The big bets that the debt fiasco will raise oil prices

Oil traders are betting as a herd that they are on the cusp of potentially their most profitable period since the Libyan uprising stoked fears of Saudi Arabian oil being lost to the market. Hedge funds, among the biggest players in oil futures, are leading this charge, according to the U.S. Commodity Futures Trading Commission, which tracks such data. They have upped their bets on a serious rise in oil prices three weeks in a row — the first time that has happened since late February-early March, Reuters reports.

We care about this directional betting because, if the hedge funds are correct, the global economic struggle faced by everyone except China will worsen. Plus, tens of billions of dollars will flow to petro-leaders — in Russia, Venezuela, Iran — whose behavior turns increasingly more discourteous when they are richer.

Specifically, here is what we have — "long" bets on oil prices in the most recent reporting week rose to 182,285. That is far below the casino peak during the Libyan-fever, when there were 350,000 such bets on the table; but it is still up 8 percent over the previous week, a reasonably large jump.

What is causing this betting frenzy? Some will say it’s a widely expected tightening of oil supplies later this year. But that explanation is not exceedingly persuasive because the long bet has come abruptly. Something more immediate is likelier at work — such as the federal debt acrimony in Washington.

Look at the price of gold, for example — it continued breaking records over the weekend, crossing $1,615 an ounce, a play by bettors perceiving higher investment risk out there.

So it is with oil. The bet is that, even if President Barack Obama manages to strike a debt-ceiling deal with Republicans in the coming days, it will not include sufficient budget cuts to satisfy rating agencies such as Standard & Poor’s. The reasoning is that, should S&P downgrade the U.S. credit rating to say AA, traders in the casino will sell off the dollar. When that happens — when the value of the dollar is driven down — the price of oil will likely go up.

Update: In his morning note to clients, hedge fund strategist Peter Beutel calls the above bet "a classic case of buying rumors only to need to sell the fact." Meaning, a price runup will be followed by a plunge if traders apply the smell test to any debt deal between Obama and Republicans, and are not impressed.Beutel said,

Raising the debt cap will get us through this immediate crisis, but it won’t lead to a single new job or a dollar in GDP (although its failure would lead to the loss of both). Once traders get over the euphoria of Congress reaching agreement, there will not be much to build on afterwards. And that makes a selloff seem likely after approval.