Crude Oil, Gold and the Middle East Powder-keg
Global Money Trends magazine
Gary Dorsch, Editor
Crude oil has entered into un-chartered territory, with prices climbing above psychological barriers, such as $50, $60, and $70 per barrel, then establishing these levels as a base of support, before mounting rallies into higher ground. Markets don't trade in a straight line, they usually move up and down within a trend. Crude oil has been marching higher in an orderly fashion since the US conquest of Iraq, fueled by a razor thin difference between global supply and demand.
The uptrend in crude oil has confounded market bears, because prices were climbing alongside a 25% increase in US commercial oil stocks from two years, to an eight year high of 347 million barrels in June. Apparently, US oil companies have been hoarding oil supplies, in case Iran decides to withhold crude-oil exports or targets oil tankers in the Persian Gulf. Iraq is also falling into a civil war and its daily oil output of 2.4 million bpd is unstable. And now China has just completed oil storage tanks in Zhejiang, Shandong and Liaoning, with capacity to hold up to 88 million barrels, and is planning a third phase of yet another 200 million barrels of storage.
There is also growing demand for crude oil in China and India that keeps oil prices bubbling. China's crude oil imports for the first five months of 2006 were up 17.9% at 12.4 million tons, importing more than 40% of its crude needs. India's oil imports rose to 9 million tons or 12% higher from a year ago, and its industrial production was up 10% in May from a year earlier, bolstering its oil demand.
These two emerging giants contain a third of the world's population, and future demand from China and India might exceed the world's spare capacity in a few more years. Chinese oil imports have climbed from 4.8 million tons per month in late 2002 to 12.3 million tons in June 2006, a whopping 156% increase. World oil demand should soar 37% from this year's almost 86 million barrels per day to 118 million bpd by 2030, the US EIA predicted on June 20th, led by China, India, and the US.
A Favorite Iranian Tactic - Tension in the Middle East
Iran is OPEC's second largest oil producer, and exports about 2.4 million barrels per day. Iranian leaders know how to rattle the nerves of crude oil traders, and have threatened to shut down the Strait of Hormuz, and Iran's president Mahmoud Ahmadinejad has frequently called for the destruction of Israel. In the latest flare-up of violence in the Middle East, Hezbollah and Hamas are doing the fighting against Israel, but Damascus and Tehran are pulling their strings.
The major wildcard in the Middle East depends on whether Tehran decides to take a chance and authorizes Hezbollah to launch long-range missiles with more powerful warheads at Israeli cities. It is difficult to assess what the Iranian leadership will decide next in its war to "wipe Israel off the map." But if Hizbollah strikes Jerusalem or Tel-Aviv, it could spark a wider war between Israel and Syria, and Iran has vowed to join the battle, if Syria is attacked.
Last week, schizophrenic crude oil traders concluded that the fighting between Israel and Hizbollah would not widen to the Iranian-Syrian axis. Hindsight is the best sight of course, and Iranian "War Premium", for crude oil did begin to unwind on July 17th, just one day after the Tel-Aviv 25 stock index put in a stunning reversal bottom at the 720 level, before rebounding 8% off its low of the day.
The reversal bottom in Tel-Aviv blue-chip stocks and the Israeli shekel's rebound against the US dollar, appeared to be ruling out a wider Mid-East war for now, and contributed to a 10% drop in US crude oil prices. However, Hezbollah's attacks might just be a sneak preview of the damage that Tehran can inflict on Israel and the global stock markets, if the United States decides to push tough economic sanctions against Iran. The brief spate of optimism among Tel-Aviv traders might soon dissipate as nothing more than a technical bounce.
Most interesting, despite being the world's fourth biggest crude exporter, Iran is heavily dependent on gasoline imports because of its lack of refining capacity and buys 440,000 bpd of gasoline from abroad, or 40% of its daily consumption. Tehran could prove highly vulnerable to international sanctions on its gasoline imports. Iran's gasoline imports are supplied by Swiss-based trader Vitol and India's Reliance. Washington could go further with a naval blockade on Iran, halting its $54 billion per year of oil exports, or 90% of the Ayatollah's income source.
The Saudi Arabia royal family has openly condemned Hizbollah's war on Israel, worried about growing Iranian Shiite influence over the region. Saudi Arabia's All-share index has tumbled by 50% since reaching an all-time high in February, losing $400 billion of market value, amid fears of an eventual war in the Persian Gulf.
The Saudi royal family has openly criticized Hizbollah, not out of love for the Jewish state, but instead, recognizes the katushyah rocket attacks as the opening salvo in Iran's war to "wipe Israel off the map" that could eventually spread to the Persian Gulf. So far, the US has defended Israel's air and sea blockade of Lebanon, to block the delivery of ammunition to Hizbollah, and to gauge the local Lebanese reactions and attitude for removing Hizbollah from their midst.
Would the US initiate a unilateral blockade of Iranian oil exports, recognizing that China and Russia would never agree to UN sanctions against the Ayatollah? The loss of Iran's 2.4 million bpd of oil exports could be mostly made up by Saudi Arabia's 2 million bpd of spare capacity. In addition, member states of the OECD, have oil reserves of about 4 billion barrels, enough to cover the Iranian shortfall for several years. And without its $54 billion of annual oil sales, Iran's economy could collapse, leading to massive unemployment, and a toppling the Ayatollah's regime.
Under this scenario, the world might have to live with $80+ per barrel for crude oil. But Tehran won't take an oil embargo lightly, and would try to disrupt the flow of oil through the Strait of Hormuz, or 17 million barrels per day, to drive world oil prices to $100 per barrel or higher. Without credible economic sanctions against Iran though, the alternative is a military strike against its nuclear facilities, or a nuclear armed Iran. There just are no good alternatives, which is why crude oil should continue to command a $10 to $15 per barrel "war premium".
The last time the crude oil market built in a $10 to $15 per barrel "war premium" was from November 2002 through early March 2003, as the drum beat of war with Saddam Hussein's regime grew louder. Yet at the moment US president George Bush presented Saddam with an ultimatum of war or exile on March 19th, the price of crude oil peaked, and began to collapse by 25% within a few days, even before the first bombs landed in Baghdad. Oil traders had correctly calculated that the war would end quickly, and without any damage to Iraq's oil installations.
There is always a risk that the current $10 to $15 per barrel "war premium" built into oil prices, due to fears of an eventual military confrontation with Iran, could evaporate overnight, if the Ayatollah flinches at the eleventh hour, and agrees to the UN incentive plan for abandoning the enrichment of uranium. But Iran is not Iraq, and the game of brinksmanship between the US and Iran, probably won't be settled until after the US Congressional elections in early November.
Until then, Tehran's leaders might suffice by stirring tension in the Middle East through its Hizbollah proxy in Lebanon. Israel is calling up its troop reserves, and warning Lebanese citizens to flee the southern part of the country, in what could be a prelude to a ground invasion, to carve out a 20-mile buffer zone between Hizbollah and Israel. Lebanon's defense minister is threatening to join Hizbollah in any battle against Israel's Defense Forces on the ground.
Lebanon's defense minister Elias al-Murr told Al Arabiya television on July 21st, "There is national unity in the army. Christians, Shi'ites, Sunnis, and Druze are all waiting for the hour Israel enters Lebanon from the ground, so they can teach it a lesson. We know our capabilities and we know that we are not of the size of the Israeli army in order to defeat them, but we are standing on our land and in our trenches to defend our country," he said.
For the past seven weeks, gold has been closely tracking the direction of crude oil prices, which give real-time clues about the future direction of global inflation. Fears of a wider war in the Middle East, might also sway Arab oil kingdoms to buy gold, as a safe haven from geo-political tensions. There are also signs that Iraq is hopelessly slipping into a civil war between Sunnis and Shiites, with most of Iraq's 2.5 million bpd of oil production under Shiite control in the south.
If Iraq breaks up into three provinces, between the Kurds, Sunnis, and Shiites, the Shiites in the south could align themselves with Iran's Shiite regime, giving the Ayatollah even greater economic power over the Group of Seven industrialized nations, and influence in the Persian Gulf region. That could keep both crude oil and gold prices buoyant, and keep the Arab Gulf stock markets under pressure.
22 July 2006
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Mr Dorsch worked on the trading floor of the Chicago Mercantile Exchange for nine years as the chief Financial Futures Analyst for three clearing firms, Oppenheimer Rouse Futures Inc, GH Miller and Company, and a commodity fund at the LNS Financial Group.
As a transactional broker for Charles Schwab's Global Investment Services department, Mr Dorsch handled thousands of customer trades in 45 stock exchanges around the world, including Australia, Canada, Japan, Hong Kong, the Euro zone, London, Toronto, South Africa, Mexico, and New Zealand, and Canadian oil trusts, ADR's and Exchange Traded Funds.
He wrote a weekly newsletter from 2000 thru September 2005 called, "Foreign Currency Trends" for Charles Schwab's Global Investment department, featuring inter-market technical analysis, to understand the dynamic inter-relationships between the foreign exchange, global bond and stock markets, and key industrial commodities.
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