THE OIL CRISIS LEADS TO 
GOLD AND SILVER
Excerpts from GLOBAL WATCH:
THE GOLD FORECASTER
by Julian D.W. Phillips
April 9, 2007

All is not well in the oil market. Not simply because of the demand supply pressures. 

Oil supplies, to a large enough extent to exert overwhelming pressure on the oil price, reside in nations that are not only involved in conflict within themselves over their own branches of Islam, but in nations that are thoroughly disposed to loathe the West, particularly the U.S. of A. 

Now add to that the wealth they themselves have in their pockets, which is sufficient to influence the flow of the U.S.$ market to its detriment, a market that is already under pressure from an over issuance of the currency to support the bleeding Trade deficit now at destructive proportions, and the potentially overwhelming surpluses in the hands of all the nations of the world. 

Now add to that the changing balance of economic power as it slowly shifts from the West to the East. Consequently the oil price is a very fragile thermometer of all these problems. 

On the surface we see that responsible forecasters have forecast oil to drop to $50, but already at the early stage of the oil year it has climbed to the mid-$60 level. 

On the surface we have media attention focused on the symptoms of these problems separately and without bringing them together as one would see tributaries of a river come together to make a more powerful and major force overwhelming the ‘big’ picture. 

What is the present state of these tributary problems and will flooding happen downstream?

U.S. Demand for Oil

As the U.S. consumer has been and continues to be the force driving the growth in the U.S. economy, what condition is he in?

With Gasoline topping $3 a barrel all eyes are on him, so will he tailor his needs to lower consumption? It seems that this is just not happening. Frankly, if we all need to drive somewhere, then we need to drive somewhere, so we won’t cut back on petrol, but will cut back in other areas first. Yes, we may stop the driving to the shops for one or two items when we run out and make a list to shop once in a while, but this is not sufficient to see a cut back in demand overall. And this seems to be the thinking of most people. So demand is showing itself to be relatively price insensitive at this level [$66]. 

The U.S. economy continues to grow and wage pressure are gaining more power as unemployment drops, so his ability to fund the higher costs is gaining strength.

The U.S. Department of Energy stated it is not comfortable with current global crude oil supply, although U.S. stocks were adequate to meet gasoline demand this summer. If the D.O.E. is correct in its view of tight oil supply, then we will be proved right in our view of the oil market as moving forward to a shortage eventually, taking oil prices much higher. 

War with Iran?

So do higher oil prices appear to have to do with far more than Iran? Would one be correct in thinking that it is the Iranian political problem that is pushing up the price? Despite the seeming relief provided by the release of sailors from Iran, the high prices do persist, so pointing to more than an unlikely war with Iran. 

Why unlikely I hear you cry? What is the political cost likely to be to the States where the President is for the war and both houses are against it? Only an emasculation of the foreign policy of the States and its Middle East policies, which is already looking more than questionable. What of the appetite of the U.S. public for war in the Middle East? We believe it is dwindling fast.

What are the possibilities that, if Iran is attacked by the States, the catastrophe that is called Iraq, will spread through the Middle East and the States finds itself facing the aggressive nations of Islam on a broad front, giving them a clandestine but suicidal enemy far greater than the small numbers of Al Quaeda and more difficult to counter.

On a risk-reward basis, such a war would rank a speculative high-risk investment, promising poor returns.

Turning to the other ‘tributary’ problems in the oil market we turn to China, where China is officially discouraging the export of strategically important commodities. Such a policy makes sound economic sense, but will reduce supply to the world markets, pushing price up still further.

China fails to export oil

An example of government control in China, China's crude oil exports fell to zero in February on the back of falling crude prices and a new export tax policy for energy-related products. Crude exports fell 31.1% in the first two months to 300,000 tonnes. 

International crude oil prices that fell to around $56 a barrel in the first two months, plus the 5% [export] tariff, left domestic oil producers with small profit margins for selling oil in the international market. Over $60 a barrel exports should pick up, or will they?

In November of last year, China imposed a 5% tariff rate on crude oil exports as part of its efforts to conserve energy, but the import tariff fell from 3%-6% to 1%-2% in line with its WTO commitment. China's crude oil imports reached a record 25.79 million tonnes in the first two months of this year, up 5.7% from a year earlier, according to China Customs. 

China continues a policy of ignoring the politics of their suppliers, simply securing future supplies through generous gifts of infrastructural developments in supplier’s economies. The policy is paying off as emerging nations welcomes the disappearance of such interference and gives them a new boldness on the global stage ad an acceptance of their bad behavior. 

This has to tighten the ‘marginal supplies,’ which set prices for the markets. Consequently the pressure on oil supplies increases and makes nations like Iran more powerful on the oil front. As this problem tributary joins the pressures on the U.S. consumer so the prospect of the double whammy [consumers plus China] gains velocity. 

Iran is now paid in the € for oil

With the U.S.$ the currency of oil across the world, the next move by Iran takes on a greater significance than the above tributaries. Perhaps the one factor that will break the $ quicker than any other is the lessening of the use of the $ in the oil market. With the € on the rise as a global reserve currency and the overhang of U.S. $ growing with its rise, any direct move away from the $ will weaken support for the already tenuous U.S.$.

For some time now Iran as been asking its customers to pay for oil in currencies other than the $ and 60% of its crude income is now in other currencies. Hojjatollah Ghanimifard, international affairs director of state-owned National Iranian Oil Company (NIOC), said almost all of Iran's European clients and some of its Asian customers had accepted making payments in non-$ currencies.

Whilst saying that the reasons are because of the weak $, clearly political strategy demanded such a change. The potential threat and present sanctions against Iran precipitated this change, but it now sets a successful pattern for other nations to follow. As they see the transition succeed and the $ retain the bulk of its strength, so we expect them to follow.

Ghanimifard had said in December that about 57% of Iran's income from crude exports was in the €. All currencies other than the $ are acceptable to Iran. In Europe all countries have accepted this and some Asian nations. Asked how much of Iran's oil income was now being paid in currencies other than the dollar, he said: "It would be something close to 60 to 60+%."

Iran is expected to earn more than $50 billion from its energy exports in the Iranian year that ended on March 20 or is that now €37.50 million? 

This troublesome tributary could add the greatest force to the problematic oil market river in days to come. Russia is promoting Ruble payments over the $ already and other nations will follow suit to secure the largest quantities of oil, using the foreign exchanges to switch from their $ reserves to the € to make such payments, so chipping away at the $’ strength.

The total pressure so far from these three problems is more than total f the three and could easily overwhelm the market levees. When this happens is there any back-up to prevent an out of control oil market?

Is Iran vulnerable to a cut-off in refined petroleum supply?

Confrontation with chests stuck out is the usual way to convince bystanders and protagonists of strength. An inkling of this was given in an interesting comment by the U.S. Department of Energy and reminded the market that Iran, while a significant exporter of crude oil, has inadequate refining capacity to meet its domestic refined fuel needs. 

Any interruption in trade flows, therefore, due to sanctions or hostilities would also interrupt gasoline imports into Iran as well as crude exports coming out. The D.O.E. may be pointing out that an interruption in energy flows would also deprive Iran of refined product. 

Is this a potential threat from Western refineries? 

With Iran’s growing oil relationship with China it is most likely that China will supply Iran refined oil and petroleum. It may take time but we expect it has been proposed already. For China the benefit would be to get a valuable long-term supply for China out of U.S. hands. Such threats from the U.S. will backfire on them.

Venezuela

As an example of the increasing power of emerging nations as they find in China a docile buyer of its oil, President Hugo Chavez said China is set to rival the United States as Venezuela's top oil buyer as when he announced new plans with the third major world economy, to jointly ship oil, build refineries and expand crude production. 

Chavez, speaking after meeting with an official from the state-owned China National Petroleum Corp., told reporters that, "As a power, the United States is going down, while China is moving up." 

Chavez said Venezuela was on track to reach its goal of raising oil sales to China to 1 million barrels a day by 2012 from its current level of about 150,000 barrels a day. 

"When we begin speaking of 1 million barrels of crude, we're nearing the level of Venezuelan supplies to the United States," Chavez said. Venezuela currently ships about 1.5 million barrels a day to the United States. 

"We do not deny what a big market the United States is -- one we have maintained and are resolved and interested in maintaining, as well as our refineries there and our great company, Citgo (Petroleum Corp.)," he said. "But now Venezuela is diversifying." 

Chavez announced plans for Venezuela and China to build three refineries in China that will process a total of 800,000 barrels a day of heavy Venezuelan crude. 

"In two years these refineries should be built and ready”. Chavez also said the two countries decided to start a joint oil shipping company with its own tankers to carry crude and other products between Venezuela and China, as well as to other world markets. 

Venezuela will also allow China to expand its oil exploration activities in the Orinoco River region, Chavez said.

Chavez said that the agreements “place us without doubt as one of (China's) most important partners, I think, not just on the continent but in the world."

Now add the joker in the pack the weather worries, a consequence of global warming, which is forecast to produce many very serious storms and hurricanes from June on. If just one of these hurricanes hits Houston, then the trump card will have been played and the balance of oil demand and supply will tip, adding not just pricing force to the oil market, but political confrontation across the world as the grab will be on for available supplies. The chances of the U.S. consumer continuing to drive U.S. growth drop and the prospect of a recession move from debate to certainty

So when these separate problems join together, far more than just a higher oil price is at stake, much more. When the flooding then occurs in this river, high ground will be gold and silver.

© 2007 Julian D. W. Phillips
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