Add Mutiny to Mayhem in the Oil Market

Your stock market is closed for a fourth day, protesters are duking it out in the streets with presidential supporters, 80% of domestic flights are canceled and businesses throughout the capital are closed.

On top of that, sea captains who pilot tankers for the government oil company -- the lifeblood of the country's economy -- are practically committing mutiny by joining a nationwide strike, opposing your rule. And opposition political parties are calling for a national referendum to oust you from office.

This is the situation Venezuelan President Hugo Chavez faces today, a situation that will likely increase volatility in crude oil and related products contracts. January crude oil (CLF3:NYMEX) responded to the devolving situation Thursday by closing up more than 2% and at a five-week high.

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The oil market's reaction isn't a surprise. Venezuela is the world's fourth-largest exporter of oil and supplies the U.S. with about 10% of its needs. A similar situation sparked oil prices higher last April when Chavez was ousted -- and then reinstated -- in one of the briefest and most bizarre coups in Latin American history.

Still, other factors are at play that will probably only increase volatility in oil. Iraq, the war on terror and the Israel-Palestine conflict remain front and center on traders' minds. War with Iraq could result in spikes above $40, similar to what happened in the 1991 invasion of Iraq.

Oil traders have been counting on steady imports from Venezuela to make up any shortfall in oil supply that might result from war with Iraq. Now that supply is in question. Last week's larger-than-expected build in national crude oil inventories was a bearish factor, but helped replenish a supply that now stands about 8% below year-ago levels. Imports have also been up, thanks in part to OPEC's failure to maintain output quotas, but quota allocations could change at the oil producing group's meeting next week in Vienna.

The recent cold blast across much of the East will also chip away at national inventories as we approach the heart of winter and the greatest demand for heating oil. All told, the situation in oil and distillates appears poised for a spat of increased volatility with the greatest risk to the upside.

January crude is in day two of a pullback from its one-month high, priming it to potentially resolve higher next week after the due date for Saddam's weapons programs laundry list.