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Oil Wars

It should not be surprising that you probably would not find many out there who believe we are in the early stages of oil wars that will dominate the first half of this century. And if oil is the commodity of choice in the first half of this century then water will probably become the focal point in the second half of the century. But right now it is oil that is up front. Oil (energy) is the engine of the global economy. Without it we could quickly revert to a Road Warrior type of world run by warlords whose armies fight over the remaining pockets and supplies of oil (energy). That still might be our future baring of course some huge changes in how we run our economies or major discoveries and conversion to alternative forms of energy.

From a low of around $10.75 in 1998 oil has been one of the fastest rising commodities and is now up about 500% (see chart below). Thus far it has not had a significant negative impact on the economy as many originally thought. It has, however, been cited as a reason the economy could be vulnerable and rising oil prices have caused the stock market to roil on several occasions. On an inflation adjusted basis oil prices remain below the peaks seen in 1980 at the height of the Iranian hostage crisis. Current prices would have to rise closer to $90 to match those prices and then yes when SUV owners are discovering that it costs $100 + to fill up then it might start to have an impact.

There are numerous web sites and books that have been devoted to the coming oil crisis most of which can be found with a quick search of the web. There is anywhere from the well thought out to some that seem more inclined to put fear in everyone. The figures have been well bandied about. The world uses roughly 80 million barrels per day. Of that the US consumes 25% or roughly 20 million barrels a day. Studies have shown that with conservation, higher prices and a move to alternative forms of energy the US could cut that amount substantially.

But a major cut in US consumption is not about to happen as vested interests in USA Inc. meaning big oil and other large US corporations would be negatively impacted. Instead the devotion seems to be directed towards securing and protecting sources of oil. The current US administration has numerous well documented ties to big oil. As soon as they took power in 2000 they moved quickly to set up an energy task force under VP Dick Cheney the former chairman of Halliburton the world's largest Oil Services Company.

They acknowledged very quickly that oil production peaked in the US in 1970 and was now well below that peak. There was the acknowledgement that discoveries of new sources of oil have fallen every decade over the past thirty plus years. They acknowledge that unconventional sources of oil (oil sands, shale fields, heavy oil) are plentiful but expensive to extract and getting at the best of it will be cost even more. They acknowledged the US dependency on foreign imports, now exceeding well over 50% of requirements and that it was growing and in the not too distant future will approach 90% of requirements. There is the acknowledgement that 65% of the world's known reserves lie in the volatile Mid-East primarily in Saudi Arabia, Iraq and around the Caspian Sea.

There is the acknowledgement that the US and the world are very vulnerable to oil supply disruptions. Indeed focus in the first year of the Bush administration was on securing those supplies and plans were laid out in that period to overthrow Iraq. This was all laid out in the book by Ron Suskind - The Price of Loyalty: George Bush, the White House, and the Education of Paul O'Neill. Indeed the recognition that securing oil supplies goes back further than the current Bush Administration. It was a primary focus of the first Bush administration as well and it has been a major focus of all US administrations since the Arab oil crisis of the 1970's when the world was given its first oil shock. It was that crisis that shook up the prevailing cosy relationship with big oil, the US Government and an elite few in the Arab oil producing countries.

In 1999 a Strategic Assessment report prepared for the Joint Chiefs of Staff and the Secretary of Defence acknowledged that "energy and resource issues will continue to shape international security". The risks in the Persian Gulf and Caspian regions were particularly acknowledged. The report and subsequent policy did not make specific reference to the acceptance of military intervention to secure oil supplies.

But following September 11 the link was quickly drawn between Iraq and Al Qaeda and despite clear evidence that WMD were not present in Iraq it was all used as an excuse for a military invasion of Iraq. Iraq is acknowledged to have reserves of at least 112 billion barrels and there is evidence to suggest to those reserves could be 100 billion barrels higher. Iraq is acknowledged as the king pin in controlling oil resources in the Middle East. Attempts to quickly privatize the Iraqi oil industry were thwarted when infighting between the State Department, oddly representing Big Oil who did not want the price of oil to fall, and the White House resulted in its failure.

But clearly the US is not the only one interested in securing supplies of oil. Oil demand has been rising sharply over the past decade primarily fuelled by the demand from Asia in particular China. China is now the world's second largest consumer of oil. It is forecasted that China's needs will continue to grow and could surpass the US within 20 years. China like the US views any shortages of oil as a threat to national security and to social stability. China currently imports at least 3 million barrels of oil a day while consuming upwards of 6 million barrels per day. China has been scouring the world seeking to secure deals that will ensure it has some control on its supply and secure its needs.

And it is here that they are and will come in direct conflict with the US. While there is no stated conflict currently existing between the US and China it is clear that the growing China economic power is a threat to US economic power. China is a major financier of the US's huge and unsustainable trade deficits. While China may import heavily to the US, Chinese investment in US bonds far exceeds current trade flows. But the Chinese economy for all its huge growth is one that is built on an unstable financial system where lending practices come no where near Western lending practices. This makes for considerable vulnerability in the Chinese financial system and a collapse could lead to significant selling of US bonds.

As well any serious conflict between the US and China could also lead to selling of US bonds. China, despite the progress made over the past decade plus in joining the world economic system and in opening up its economy remains essentially a police state. Conflicts are clearly apparent over Taiwan and they have threatened invasion if Taiwan were to separate. China has also allowed major protests against Japan over Japanese atrocities in WW2. These protests are allowed to take place although clearly protests for example over Tiananmen Square would be crushed. But the protests towards Japan may be more than just WW2 atrocities. Japan is a major economic power and its lead role in Asia is in the way of China's economic ambitions. As well there are disputes over offshore oil and gas reserves.

In seeking to obtain secure sources of oil, China is signing major deals with Saudi Arabia, Iran and Venezuela amongst others. Its involvement with Venezuela is made more fascinating because of the animosity between the democratically elected government of Hugo Chavez and the US. It is believed that the US has been behind coup attempts. Venezuela supplies upwards of 11% of US oil and any major diversion of oil away from the US to China could bring on a serious conflict. In neighbouring Colombia there are US troops patrolling pipelines. As well China's deals with Iran add an edge to the ongoing war of words and conflict between Iran and the US over alleged WMD.

And the US is not the only one with troops in foreign countries. China's insatiable need for resources finds them in particular in numerous African countries including Nigeria (oil), Zambia (copper) , Equatorial Guinea (wood) and others particularly for oil and gas reserves and wood (which China has a shortage of). Besides engineers and technicians there are also Chinese troops protecting facilities.

One country that China is making overtures to for major investments is Canada. China has attempted to purchase Husky Oil owned by Hong Kong billionaire Li Ka-shing and is looking at significant investments in Canada's oil sands. But here their need to secure supplies of oil comes in direct conflict with the US's needs to secure supplies and under the terms of the North America Free Trade Agreement (NAFTA) the US is guaranteed a percentage of Canada's oil. Any deals between Canada and China could cause problems with US interests. It is a growing problem not only for the Chinese and the Americans it is a problem for Canada in determining where it wants its business and exports to go.

For Canada a diversified market for its oil and gas is positive as it also means more competition and more foreign investment. But it is in direct conflict to the US's need to secure supplies. But to extract from the oil sands is very expensive and for China cost is less of an issue. If the US decides that cost is not an issue either the boom that started years ago in the Canadian oil patch will heat up even further. But the potential for international conflict adds an edge to the debate that would not be present if not for China's own insatiable needs.

The potential for a major conflict between China and the US at this stage remains low. But as we move forward and demand keeps rising (and not only China as India, Brazil, Russia and Japan are right behind with demand growing faster than in the US) and discoveries and refining capabilities lag coupled with rising costs because of the cost of extraction in oil sands or deep sea plus the ongoing potential for supply disruptions in the volatile Middle East the potential for a military clash of some significance grows with it. We are always fascinated with pundits who believe that oil prices are going to fall to levels of $40, $30 and even $20. Oil prices are high and will go higher for good reason. Supply disruptions, growing shortages, sharply rising demand and the potential for global conflict over a commodity that drives the world economy. And at the centre of it are China and the US.

Our weekly charts below show light sweet crude and the TSX Energy Index. Oil has been in a major uptrend now since 1998. A major correction took place in 2001/2002. There were negative divergences at the recent highs. Major support is at the 40 week moving average currently near $46. We would not be surprised to see a test of that zone in this correction. Longer term trendline support can be seen at $40 and again at $33 although if we are in the throes of a longer correction a test of these zones can not be ruled out. The $40 target we believe would be the worst case. The long term basing pattern on oil suggests minimum targets of $70/$75. New highs would suggest that we are on our way to those targets.

The TSX Energy Index demonstrates the massive strength in the Canadian energy markets over the past few years. This chart is also in a major uptrend with no sign of any major topping patterns. Major support can be seen at 200 and at 175 and 145/150. The second level is possible in a significant correction. There are no negative divergences in the MACD indicator but a weekly sell signal is clearly visible. Investors would be wise to be patient and significant buying opportunities should be seen in the next month. Canada's stability and the massive interest in our oil reserves by both superpowers coupled with all the other global problems related to oil ensures that Canada will be a highly sought prize.

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