the regime change in Libya is not a positive development for the markets. The key is to remember that the news of events in Libya will be actionable over the long term. The most optimistic predictions have Libya back to full production in a year. Other economists believe it will take two or three. All agree that this will eventually lead to dramatic drops in the price of oil. This is especially true in European markets since Libya was a major supplier to Europe.

Lower oil prices are good for recovering economies. This should help Europe and the United States out in the long run. When the EU and US economies are doing well they will help bring up the rest of the world as well.

Have no doubt about it: the fall of Tripoli was good news for the people of Libya and for the world economy, too. It will just take time before it fully shows up in the markets. Watch the long term price of oil because that is where the impact will be felt most. My philosophy or system, if you will, would be to sell the EUR/USD if oil goes below $100 a barrel and look for the US dollar to gain strength.

Good trading,

Jason

facebook   twitter   linkedin   reddit   email