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The Pros And Cons Of The Federal Interest Rate Hike

The Pros And Cons Of The Federal Interest Rate Hike

The United States Federal Reserve…

Black Gold!

All wars are economic. Despite the pleas of some they usually have very little to do with liberation, democracy or weapons of mass destruction even if they are the stated reasons. Usually it is simple. Offensive wars are usually started because one country wants or needs something that another country has. Defensive wars are wars that threaten the economic well being of a country. This one is no different.

In 1991 the Gulf War was largely about oil. One of the reasons that Iraq went into Kuwait was a long-standing complaint that Kuwait was cross-drilling Iraqi oil. The Rumalia oilfields in Southern Iraq are adjacent to Kuwait. Kuwait was a large oil producer and an important moderate voice in OPEC. Kuwait had also been accused of overproducing in 1990 at a time when oil prices were low. Finally Kuwait had reneged on a promise to compensate Iraq for defending it from the Iranian ayatollahs during the Iran/Iraq war. Iraq needed to pay for the long costly war with Iran, which in itself was a territorial dispute over the Shatt Al Arab waterway, an important oil and freight route bordering the two countries. The fear of Iraq taking over Kuwait was that it would have given Iraq control over a very large swath of oil rivaling Saudi Arabia the world's largest producer.

But if in 1991 oil was so important then why did the UN forces led by the United States not keep going to Baghdad to gain control of the oil at the time?  That is another debate but suffice to say it did not happen but is often cited as one of the reasons why this one is not about the oil. Iraqi production of oil since then has been largely based on the UN oil for food and medicine. Production, that was easily 3.6 million barrels per day pre Gulf War had been cut in half. Potential for Iraq is 7 million barrels per day if the country could upgrade its wells and move to maximum capacity. This kind of production would rival Saudi Arabia and could reduce the Saudi's grip on OPEC.

Today there has been the accusation that this war is about oil or more specifically the desire of the US to control the oil supply. Certainly there are aspects of that argument that are compelling. Iraq contains at least 10% of the world's known reserves. They are producing far below capacity. It is suspected that there is even more reserves in Iraq (current reserves are estimated to be 112 billion barrels with some studies indicating possibly up to an additional 100 billion barrels) that if proven correct would rival Saudi Arabia. Control Iraq oil and price pressure could be brought down on Iran and Saudi Arabia and other oil producers.

The US is the world's largest consumer of oil using some 25% with barely 5% of the world's population. World demand is growing particularly in Asia and there is a need for more even if in the North American economies for one oil is not at the same level of importance as it was at the time of the 1970's embargoes. Today the world consumes roughly 75 million barrels per day and by 2015 it is expected to be at least 90 million barrels per day. The US alone consumes 20 million barrels per day and has to import close to 60%.

Oil is paramount to the economic well being of the world and the US in particular. The US and the world economy are slowing down simultaneously. High oil (energy) costs, have, amongst other reasons, though not the most important one, contributed to the financial woes of the North American airline industry. High sustained oil (energy) prices threatens the economic well being of especially North America, as our energy prices are the lowest in the world to the consumer. Every major recession since the 1970's was preceded by a sharp spike in oil (energy) prices.

If demand is growing, not so supply. There have been no major discoveries in 30 plus years. Excess capacity that was 13 billion barrels in 1991 today sits at 2 billion barrels. Inventories in 1991 prior to the Gulf War were high while today they are quite low. While there are some sources in the world such as the huge Alberta tar sands that oil is heavy and dirty compared to the light cleaner oil that one gets from the Mid East. While the US does not get even 10% of its oil from the mid east its declining production and the lack of new resources means that the dependency on the Mid East will grow. It is expected that by 2010 the world could be experiencing shortages threatening the economic well being of the world economy.

The US has been concerned about energy security for years. The Bush Administration is an oil administration backed by the oil companies, owing considerable allegiance to the industry. Energy security is a clear stated policy of the government. The Mid East oil producing nations are under the control of autocratic governments who have embargoed in the past. They also are at the center of the current opposition to USA hegemony in the Mid East and alleged to be behind the attacks of September 11, 2001. Strikes are a problem in numerous countries the most recent in Venezuela and currently Nigeria. While the oil was never used as the word of excuse for the war there was considerable concern about the Iraqi oil fields prior to the current war. There was concern about securing them, concern about the wells being set afire (and as a byproduct creating an environmental disaster). Plans were set in place to make the seizure of the oil fields of utmost importance.

There has also been well laid down plans of how to use the oil after the war is over. It has been well documented prior to the current invasion that regime change was necessary in Iraq and that the oil was to be used to pay for the war itself and the occupation that could last anywhere from 3 to 15 years. But others also have huge economic interests in the oil fields of Iraq.

Both Turkey and the Kurds of Northern Iraq claim ownership of the northern Kirkuk oil fields. Russia and France have invested billions in Iraq particularly in the oil industry and hold contracts through Russia's Lukoil (LUKOY-NASDAQ) and France's Total Fina Elf (TOT-NYSE) amongst others. It is well known and accepted that both the Russians and the French will be cut out upon the successful execution of the war. On the other hand American oil companies are being geared to rebuild the Iraqi oil fields once the war ends with an already set up oil and gas-working group that includes members of the Bush administration and the oil companies. One of the prime beneficiaries will be Halliburton Co. (HAL-NYSE) where Dick Cheney the current VP was the past CEO and still holds a substantial interest. None of this will stand well with the Russians or the French or with many others for that matter. Their economic interests are threatened. That may pave the way to further conflicts over oil.

Many believe that once the war is concluded that oil prices will fall sharply. Today's high prices are there because of a fear premium. Indeed as the war was about to get underway oil prices fell precipitously on the expectation that the war would be over quickly and that prices which had risen as high as $40 would fall back into the low $20's. No such luck. Combined with the strike in Nigeria and a slow realization after only a week that the war is going to take a lot longer, prices have once again started to rise. We maintain technical projections that point to oil reaching at least $55.

This will be positive for oil (and gas) stocks going forward as they had been languishing as well on the same expectation that once war started they would fall. In sympathy they never rose even as oil prices soared to $40. Juniors were a notable exception. We spoke with Crude Ken our man in the Calgary oil patch. He helped us with some of the data presented above. He is quite optimistic for oil stocks going forward. He is as well optimistic on natural gas. Natural gas like oil is facing potential future shortages as demand rises. Potential new natural gas sources exist in the Mid East and Central Asia emphasizing once again the importance of this volatile part of the world to who ever is able to control it. The economics of oil dictates it. The wars of the 21st century will be about scarce commodities.

Our weekly chart of both oil and the TSX Energy Index shows us in a clear up trend from the 1999 lows. The recent shakedown in oil prices bounced off the weekly trend line and the four-year moving average. The TSX Energy Index has been trading around the converging 13 and 40 week moving average and above the trend line near 120. As long as these trend lines hold owning some oil and gas stocks in your portfolio is essential.

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