The Next Massive Spike in Oil Prices

Seven months ago, I warned Fools to carefully watch relations between Iran and Saudi Arabia as both vie for power as the U.S. leaves Iraq. Three months ago, the situation heated up after the foiled Iranian government plot to kill the Saudi ambassador to the U.S. This month, Iran and Saudi Arabia have been publicly sparring over the West's plan to embargo Iranian oil. This continuing situation has me, my fellow writers, and Goldman Sachs convinced that a portion of your portfolio should be in oil stocks, as sky-high oil prices are not as far off as you may think.

Goldman Sachs' top commodity picks
Last week, Goldman Sachs' head of commodities research, Jeff Curie, revealed to investors the company's top commodity picks for the year. Goldman expects Brent crude to average $120 in 2012 but end the year high at $127 per barrel, a 14% increase over Brent crude's current price of $111 per barrel (WTI crude oil is just below $100 a barrel). While its expectation is only 13% higher, Goldman believes oil has "massive upside price risk relative to our target." In other words, Goldman believes oil prices could spike.

Oil price spike
Goldman's reasons for a possible spike are "the current environment, tight fundamentals, [and] the current geo-political situation in Iran." The big factor is the geopolitical situation in Iran. The U.S. has been pushing a plan among Iran's major oil customers to embargo Iranian oil over the country's nuclear program. As this chart from the Carnegie Endowment shows, these customers include the EU, as well as the large Asia-Pacific nations:

In retaliation, the Iranians have threatened to close the Strait of Hormuz, the gateway for 20% of the world's oil. The U.S. has said it will ensure the strait stays open. U.S. Defense Secretary Leon Panetta said, "We cannot tolerate Iran blocking the Strait of Hormuz, and that's a red line."

With all of this going on earlier this week, Saudi Arabia stepped forward and announced it would boost production by as much as 2.7 million barrels a day -- slightly above Iran's exports -- if there were a large drop in supply. On Wednesday, Iran warned Saudi Arabia against delivering more oil to compensate for a drop in Iranian exports if they are hit by sanctions. Iran's foreign minister said Saudi Arabia's promises "will create all possible problems later" between Saudi Arabia and Iran and said the promises are "not friendly signals."

While Europe has said that an embargo is not on the table for at least six months, as the Arab Spring has shown, conflict can arise very quickly. Iran's leaders are not the most rational, and as Mark Helprin stated in The Wall Street Journal: "To assume that Iran will not close the Strait of Hormuz is to assume that primitive religious fanatics will perform cost-benefit analyses the way they are done at Wharton. They won't, especially if the oil that is their life's blood is threatened."

Why this matters
Chaos and unrest have a much larger effect than most people realize. When large oil powers go through chaotic times, a significant amount of their oil-producing capabilities is lost for years. Often, these countries never return to the production levels they had before chaos started.

As the events in Libya last year showed, moderate drops in production can lead to large spikes in oil prices. The loss of Libya's 1.5 million barrels per day (total world supply was roughly 82 million barrels per day at the time) added an estimated $10 to $15 premium to Brent crude oil prices.

It is a big "if," in terms of if Iran and Saudi Arabia fall into chaos, but it's still worth pondering what could happen given that Iran and Saudi Arabia produce 4.2 million barrels a day and 11.5 million barrels a day.

While we can't know the future for sure, it's good to follow the Boy Scouts' motto of "be prepared." If the Strait of Hormuz was closed and a conflict erupted between Iran and its neighbors or the U.S., oil prices would spike.

Who's it bad for?
As fellow Fool Travis Hoium has noted, if the Strait of Hormuz were closed, oil shippers would be hit hard. There is already an oversupply of ships, and if 20% of the world's oil was stopped, Frontline (NYSE: FRO  ) and Nordic American Tankers (NYSE: NAT  ) would be hit hard. Both tanker companies are suffering and it's starting to show. Frontline took a hit after it announced its third-quarter earnings and said it would need to raise cash. Nordic American Tankers has also been struggling and announced a share offering yesterday.

Who's it good for?
In a crazy year where the Dow Jones Industrial Average (INDEX: ^DJI  ) went everywhere but nowhere, swinging from being up 10% to down 10% to up 5% for the year. Dow components ExxonMobil (NYSE: XOM  ) and Chevron rose 16% and 17%, respectively, buoyed by consistently high oil prices. We expect oil prices to remain high as both the Saudis and Iranians need high oil prices to sustain their domestic spending programs. Any spike in prices would be a boon to both Big Oil and smaller players like SandRidge Energy (NYSE: SD  ) , which is largely undervalued.

With situations like this in mind, The Motley Fool has created a new special oil report titled "3 Stocks for $100 Oil," which you can download today, absolutely free. In this report, Fool analysts cover three outstanding oil companies, including the stock Fool analyst David Lee Smith calls the "energy king." To get instant access to the names of the three oil stocks, click here -- it's free.

Dan Dzombak holds no position in any company mentioned. Click here and like my Facebook page to follow my coverage of the oil and gas sector. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


Read/Post Comments (26) | Recommend This Article (119)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On January 20, 2012, at 6:58 PM, Fonz56 wrote:

    Only 1/6th(world) oil shipped thru the canal. Oil companies like to have a reason for raising prices. Bird pees on a pipeline and prices go up. The US should stay out of the area. The Shites(Shia) and Sunni will handle the problem. You would think one 10 yr war is enough. This government needs to encourage energy development, be it oil, gas or other sources. Spend the money here.

  • Report this Comment On January 20, 2012, at 7:21 PM, clbjblk wrote:

    I like the fools PBKEF was nice and still will be especially if you sold half and are just riding the divy drip train for free now but do not forget FCGYF because they might try to play ball together and they are dripping to,but they still have to wait for gov't approval and payoff ENCANA before you really get wet and the flowers will grow in spring,do not forget about GASFRAC,s little merger to make the EPA start looking for a new job because there new process is very clean,it,s just ashame that the white house thinks this could be a crack pipe problem,Fort CHICAGO,MIKE JORDON will be playing buckets with Barrack on FCGYF crack pipe money,no jobs for KEYSTONE PIPELINE they didn't like the nuggets bypassing NEB on there way to the Gulf coast refineries when the White House Chicago Bulls can run up the treehugger score you know the union guys are mad,thats why they play the game.NIKE!

  • Report this Comment On January 20, 2012, at 7:29 PM, Davemuse wrote:

    The analysis seems to lack hard-nosed substance. Earlier in the paper, Iran is said to produce less than 2.7 mbd, and then later production is reputed to be 4.2 mbd -- which is a huge disparity. What is not seriously considered is whether the Saudi's have the capacity to increase their production by that amount; I read some years ago I read that they could do that and more. And given the power of religion to drive people in that region, it is quite conceivable that Saudi and others could increase production in order to maintain current levels of oil production in the world -- if they chose to do so.

    Conversely, the various oil producing nations could cooperate in a manner that would facilitate a significant increase in the price of crude. We need a better analysis of the pressures in the region.

  • Report this Comment On January 20, 2012, at 7:52 PM, 1960vw wrote:

    One word KEYSTONE

  • Report this Comment On January 20, 2012, at 9:27 PM, PurringCat wrote:

    Investors better hope that there is not a major outbreak of violence in the Persian Gulf between Iran and the US, or Israel, or Saudi Arabia.

    While you can dream about huge profits from very expensive oil, a quite likely result from any cut off of Middle East oil will be a devastating global recession/depression. Unfortunately, the world is very dependent on fossil fuels to propel the world's economies. When significant portions of these fossil fuels are not available the global economy suffers significantly.

    The US stance against Iran is silly and stupid. Iran should have the right to develop civilian nuclear energy as much as any country in the world. There is little evidence that Iran is on a course of developing nuclear weapons. Even if they did, it would be of little use to them.

    When will this country learn to stop needlessly meddling in the affairs of other countries?

  • Report this Comment On January 21, 2012, at 9:10 AM, JacksonInVA wrote:

    Your are quoting Goldman Sachs? Sorry they have no credibility with me. They stole many peoples money and excepted my tax dollars. I hope they collapse.

  • Report this Comment On January 21, 2012, at 2:27 PM, Gorm wrote:

    AND what does $120/bbl oil do for Motley's BOLD 2012 predictions?

  • Report this Comment On January 21, 2012, at 4:43 PM, becdon wrote:

    canada and usa can build a relief pipeline across the aluetian chain shipboarding terminal for small yet cheaper exporting to asian nations for a quicker profit for nat gas supplies that are allready capable of bringing in money presentlly. then as further supplies are available the newly elected enlightened leaders can get that local line completed which is badly needed.

  • Report this Comment On January 21, 2012, at 5:43 PM, DivingDan wrote:

    Last time someone predicted $5/gal gas.. it never happened. Give us concrete news, not silly predictions

  • Report this Comment On January 21, 2012, at 10:56 PM, davfoo wrote:

    Gasoline prices are likely to jump this summer to around $5 per gallon because there is an election and the oil industry wants to make sure Obama is not reelected. Higher gasoline prices will have a negative impact on the economy in time for the election. That is why we are hearing predictions of $5 a gallon gasoline and reasons for it now.

  • Report this Comment On January 22, 2012, at 5:13 AM, MichaelDSimms wrote:

    It matters not. Oil will stay around 100 a barrel or above even without conflict. Good oil companies producing in non volatile global areas are a good bet. It will be a good year for energy companies.

  • Report this Comment On January 22, 2012, at 9:20 PM, Marshalldedr wrote:

    @ purring Cat. Iran isn't simply developing civilian nuclear power. They want a baseball bat and Iran with the potential of nuclear weapons is a bad thing. That being said let's go back to the U.S., U.S.S.R weapons race. As with that race which was essentially two super powers racing to a finish line no one would be willing to cross, the middle-east is now in the same situation with countries vying for power. It has to be monitored...carefully. Going forward we, as consumers are being told, way out on front of the occurence, that gasoline prices are going to be spiking. We can invest in energy companies and try to recoup some of the extra cost we will be incurring but unless you can invest a lot of money how much can one expect to offset the budget impact of what we are being told is coming? Wouldn't it be a great idea if consumers began our own adjustment now by using less gasoline and forcing inventories up now in order to level out the expected spike?

  • Report this Comment On January 27, 2012, at 12:01 PM, SlikWilly wrote:

    Be glad you don't live in the UK, we pay roughly $9 per gallon, mostly tax. Don't take those Sunday drives like we used too.

  • Report this Comment On January 27, 2012, at 12:17 PM, foolgabby wrote:

    One simple solution, stop antagonizing the people in that part of the world and send all the Euporians living in the region back where they came from and you'll be surprised at the results. Peace and harmony, except in Europe.

  • Report this Comment On January 27, 2012, at 12:30 PM, karlyundt wrote:

    And if you believe the Iranian "plot to waste the Saudi ambassador" line, more Fool you!

    Why would the Iranian Revolution Guards, with 20+ years of global acts of terrorism on their CV, sub-contract to a motley crew of Mexican drug lords?

  • Report this Comment On January 27, 2012, at 12:35 PM, QSfromKS wrote:

    JacksonInVA - Im with you 100%. Goldman Sachs is nothing more than organized crime. Their job is to find new ways to vacuum money out out of our economy. Hope they get the hose stuck to their mouth.

  • Report this Comment On January 27, 2012, at 1:01 PM, foolgabby wrote:

    Some day we will all learn from this. In the meantime, we just have to cope. We are all one life force and the more we work together instead of exploiting each other for our own self interest, we'll spend less time destructing and more time constructing. We are still in the primitive stage of evolution. As the single cell became multi-cellular and every cell worked for the survival of the whole, so to our bodies and we're moving to the awareness of the whole. In our selfish little minds we can't see the big picture. If this planet gives us enough time, this is our destiny.

  • Report this Comment On January 27, 2012, at 1:21 PM, rocketman67 wrote:

    IMHO Iran will play the "stall as long as possible" game because time will be on their side. Iran has China and Russia coaching them to keep the saber rattling up to help keep their regime's morale up. Don't be too trigger happy, don't get caught in a "rope a dope" game with your opponent.

    Iran knows that if it tried to slug it out with the US and it's allies it will loose not only militarily wise but more than likely get booted out of power. Plus all the work that's been put in developing nukes will be lost or severely delayed.

    China has proof that their stall tactics work ......North Korea. So does Russia with the same tactics used during the Cold War.

    I rest my case. :-)

  • Report this Comment On January 27, 2012, at 1:29 PM, slaminsami wrote:

    To whom it may concern: NEVER FORGET THE BUTTERFLY AFFECT ! once , if, should, IRAN do anything stupid, use your imagination ! just for starting it they would receive the death sentence.

    How about how JAPAN has been viewed for all these decades, The Worlds perception of Germany for how long now? N. Korea, The word is trust and respect, which negates the whip. The reason I can step over my 500 pound Lioness and she won't blink an eye. I do not believe Iran would dare chance the rath of the world or it's citizenry, just to draw blood ONCE. The U.S. and it's true allies would simply have to blink and Iran would quiver for a millenium. True these hasty children must be taken to task, but a firm resolution buy the joint powers would be sufficient. Once again the same logic applies for Isreal. Always remember what is right in the heart of JerUSAlem. how interesting ?

  • Report this Comment On January 27, 2012, at 2:16 PM, Charnar wrote:

    Weird, emotional commentary today. Reads more like commentary on a Yahoo news story than TMF-- complete with terrible spelling, twisted grammar and all-caps.

    Strange

  • Report this Comment On January 27, 2012, at 3:07 PM, MrBearBull888 wrote:

    Hi I'm a Fool from London England and we dont use the euro here! Of the euro will be renamed the German Frank or just the D Mark. But what makes post is the quality of TMF seems to be going down the tubes. Witness the poster before me. Have they grown so big that they are now ex growth like a dinosaur?

  • Report this Comment On January 27, 2012, at 5:53 PM, RobertC314 wrote:

    I have to agree with the last 2 comments. That being said, I couldn't help but respond to this one from rocketman67:

    "China has proof that their stall tactics work ......North Korea. So does Russia with the same tactics used during the Cold War."

    Some facts on Korea:

    * Split in 1953, they were in a very similar economic position at the time

    * Government: North: Dictatorship; South: Democracy

    * GDP Per Capita (2010): North: $1,600 (est); South: $20,000

    * Life Expectancy: North: 68; South: 80

    * Urban population with access to modern sanitation facilities: North: 58%; South: 100%

    * Lifestyle: North: Live in fear under the rule of a ruthless dictator; South: Live in a thriving modern society

    We could do the same thing comparing the US to Russia at the beginning then end of the cold war.

    The point is, what exactly are we thinking "worked" about the hard-line anti-cooperation style of international relations in the past?

    Moving to now, what is Iran thinking they are going to win in the long run? The same fate as North Korea and Russia? I'll take the US or South Korea's position any day of the week.

    In the short run they get everyone pissed at them and maybe cause some minor issues in the rest of the world, but there is no benefit to them now or in the long term.

    Just some food for thought,

    -Robert

  • Report this Comment On January 27, 2012, at 7:47 PM, MichaelDSimms wrote:

    A big fallacy in this article about the U.S. Yes we are getting out of Iraq, we are still in the region, in a pretty big way. If Iran does something stupid yes oil prices would spike, but the world can do without their oil quite easily. Saudi would make up for it I believe, and be quite happy with the added income.

  • Report this Comment On January 27, 2012, at 9:01 PM, davfoo wrote:

    Seems like prices should be dictated by supply and demand.

    This winter has been very warm in North America and Europe reducing demand for oil. In addition the economic slowing of growth in China and the troubles in Europe have further eroded demand for oil. Finally the removal of US troops from Iraq and the draw down beginning in Afghanistan are further decreasing demand for oil.

    Meanwhile production of oil in Iraq has been reported to be recovering. In North America production has increased significantly to the point that now the U.S. is actually importing less than 50% of its oil for the first time in many years. What the US is importing is coming from places like Canada and Brazil.

    The threat of a cutoff of Iranian oil is likely to be made up by Iran's adversary Saudi Arabia in any event.

    Since demand is not rising at the rate expected and is going down in the U.S., and supply is going up at least in the US market, one would expect that the price of oil should be going down not up (if we were dealing with a free market.)

  • Report this Comment On January 28, 2012, at 5:02 AM, foolgabby wrote:

    Don't forget about the 15% annuall increse oil use in the emerging markets.

  • Report this Comment On January 30, 2012, at 5:10 AM, Bluegrew wrote:

    Hey rocketman - it's not "loose" - it's "lose" - loose is the change in your pocket. How many times do you have to be told?

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