Monday, June 23, 2008

The War Between Saudi Arabia and Iran

Yesterday, the Saudis held a conference to assure an oil thirsty world that supplies will be adequate. This conference was held just a few days after the Saudis accused the Iranians of using Bahrain's citizens to spy on Saudi Arabia. There is no love lost between Iran and Saudi Arabia. At the conference, the Saudis spoke of increasing production while Libya spoke of potential decreases by Libya, Algiers, Qatar and Venezuela. The situation in the Middle East is always more complicated than it seems. The Libyans are Sunnis. Did they show support for the Shiites of Iran or are they simply after keeping the oil price high? Does the support of Venezuela help or hurt Iran's cause?

British Special Forces have evidence that Iran is supporting the Taliban against the government of Afghanistan and the US has evidence that Venezuela has 5 bases where Hezbollah terrorist are trained. Those who want peace know that Iran is the ring leader of war. It is clear that Chavez is nothing but a petty dictator. The response of Chavez was to nationalize a milk plant to "cure" the problem of milk shortages in Venezuela. As is typical of command and control economies, now that Venezuela has nationalized a number of industries, shortages are the only thing in abundance.

There are exceptions to every rule. The Saudis produced 9.6 million barrels of oil per day for some months following Katrina. Production continued at an average of about 9.4 million barrels per day until prices fell significantly in the fourth quarter of 2006. Saudi production was cut by a million barrels per day by June of 2007. The high prices of 2008 induced a climb to 9.2 in April, to 9.5 in May and the announcement of 9.7 in July. The Saudis are rationally responding to the market price. In the meantime, Iran has 30 million barrels loaded onto ships and has offered this oil to any taker for $6 per barrel below market rates. The Iranian oil minister, Ghanimifard, said just a week ago that the oil would not be discounted. Bloomberg reports that 13 oil tankers are still parked. Bloomberg cannot confirm the 30 million barrel figure but there is no indication that the oil has been sold. Ghanimifard says the seasonal maintenance of heavy oil refineries will be finished by the end of June and the oil will start flowing again, and the Easter Bunny will deliver. His words were directed to the Iranian people. Ahmadinejhad just closed down another critical news paper.

India has worked its way into a bargaining position. India completed a huge refinery just a few months ago and is looking for a long term supply contract. The oil being offered by the Saudis is a good fit. The new refinery is designed specifically for the heavy - sour crudes that the Saudis can add to the market quickly. A major Saudi field has been mothballed for several years while the Saudis have waited for higher demand for sour crude. The Saudis say they can add 2.8 million barrels of production by the end of 2009. The Indian refinery is huge but it can only handle 1.2 million barrels per day. India is trying to play Iran and Saudi Arabia against one another. Iran, Pakistan and India continue to assert that the IPI pipeline, a 7.5 Billion Dollar gas pipeline, should be built. Those who desire Iran to give up its nuclear warhead ambitions are ready and willing for Iran to sell gas and oil, as soon as a deal is made on the nuclear/terror issue. The UN Security Council and Germany have offered free nuclear fuel to Iran as one of several incentives to "make a deal".

Whack a Mole -- In Canada?

The good folk at Stratfor report that Hezbollah seeks to pull off a major terrorist attack, perhaps in Canada, as the way to convince Iran to continue its support. My take is that any attack right now would be bad news for Iran. The EU will meet to discuss additional sanctions tomorrow. Syria, which has negotiated a deal with Israel in regard to the Golan Heights, Lebanon and protection of Israel from rocket shots from Hezbollah, supports the end of Hezbollah terrorist activities. The negotiations with Iran must be handled carefully because a trapped animal is prone to lash out. Still, little by little, the wall around this trapped animal is approaching completion. For example, a "Shiite Awakening Council" in Iraq has accumulated 3 million signatures on petitions asking Iran to stay out of Iraq!

Goldman's Joke

A couple of weeks ago, when jet fighters from Israel were engaged in joint maneuvers with Greece, the price of oil made its biggest one day jump ever. This past Friday, negotiators re-told the story of the maneuvers to "turn up the heat". The maneuvers were suddenly being described as a "practice run". Goldman predicted oil prices of $200 per barrel back when the maneuvers were taking place. This past Friday, Goldman used the report of maneuvers as a good time to offer twisted logic in concern to oil demand in China. After a meeting with Hank Paulson, US Secretary of Treasury and former Chair of Goldman, China made a significant move to curb oil demand. The consumer price in China was raised by 18% to $3 per gallon. China will need to raise prices another 30% to reach market rates. The 18% jump was huge.

The average American now spends 9% of his disposable income on fuel. Averages, like all statistics, sometimes hide the truth. The truth is that many "big city Americans" ride subsidized trains, buses and subways. Many of these Americans spend 2% or less on fuel. Many rural Americans spend 16% on fuel while many others spend 10% while paying extra taxes to support the 2% price. Americans who spend 16% can live with $4 gasoline for a while, a tough price to pay but doable. Three dollar gasoline in China is a more serious blow to the family budget. Officials need to end wasteful use of fuel by raising the price to the market price but they must take the price up in steps in order to avoid the kind of shock that could cause armed protest.

The 18% increase in the price was a blessing to Chinese oil companies. They were being squeezed by high wholesale but restricted retail prices. The Goldman logic is that because fuel will become more available in China, now that the price is higher, the total usage will go up. This is another one of those short-run versus long-run issues. Give China another 30 years of rapid growth and the country will use as much oil per capita as the USA (except that they are into battery powered vehicles). Give them an immediate 18% increase in price and the fear of additional increases and they will find ways to cut back in the near term.

UN negotiators have reportedly offered Iran the option to begin talks without suspending production of uranium. The UN will accept a freeze at current levels of production as a way to get the next step of the negotiations moving. Iran needs to take the deal because its oil market is drying up and it could miss the chance to join a nuclear consortium that will refine fuel.

If you take a few steps back, the view is interesting. After three mile Island, it appeared that nuclear power was dead. Since that time, tens of thousands of coal miners have died and millions of pounds of toxic fumes have poured out of coal fired power plants. Hundreds of thousands of people have died early deaths due to air pollution.

Today, there is a world wide scramble to build nuclear power plants. Over the past 30 years, many billions of dollars of subsidies have been dolled out in support of windmills. The facts are that wind power cost about 3 times as much as nuclear power and that all these subsides have gotten us to only about one half of one percent wind power. It took a lot of time, a lot of waste and a lot of deaths, but the majority now supports drilling for oil and building nuclear power plants. Grandpa told me to stay on the road because it is really hard to get back on after you run into a ditch. Nuclear power ran into a ditch 30 years ago but it is finally back on the road. Is it ironic that Saudi Arabia is a major player in getting nuclear power back on the road?

The War Between Saudi Arabia and Iran

This "cold war" is actually between Iran and most of the rest of the world. A friend says he wants the USA to reach total independence from foreign oil. I asked him about bananas. He said he has a choice to buy bananas or not. Yes, he does. He has a choice to buy gasoline or not. We choose to buy bananas from the tropics because they are cheap. We choose to buy oil from Saudi Arabia because it is cheap.

The Saudis own a lot of oil and India owns a lot of bananas, does it not make sense that they remain dependent on one another? Why should the Saudis even consider trying to raise bananas in their deserts. My friend seems to think that one can get along without bananas much easier than without fuel, but how about corn, wheat and barley? Which is strategically more important, food or oil?

The tricky thing is that governments must create a false crisis in order to "move the agenda". "Peak Oil Theory" gets a lot of press because drilling for oil in the USA was purposely restricted. To get "permission" to build nuclear power plants, required an energy crisis.

After the "war to end all wars", America withdrew from international affairs. The results were horrible and the next war cost about 80 million lives, included more than 500,000 US servicemen. To reach the promised land of peace and security, nations must build strong international relationships. In the grand scheme of things, it is pretty amazing that millenniums of war in Western Europe have ended. It is pretty amazing that Saudi Arabia, Israel, Western Europe, Australia, Canada, China and Russia are all cooperating in trying to reach a peaceful settlement with Iran. I am thankful that all these countries and many others are "on our side". We do not desire to take anything from Iran. We only want to abide in peace. The odds of peace in the Middle East are as high as they have ever been.

A Quick Turn

Just a few weeks ago, a number of broker dealers suggested that most of the big airlines were flying toward bankruptcy. Last week, a deal was made for these same brokers to help CAL sell 11 million shares of stock. Today, brokers are calling their clients telling them that they have a good CAL deal available. Part of their spiel is that CAL will pay the sales commissions. For CAL holders, the additional shares are dilutive. My favorite comparison is to the Oakwood Homes dilution some 20 plus years ago. A lot of investors took the dilution as extremely bad news but the extra cash was used to build additional capacity right at the start of a "jump phase" in the business.

CAL is prepared to maintain the most efficient major carrier fleet in the USA. Midwest Air just announced that it will park all 12 of its MD-80s. The company will furlough 25% of its pilots and restructure its remaining routes to fit its remaining fleet of Boeing 717's. The "old SUV s" and the "super sports cars" of the airline business are being parked. The newer and more efficient "buses" are flying full and the ticket prices are going up. Higher fares on the most fuel efficient planes will lead to higher profits.

CAL has made a major deal with UAUA. The deal will not close for many months, but the direction has been set. Governments are allowing major carriers to "merge without merging". The integration of airlines has proven to be difficult. Agreeing to cooperate in markets has proven to be the way to cut costs and to increase revenues while avoiding the process of integrating operations. The process could easily ultimately lead to a merger of CAL and UAUA. It will also make a deal between AMR and BAY all the more likely. Trust busters will view a deal between British Airways and American as necessary to fair competition, rather than a monopolistic move by the "big boys".

The first quarter profit of Exxon was enough to buy all the shares of AMR, UAL, DAL, NWA, CAL, Alaska Air, JBLU, LCC and AirTran, with a billion dollars left over. Airline stocks are cheap.

Reader Comment -- $1,000 for Some Kids, Not for Others.

A regular reader teased me Saturday. He said, "you really do not like government subsides do you?" NO!

Government "incentives and disincentives" have unintended consequences that only government can "fix". When the government fixes one problem, it creates three more.

The $1,000 tax credit for children is an example of the crazy results promoted by the government. Some of you will laugh and say that a $1,000 annual tax credit is not enough to cause you to have a child. That might be true but the laws of economics are clear. Taxes and anti-taxes do effect behavior. Some Americans have at least one extra child today because the government pays.

But wait, who receives the $1,000 "bonus"? Not the poor, they are paid more than $1,000 per child in other subsides. Not the rich, they do not qualify. The $1,000 is a tax credit but the poor pay no income taxes and the "rich" are subject to the AMT and thus do not get the credit. So, a small percentage of the middle class are being paid $1,000 per year to have children and, due to many other subsides (details at another time), the poor are being paid many times $1,000 to have children.

Once again, the laws of economics are clear, pay for poor and middle class kids and you will have more; charge extra for rich kids and you will have less. The beauty for the politician is that the increase in the number of poor kids becomes the rational for having more government programs to help poor kids. The next thing you know, mothers are being paid to leave their husbands. While many a single mother does a great job of raising kids, the chances of a child from a single home making it though high school in 4 years is relatively slim. The odds of years in prison are relatively high.

Iran is subsidizing the bombing of innocent men, women and children. It is my hope and belief that the actions of Saudi Arabia to help cut off the income of Iran, will help end the practice of governments paying for terror.