Why Oil Prices Are Jumping Again

Since the 1970s, the price of oil has been set, not by OPEC, but by buyers and sellers through two independent exchanges in New York and London. The US has been able to substantially control this price through most of the intervening period because (1) all three exchanges quote the price and transact only in $USD, so the US does not need to worry about the free-fall of its currency interfering with their ability to buy, (2) oil companies and oil nations friendly to the US have been overstating their reserves in an effort to counter the growing evidence that global production is about to peak, and (3) the OPEC countries have substantial leeway in adjusting production levels to ‘moderate’ prices. Recently, OPEC producers friendly with the US have been producing well beyond sustainable capacity, using forced water injection and other methods in their wells to increase oil flow per day beyond sustainable levels in an effort to keep the market price from rising too quickly. When you control the currency of the transaction, the information flow on production and reserves, and the rate of production, you pretty much control the price, at least in the short run. And when your economy is utterly dependent on foreign oil, you are really motivated to control that price.

Why would OPEC be complicit in this? Many of the non-democratic members, notably Saudi Arabia, need arms, intelligence, and political support to fend off insurrection from their people. There have also been times (even quite recently, believe it or not) when OPEC members have needed support from customers to keep demand high so that the price does not fall significantly — their economy depends heavily on demand for oil. The US provides huge military and political support to the Saudis and others, and most US administrations have encouraged waste and discouraged conservation. Like the US-China co-dependency for manufactured goods, the US-Saudi co-dependency for oil ensures an artificially low price to US corporations and consumers in return for political support and sustained high demand for producers. Deals with the devil (or perhaps between devils).

Neither of these massive market distortions is sustainable, of course. And there is a rash of new information suggesting that, for oil at least, the end of this devil’s bargain is near:

  • In late 2000, Iraq, annoyed by the decline in the $USD, announced that from that time on they would sell and settle only in euros. We all know America’s response to that. Since the US occupation, Iraq oil sales are back to using the $USD.
  • As a result of the recent hurricane season, Gulf of Mexico production, which destroyed 115 oil platforms and damaged 183 pipelines, remains down 27% from pre-hurricane levels, and only 10% more production is expected by the onset of the next hurricane season.  Rita and Katrina also caused hundreds of oil spills, which received almost no publicity in the media.
  • Iran recently announced that the consequence of any embargoes or other sanctions against it (threatened because of their refusal to stop nuclear research & development) would be a huge spike in oil prices to over USD$100/barrel (it has recently jumped to $68). European leaders confirmed that, thanks to the insatiable demand for oil by China and India, this was no idle threat.
  • Almost every day brings new warnings about the unsustainability of the US trade deficit. New York Federal Reserve President Timothy Geithner said yesterday the massive and growing U.S. current account deficit presented “a threat to the world economy.” As a result, the value of the $USD dropped 1% in a single day yesterday against a basket of other currencies. 
  • On Friday Kuwait confessed that its actual oil reserves, which previously accounted for 10% of the world’s total, were less than half what it had previously reported.
  • Shortages are already starting to occur in areas of high demand, or due to political instability. This week Turkey lost its supply of natural gas when Iran cut supplies, citing cold weather problems. And recent pipeline sabotage in Russia has cut off supplies to Georgia and Armenia.
  • Iran proposed in 2004 to create a bourse (market) for its oil, to be denominated in euros. It is scheduled to open this spring. Iran is already accepting and settling orders with European customers in euros. But the new bourse will enable any country (especially China and India) to dump their $USD reserves in favour of the healthier euro, making them less dependent on the value of the $USD. This could precipitate a collapse of the $USD, domino-style, as countries scurry to switch from dollars to euros before the dollar falls further. That would mean that customers — especially China — would take a bath on the trilions of $USD reserves it is sitting on to back its receivables from the US, and would likely cause them to abandon the dollar for future trade in favour of the euro (and revalue their currency). The artificially-suppressed price of Chinese goods would therefore soar in the US market, with two consequences: (a) a sharp drop in Chinese sales to the US, damaging the Chinese economy, and (b) a sharp spike in inflation in the US, as measured by the consumer price index, damaging the US economy. In order to hide the impact of this change and stave off panic selling of the $USD, the US Fed has agreed to stop publishing data on eurodollars — the amount of money countries other than the US are holding in $USD to secure oil payments and $USD receivables.
  • Iran has recently started pulling its assets out of Europe and shifting them to Asian banks (all Iranian bank accounts in the US were frozen in the 1970s as punishment for Iran’s overthrow of the US-backed Shah). $8B has been shifted already. Dale* speculates that this means Iran has already made a deal with China to sell its oil to them, whether sanctions against Iran come into effect or not. I suspect that would require another oil market to be established in Asia, perhaps denominated in some ‘basket’ of Asian currencies. That would be a win-win for Iran and for China. Some European banks have stopped doing business with Iranians already, presumably in anticipation of the imposition of sanctions.

Here’s an interesting article on this whole subject published recently in the dubious Moonie-owned right wing paper chain. The Moonies, thanks to their purchase of UPI, now have a seat in the inner circle of Bush media contacts — a seat on Air Force One. Are the Moonies warning us, or Bush, of the possible consequences of invading, or not invading Iran?

And here’s a recent, sobering overview of the vulnerability of the entire oil market, written by a former British oil industry executive.

Anyone want to give me odds on $100/barrel oil at some point before the end of this year?

*Thanks to Dale Asberry for most of the links above, and for connecting the dots.

Chart is from peakoil.net. Part of the thin white band on this chart will be the only benefit the US will receive for the destruction of the ANWR and the massive damage to Alaska’s fragile ecosystem.

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5 Responses to Why Oil Prices Are Jumping Again

  1. adrian says:

    Hello Dave — have you taken a look at Matthew Simmons’ “Twilight in the Desert”? It details some of the claims made in the Independent article you linked to. He concludes that Riyadh’s doing what US oil companies did a half century ago: fudge the numbers to maintain the illusion of abundance.http://www.amazon.com/gp/product/047173876X/qid=1138123749/sr=2-1/ref=sr_2_1/103-0807715-0859825?s=ebooks&v=glance&n=551440

  2. Hi Dave,Thanks for this article. I feel that it really sheds a lot of light and helps me understand some of the things that are going on.Incidentally, a great article on the same topic was sent around today at work. It makes a similar analysis, but also provides a historical explanation for the importance of the dollar in the world and for the US.http://www.financialsense.com/editorials/petrov/2006/0120.html

  3. Dale Asberry says:

    ‘The Proposed Iranian Oil Bourse’ was one of the articles (but a different linked site) that I sent to Dave.

  4. akirrrsra@yahoo.com says:

    Wonderful Site! Thanks for the good material.

  5. Dave Pollard says:

    Adrian: Wow, thanks for this! I’ll pick up a copy. Julien: Merci. I read that article in researching this post, and thought it was interesting, but I found the tone a bit strident, which detracted, I thought, from the credibility of his argument.Dale: Yes, thanks for that clarification.And no, I’m not going to acknowledge compliments from the last ‘commenter’ above, a porn-bot. The spammers are getting pretty sneaky, eh?

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