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$20 Crude Oil Is On The Table Again: Can Obama Pull The Israeli Rabbit Trick?

Commodities / Crude Oil Jul 07, 2009 - 03:25 AM GMT

By: Andrew_Butter

Commodities

Best Financial Markets Analysis ArticleThe bears are out again and there is talk of $20 oil; the logic is:

  • All the oil stored up in super-tankers will flood the market.
  • World GDP growth is low and perhaps getting lower or at least not likely to rocket any time in the immediate future.

But much of the oil stored in tankers was bought against futures contracts so it's sold waiting delivery. That was a nice little win-win situation for anyone who could buy oil when the current price was a lot less than what you could sell futures for. But don't expect the tooth fairy to touch you on the shoulder twice in a row; sure there may be a trading opportunity when that unfolds, and maybe not, it will all depend on the "discipline" of OPEC, and if you are a betting man on that sort of thing, well place your bets!

The theory that increased GDP creates an increased demand for oil, is not supported very well by history (http://seekingalpha.com/article/140546-the-price-of-oil-parasite-economics-explained); trend the past ten years in OEDC countries up to the start of the “crisis”, demand was flat and GDP went up about 20%, outside of OEDC demand went up by 40% and GDP went up about 30%. That doesn't prove much.

But longer term there is a clear dependency relationship between oil price and GDP growth, when prices go up dramatically GDP slows, that suggests that oil is a required ingredient for GDP growth rather than the other way around.

That's logical, if you have a job and you drive to work, you use up "X" gallons of gas doing that, if prices go up, you can't say "oh well I'm going to ride my bike", sure you can move closer to your job, the railroads can do more, you can car-pool, and trash the SUV, and buy a Fiat Panda, but those are structural changes that don't happen overnight. What that means in the short term is that the value-added of your work is less because your costs go up, and if you can't pass those on, you make less money net, then GDP which is economic value-added, goes down.

Historically price rises were dictated by either artificial constraints on supply (the First Oil Shock for example, plus whenever OPEC gets its act together (for example from about 1999), or real constraints (as in 2008 - at least that's the opinion of the IEA which discounts the theory that the $147 spike was just the work of speculators).

Actual constraints in the near, medium and long term are a subject of conjecture; everyone lies and the incentive is to exaggerate production capacity and reserves is high (that helps get credit and boost share prices for the oil companies and they are the ones who work out the reserves, and it helps bump up OPEC quotas); the problem is no one lies consistently (if they did it would be easy).

The reality is that Mexico and the North Sea are running out, there is a theory that Saudi is running out too; and the oil-sands producers are not investing (they all got hammered by the drop and they are feeling sorry for themselves), and Brazil's new fields are years away.

However there are political issues, the main changes in oil prices over the past fifty years were due to political rather than supply constraints.

The issue right now is that Saudi is debt free, UAE is smarting from what the crisis did to it's SWF, but they have plenty set aside, either-way and whether the story about peak oil is true or not, there is a specter that it might be true.

For many oil producers including spendthrift countries like, Venezuela, which holds $75 billion or so of US Treasuries, the problem is a pile of Yankee Dollars that they don't know what to do with. Cutting back on production for a while would solve that headache, so unless someone can make a good argument that a US Treasury “in the hand” will be worth more in three years or five years time, than oil will be "in the bush"- even after counting the anemic rate of interest, there will be a debate. Sure that's debatable, but the debate is on the table.

The Saudi's say they want $75, and chances are what Saudi wants Saudi is going to get, with long term prospects of rising oil prices (unless electric cars deliver what they didn't deliver for thirty years), selling oil too cheap is just desperation, and many of the sellers simply aren't desperate. The buyers don't have much option though, America just doesn't work without oil, and even if a cost-effective electric or hydrogen car was put on the market today, how long would it take before even 20% of drivers went that route...ten years? And how long will that take…ten years? (10+10 = 20).

Sure many oil concessions give a fixed price to the concessionaire, that limits the ability of the producers to play the price wave (and notice how the recent concessions orchestrated by USA in Iraq were structured around a fixed price - go figure). But it's not all like that, and well if you can buy off the concessionaire at $2 a barrel to let the "field" lie fallow? Well that's happened before.

The biggest threat to oil producers, long term is development of transportation technology that doesn't require oil, and development of alternative sources to oil. The best defense against that is uncertainty because all of those options require commitment of capital, and if no one knows for sure if oil will be $20 or $200 in ten years time, how do you do your sums? Volatility in the oil price is the best friend of the producers.

One wild card is President Obama. Since the collapse of the Arab Oil Embargo in 1986 the President of USA carried a big stick, and if oil prices went up, well he started waving it around. Those days are gone thanks mainly to the invasion of Iraq, but now The President of the biggest oil consumer in the world is carrying a big carrot.

The carrot is that he will be able to do the necessary to put the seemingly endless Israeli Palestinian conflict into the history books.

If there is one thing that has soured US foreign relations that is it, put aside the semi-incoherent rants from the Grotto, the real bee in that guy's turban was the US support for Israel, not much change from 1971, that was about Israel and oil. And just because you don't jump up and get yourself strapped, doesn't mean you don't have an opinion.

Outside of the effect on oil prices, and outside of the direct and indirect "aid" to the "special friend", (trade breaks, and defense contracts to keep Israeli workers busy), there was a real cost to USA of that friendship.

Although no one wants to talk about it, 9/11 had a direct economic cost, plus the invasion of Iraq benefited no-one except Israel who were provided the security of the demonstration that "Big Daddy" would "do the necessary" if pushed too far.

Which makes one wonder how much of that "intelligence" on the WMD was thanks to the "special relationship" of OUR boys on the ground, funny how the capability of Iraq to deliver on it's threat was regional, and so who was at threat, Iran?

In reality the only other explanation for that perfect demonstration about how to shoot yourself in the foot was that George Bush was livid about 9/11, which is perfectly understandable.

But was it smart? The whole point of terrorism as a strategy for a small bunch of people with limited resources and a lot of grievances is to get the "enemy" to commit to the field, so you can take pot shots and plant roadside bombs. In 2004 The Economist crowed that the man in the Grotto must be feeling pretty sick, they pointed out that two Muslim countries had been invaded, and declared that the war on terror was won!

Oh yeah, sure The Economist got that one right! The reality was that the US influence over Saudi Arabia went to about zero (they asked the US troops to leave), and the Greatest Nation on Earth got itself hamstrung in a trap of it's own making that it still hasn't extricated itself from. And if the hidden agenda was to secure oil supplies, and keep prices down, well it didn't.

On top of that the main reason that Allan Greenspan dropped interest rates so "boldly" was not to help out the suckers who had bought into the Dot.com story, but to re-energize the economy after 9/11 (at least that's what he says in his book). There is now no dispute that led to the housing bubble which led to the credit crunch, there is therefore a linear logic that links that to the man in the Grotto, and just because no one wants to join up the dots (least of all the all-knowing Economist Magazine), doesn't mean you can't.

Add that up and one wonders how long America can afford its special relationship, and who knows what new "pleasures" that lunatic in the Grotto or his acolytes will dream up next?
Perhaps at some point USA will need to make the choice between what Paris Hilton calls a Best-Friend-For-Life, and a circle of friends?

The reality is that the business model of Israel depends on conflict, take away the conflict and you take away the aid. The corrupt "leaders" of the Palestinians  depend on conflict too, (and boy are they corrupt! That's what you get from a government in chaos, sure Hamas are a lot less corrupt than the "old guard" (which is why they got democratically elected - not that that did them any good), but that's just relative), a significant proportion of the "aid" they get ends up in personal bank accounts well out of range, chances are many Israeli politicians have accounts in those banks too.

That's why the issue about Hamas seeking the annihilation of the State of Israel has served both sides so long. Hamas could have lied, that would have been easy (OK they got "principles" but if they tried real hard I reckon they could make an exception), although there again Israel can always think up another reason not to talk.

The reality is that only USA can sort out that mess, and this is the first US President for a long time that has the smarts, the credibility, the integrity, and dare I say it, the balls, to pull that off. Key to that will have nothing to do with ideology or body counts, it will be working out how both sides can prosper economically afterwards. In the final analysis, war is about money, nothing else.

If he does that, or makes credible progress, that will affect the stability of the price of oil more than anything, and that will be manifestly in the long term interests of USA and the world, the essential resource of oil has been shrouded in conflict for too long.  Sure he won't get $20 oil, but he might get commitments that hold; and that would be a start.

By Andrew Butter

Andrew Butter is managing partner of ABMC, an investment advisory firm, based in Dubai ( hbutter@eim.ae ), that he setup in 1999, and is has been involved advising on large scale real estate investments, mainly in Dubai.

© 2009 Copyright Andrew Butter- All Rights Reserved
Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.

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