Market Report: Missiles, Madmen and Spare Capacity

Iran shot off short and long range missiles in what they said was an act of defiance against the rest of the world. Of course it was more like a child's temper tantrum because they were caught in a lie.

Iran, a nation that has built its economy on oil, is not as important to the global economy when the world is awash in oil. When Iran exports hover just above 2 million barrels a day, there are many oil producers waiting in line ready to pick up that extra slack. Saudi Arabia has enough spare production capacity to replace Iran's exports two times over. Because of this, in a weird way the Iran's lies and fireworks display might actually be more bearish for oil than bullish. Why you ask? Well because traders may seek the safety of the dollar as this global crisis plays out. The dollar has had more impact on oil than supply anyway because we already know that we have plenty.

This may be even truer as demand continues to be weak around the globe. For example, take a look at Japanese crude imports which fell by 12.4%. That is the seventh consecutive month that Japanese imports fell. Japanese exporters have been having a hard time as yen strength has cut into their pricing power. This is leading to less production and lower oil demand.

There is some doubt about the makeup of Chinese oil demand. The Chinese have yet to say whether or not they may join in sanctions against Iran yet it has been their demand numbers that have kept oil humming. China is a big buyer of Iranian crude but as of late China has been importing more oil than they have been using. A lot of that oil is going into their oil reserve. Bloomberg News reported that China is setting up an oil reserve equivalent to 100 days of net imports before 2020 to avoid supply disruptions. Bloomberg says that the stockpile will be built under three phases according to China Petrochemical Corp., the nation's top oil refiner. The volume is equal to about 349 million barrels based on China's net imports in 2008. China completed building reserves equivalent to about 16.4 cubic meters of oil, or about 30 days of net imports, under the first phase, the National Energy Administration said in June. U.S., the world's biggest energy user, has reserves of about 94 million tons, accounting for 56 days of net imports.

This has helped support oil in the short run but is bearish in the long run. China may try to block sanctions against Iran. The Russians may go along to get along yet if we cannot get Russia and China to go along, then what's next?

This brings us back to the dollar. If military conflict fears increase, so too will the dollar. Add to that the fact that the G20, IMF and Fed officials dropping hints that the amount of historic fiscal stimulus is coming to an end. The oil market and a host of other foreign currencies will have to see if they are strong enough to stand on their own.


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