Oil’s River Card

05/20/09 01:23PM EDT

RESEARCH EDGE POSITION: We are "bullish of" oil and are currently long the XLE, SPDR Energy etf

In our note on crude oil from yesterday we wrote:

"The price of oil appears to be signaling one of two things:  either demand will at some point in the near future accelerate or that there is a geo-political event on the horizon that will reduce supply."

This morning, the river card was revealed in the way of an announcement from the Islamic Republic of Iran.  According to a newswire article:

"The defence minister (Mohammad Mostafa Najjar) told me today that we launched a Sejil-2 missile, which is a two-stage missile and it has reached the intended target," Ahmadinejad said.

The missile was launched from here in Semnan," he added to cheers from the crowd.

I was told that the missile is able to go beyond the atmosphere then come back and hit its target. It works on solid fuel," he added, without specifying the missile's range."

According to other reports, this was Iran's second test of the Sajjil-2 missile, with the first test occurring approximately 8-months ago.  This missile purportedly has the ability to reach targets 2,000 kilometers away with great accuracy.  A quick google map search indicates that the walking distance from Jerusalem to Tehran is 1,559 kilometers and presumably the missile distance is as close.

Now we certainly do not want to be alarmists and this is a test comparable to the one the Iranians performed 8-months, so it's not an example of new technology.  That said, the timing of the test is noteworthy in that it comes only two days after President Obama met with Israeli Prime Minister Netanyahu.  While President Obama was not willing to be nailed down on an artificial deadline, he did note the following  after the meeting:

"Foreclosing a range of steps, including much stronger international sanctions, in assuring that Iran understands that we are serious.""

While Obama does seem to be continuing to pursue a diplomatic approach to Iran, this statement had the appearances of a tougher tone with the Iranians.  Recall that one of President Obama's first major foreign policy moves was an address to the Iranian people on March 20th in which he called for "a new beginning" of engagement with Iran.

As a prospective client emailed us today, the missile test appears to be a "message to Obama", which was a play off the popular Police song, "Message in a Bottle", whose lyrics are as follows:

"I send an SOS to
I send an SOS to
I hope that someone gets my...
I hope that someone gets my...
I hope that someone gets my...
Message in a bottle... Message in a bottle..."

While we don't know for sure if Iranian President Ahmadinejad is a Police fan, he does seem to be sending a message to both Obama and the World.  The immediate reaction to this missile test was that Italian foreign minister Franco Frattini cancelled a planned trip to Iran, primarily because Ahamadinejad wanted to meet in Semnan, instead of Tehran.

From an investment perspective, the idea of geo-political risk was reintroduced full force back into the price of oil today and oil is trading up ~2.5%, which of course is on the back of a ~35%+ move in the year-to-date, despite negative "fundamentals"...

Iran is very relevant in terms of the global oil market.  According to the most recent data, Iran ranks third in the world with ~136 billion barrels of total reserves (second excluding Canada's non-traditional reserves), which is ~10% of the world's reserves.  Iran is the world's fourth largest producer and OPEC's second largest, after Saudia Arabia.  

Increased tensions with Iran rightfully support a bullish case for oil.

Daryl G. Jones
Managing Director

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