Thursday, May 22, 2008


Iran is drowning in oil. Since the US, along with the other permanent members of the UN Security Council plus Germany, picked the timing of the oil "embargo", it is clear that the world is ready to face down Iran. It took the cooperation of Saudi Arabia, which is selling an extra 300,000 barrels per day at a cheap price, to bring some nations on board. If given the opportunity to save money and not go against the US, why not buy Saudi oil rather than Iranian oil?


Iran has 30 million barrels of oil parked in ships to nowhere, in addition to full tank farms, tanker cars and pipelines. Meanwhile, halfway around the world, Brazil is 3 for 3. In the 15 or so deep water "formations" near its coast, the first three have all been gushers. Brazil is ordering no less than 40 of the monster drilling ships to explore and develop these fields. If one extrapolates these early results into the future, Brazil is the new Iraq, Iran or Saudi Arabia of Latin America. The first production from these fields is two years away but these fields illustrate again that there is ample oil still on this planet. If the congress would permit the USA to drill, our oil problems would be over in less than 3 years.

Iraq has 115 billion barrels of reserves, so far. Iraq has been isolated for about 20 years. As a result, it's oil fields have not been developed. So far, there have been about 2,000 oil wells drilled in Iraq. Compare this to over 1,000,000 in Texas and one begins to wonder just how much oil there is in Iraq. Iraq is in the process of signing "technical agreements" with major oil companies. In the years ahead, the development of fields in Iraq and Iran will provide billions of new reserves.

With billions of people moving out of poverty, demand will continue to grow. Thus, we need to allow development of nuclear power and we will ultimately need to build coal to liquid processing plants. We have 1 and a half times as much coal as Saudi Arabia has oil. Guarantee the current or higher prices and plants will be built to convert coal to liquid. The world demand can be met in an orderly fashion, if our world leaders will think rationally and get of the crazy global warming band wagon. The temperature on the planet is lower today than it was 10 years ago. Carbon dioxide is the breathe of life to our oceans and plants. We need to feed them.


Nine days ago!

It has been 9 days since Iran submitted its latest proposals to the Security Council Members (the 5+1, which includes Germany). Since then, Condi Rice has once again called on Iran to suspend its production of nuclear fuel and to comply with the terms of the Nuclear Proliferation Treaty. The IAEA has once again asked Iran to "open its books" in regard to its bomb making activities. Iran has agreed to meet with the 5+1 negotiators in regard to three broad issues. This agreement to open discussions is a significant development. In the final agreement, it does not matter if Iran is allowed to refine its own fuel or not. It would be less costly for them to rely on the international consortium for their fuel but, if they comply with the rules regarding inspections, the processing for peaceful purposes is not a problem. In other words, there is room for face saving proposals.

Drowning in oil is no fun. Iran produces 4.5 million barrels of oil per day. As such, it only took 7 days for Iran to fill up all those super tankers parked off its coastline. Eleven super tankers, sitting around at a cost of $59,000 each per day, with no place to go. How long can the world do without Iranian oil? A very long time.

Of the 4.5 million barrels produced, Iran normally re-imports 2.5 million as refined products. Thus the net production is only 2 million barrels per day. We know that the Saudis are making up 300,000 of that 2 million. We know that Iraq is making up about 200,000 barrels. We can guess than Russia is also helping to make up the difference. We also know that high prices are causing demand destruction. Furthermore, the US SPR holds 700 million barrels for the expressed purpose of dealing with supply disruptions. Using our reserves to replace 100% of the embargoed oil would give us 350 days to watch Iran drown, they have no chance.

In this crazy market, oil futures have gone into contango for the next 10 years! This is a highly unusual development. Speculators are putting down deposits on contracts to buy oil at $140 per barrel 10 years from now! When this bubble pops, those contracts are going to cause a lot of pain and a lot of gain. The value of these contracts could easily be cut in half in a matter of days. With leverage involved, the loses and gains will be huge.


The big investment banks, such as JP Morgan and Goldman Sachs, are likely to make out like bandits. Each time one of these futures contracts is bought, someone else has to sell it. The number of contracts exceed the total supply of oil many times over. These contracts do not call for the physical delivery of oil. They are nothing but a way to bet on the future price. You are one of a very few people in the world who even know that the "embargo" is in progress. Investors who are responsible for trillions of dollars of pension funds are buying oil futures contracts without full knowledge of what is going on. The bid draw down in inventories in the USA announced yesterday, was a natural result of the "embargo". US supplies are still very ample. Again, we know that Russia signed on to the sanctions only a couple of days after signing the civilian nuclear deal with the USA. It is simply too early to know if Russia has stepped up production to help. Those who are buying high dollar contracts have no way of knowing if the combined new supplies are more than greater than the amount of embargoed oil. The current craze quacks like a bubble. Bubble prices are not rational.


Iran will totally drown in days, not weeks. Sure, if Iran has no income, it can draw down on investments for a while and it can print more money. Iran has experience severe inflation for the past couple of years. Iranian clerics have become vocal about Amadenijhad's handling of the economy. The pressure on Amadenijhad has reached a boiling over point. Consider the effect on Iowa if the World suddenly refused to buy its corn. The World would suffer from extra high corn prices but the people of Iowa would soon be facing an economic depression. Iran is facing an economic depression if it does not "make a deal".


This morning the talking heads are going on and on about high oil prices and what this means for airlines and other businesses. There has been no mention of the Iranian oil "embargo". A search on the Internet provides little information. An article that was on the UK Guardian web on May 14 is no longer available! One of the few additions to the information available last night was an excellent and detailed comment on a blog. The comment was posted by anonymous!


Consumption in emerging growth economies is 40 to 45% more volatile than in developed countries (according to a study done by Mark Aguiar and Gita Gopinath). This is only common sense. If you were one of the billions of people who live off of less than $3 per day and the price of food and fuel soared, you would naturally cut back your discretionary spending by a large percentage. Economist call what happens to emerging economies during a world wide crunch a "sudden stop". These economies can go from hyper speed to zero in no time flat. Dennis Gartman of Gartman Letter Fame mentioned today that the Chinese have seen a 3.7% rise in their currency in just one month. A country that depends on the export of low priced, low margin consumer goods has a steep hill to climb when its competitive advantage falls by 3.7% in a month.

Of course, some of the emerging growth countries are resource rich. These countries are enjoying the surge in oil, but the price of nickel fell the limit yesterday. The oil rich countries are drowning in currency. Suddenly Brazil is one of the heavy US investors. It is extremely important that these investors be permitted to reinvest in any manner they please. With the exception of strategic military investments, it is good for both parties if those with money are able to shop for the best investment.


The whole concept of loving your neighbor comes down to a willingness to build relationships with one another. Those who have built relationships have economic reasons to solve their differences. Israel and the USA have offered Syria powerful economic incentives to sign a peace treaty. This treaty was negotiated over 15 months with Turkey serving as the mediator. Yesterday, a line was drawn in the sand, the US and Israel will not go forward unless Syria cuts its ties to Iran and Hamas. Syria and Iran are in the midst of a game of prisoners dilemma, who will give up the other first?

Iran, being the richest country in the world in regard to natural gas reserves, has an incredible incentive "to go along to get along". Iran will sell trillions of cubic feet of gas to Pakistan, India and China after Iran agrees to live peacefully with its neighbors.


The package of incentives offered has not been taken away. The "oil embargo" is only a lever to encourage Iran to take the life preserver. Sometimes you have to almost force a person or a country to do what is right for that person or country. Condi Rice says that Iran has a choice to make and I say they have little choice. The country has negotiated hard to "win" many concessions. A deal will be a victory for Iran and for the rest of the world.