Pipeline Attack Reveals Upside Price Dangers

Energy prices experienced a day of respite after Kurdish militants damaged a key crude pipeline in eastern Turkey. While the pipeline is substantial and can handle up to 1m barrels a day, the incident serves to highlight upside issues in the supply/demand spectrum that may be overlooked at the moment. World inventory levels remain at discouragingly low levels and Opec spare capacity, as well as that of non-Opec producers, continues to decrease. Until these issues are resolved, the threat of oil prices returning to levels above $130 will remain with us on a day-to-day basis.

With this in mind, hedgers may want to lock in at least 50% of their 2009 fuel needs using inexpensive option strategies. $20 of upside protection is available for Zero Premium by purchasing the $130 / 150 call spread strip for every month in calendar year 2009. The price of owning the call spreads is offset by selling every $88.50 put in 2009.