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an Audio Format for 3rd Hour Last 5 OF 10 THEMES THAT DOMINATED THE MARKETS THIS YEAR See Part 1 for 1-5 [montage of voices] Well, actually it's a time machine. I call it a ‘way back’. We just set it, turn it on, open the door and there we are – or were, really. The West is deluded to rely on Saudi oil. The places with the really major reserves, Saudi Arabia, Iran, are very difficult if not impossible for the Western oil companies to get into. You have governments of producing countries taking back oil from the oil majors. If you look at Wall Street, basically what you'll see is that there's not one firm out there, not one, who expects oil prices to be higher in 2010 than they are today. I believe this is an inflationary bubble economy. He had to sell, publicly, the concept that things were fine because that's what was good for his employer. Given the situation that we have, making the best of it in terms of conserving in our own lives but also profiting from the crisis. Well, we do have to talk about that. And it's going to a world in which most really suffer, unfortunately suffer a lot, but there will be a very small percentage of people that get, I think, tremendously rich. It's a time machine. I call it a ‘way back’. We just set it, turn it on, open the door and there we are. JOHN: Another New Year is beginning in just a few days. Welcome to the Financial Sense Newshour as we round out the end of 2006. Happy New Year everyone. Welcome to the second of our two-part year-end program on the Financial Sense Newshour. As we said last week, this was going to be a special edition as we took a look at the year and trying to put it all together.
We covered the first six months of the year in last week’s program. Today’s program covers not only the final half of the year but also an in-depth look at the emerging energy issue. Indeed, as we round out the end of the year, there was a significant story in Bloomberg on December 29th, and here's how it went: Crude oil ended a four-year rally in 2006 as record high prices, slowed demand growth and less extreme weather bolstered supplies. Oil rose 1% this year to 61.05 a barrel in New York after surging 40% in 2005 and 36% in 2004. Global demand growth slowed to 1.1% from 1.5% last year, and storms spared US Gulf platforms battered by hurricanes Katrina and Rita in 2005. And now the US winter is warmer than usual. “Global demand has grown very slowly this year while supply has picked up, and it's likely to continue next year,” said Dariusz Kowalczyk, chief investment strategist at Hong Kong based securities firm CFC Seymour Ltd., “the weather has been negative for prices throughout the year.” The Organization of Petroleum Exporting Countries, producer of 40% of the world's oil, responded with it's first output cuts since 2004. The plan may fail. New York futures will average $62 a barrel in 2007 and $60 a barrel in 2008 according to the median forecast of 36 analysts surveyed by Bloomberg. Oil rose to a record $78.20 in New York on July 14th on concern that fighting between Israel and Hezbollah militants in Lebanon would spread through the Middle East. The conflict ended a month later, and oil fell to $62.91 at the end of September. It hasn't been above $65 since. As winter in the northern hemisphere when global demand typically peaks started milder than usual. Tensions between the US and Iran, the Middle East's second largest exporter eased after an August 31st United Nations deadline to stop Uranium enrichment passed without immediate action from the Bush administration. The UN imposed sanctions on Iran's atomic research in December. “Geopolitics was one of the dominant themes of the year. But the risk premium has declined substantially,” Kowalczyk said. The winter is shaking up to be surprisingly mild. Warmer than usual weather has kept US heating demand at 17% below average since November 1st according to data published yesterday by Weather Derivatives, a US based forecaster. Global oil supply rose 1.4% to 85.5 million barrels a day in the third quarter from the same period in 2005 according to the International Energy Agency. And the game was led by non OPEC producers and the former Soviet Union and Sub Sahara in Africa. Non-OPEC output rose to 51.7 million barrels in the fourth quarter, 3% more than a year ago. No output was lost to hurricanes in the US Gulf in 2006 for the first year since 2001. In 2005, Katrina and Rita caused outages to peak at 1.1 million barrels a day in December – equivalent to 5% of the U.S. consumption. The lack of storms helped US stockpiles stay above during the year. “People have to be reminded that we still have too much crude,” said Chris Mennis, owner of oil broker New Wave Energy LLC in Aptos, California, “we're still over supplied.” OPEC will reduce production by 500,000 barrels a day from February 1st. In October, the group agreed to cut output by $1.2 million a day from November 1st. [6:54] You know, Jim, I know as we started the year, you were calling for the fact that in order for the Fed to go on hold, they were going to have to hammer commodity prices in order to be able it do that. And indeed that was one of your predictions for the year, and that happened. Now we're looking at the subject of energy and everything is being painted as rosy, rosy, rosy, no problems if we have no storm clouds on the horizon, but I know for this part of the review of what really happened in the year, you're not as favorable as that outlook. JIM: John, I'm not going to belabor the point of hammering the commodity markets, though I'll just give you a good example. The day after Christmas, I woke in the morning and there were two news stories: Iran basically told the rest of the world to go fly a kite regarding its nuclear program; and another story out of Nigeria, rebels basically took out an oil platform. Now, with that kind of geopolitical news, in other words, any time Iran said something prior to, let's say, August of this year, the price of oil would spike – or if you would have rebels take out a oil platform – oil went from being up a buck in the morning to being down a buck fifty. Now, if you're an oil trader, you just saw Iran tell the rest of the world to go fly a kite, you just saw rebels just take out another oil platform in Nigeria, John, what would you do? Would you buy oil or sell it? JOHN: I would buy it because obviously that means there's trouble on the horizon, even if it's only the storm clouds ahead of it. JIM: Well, that's not what happened. Instead derivative markets took the price of oil down. So a lot of the same geopolitical tensions that you referred to in that Bloomberg piece that were driving oil markets are now causing oil markets to go down. And that's because they are using the paper markets to drive this whole thing – just as they did by changing the Goldman Sachs commodity index at the beginning of August. So the important thing to understand here is the fundamentals haven't changed. Demand growth was 1.1%. The fundamentals supporting higher energy and precious metal prices remain in place. Indeed, this year we had a number of guests on the program that have done a pretty good job of laying out the fundamentals in energy, and we'll get to some of those points later on in the program in just a couple minutes here. But first I need to point out that something that investors have a hard time understanding and that is the paper markets dominate the physical markets. The way governments and their accomplices intervene to control prices is through the paper markets or derivatives. [9:34] JOHN: So why did you feel so strongly when gold and oil prices were rising that they were actually going to hammer the commodity markets? JIM: I think one real reason is unlike past recessions where we saw commodity prices remain tame, this cycle, the price of commodities have erupted into an explosive uptrend. You couldn't have the Fed go on pause if oil prices kept going up, or gold prices remained above $700. Nobody would buy the low inflation story. They had to get those prices down in order to demonstrate that inflation had peaked. In fact, in earlier shows, as oil prices were heading up to $80 a barrel, you had a geopolitical premium along with a demand premium built into the price of oil. This added about $20 to the price of oil. In other words, demand itself and supply factors would price oil somewhere between $50 and $55 a barrel. So what they did was attack the demand premium with the reworking of the Goldman Sachs Commodity Index. That caused forced selling of natural gas, oil and gasoline. As forced selling kicked in, you had the large institutional players dump their energy positions, and this triggered a downward spiral in energy prices. They did the same to gold. [10:50]
JOHN: This is obviously something that can't be held up forever. How long can this keep going? You know as you’ve said the fundamentals remain firmly in place for the higher energy prices. JIM: There's a power struggle going on in the world between producers and consumers. The Western countries are the consumers. Then you have the producers, which are primarily OPEC and Russia, which account for 85% of the world's oil reserves. Yet the price of this commodity is controlled by the markets of New York and London. You can manipulate prices in the short run, but ultimately, the fundamentals eventually take over. That's why we've seen five years of rising oil prices: excess capacity is very thin. We've gone from $10 million of excess capacity to today somewhere around the neighborhood of one to two million barrels. So when you have bad weather, a political prices, you see oil prices spike. You also are running into the problem of peak oil. Oil discoveries peaked in 1965. And since 1985, we've been unable to replace the oil we consume each year. And that was no different, John, for this year in 2006 – we will have consumed more oil in the neighborhood of 30 to 35 billion barrels. And we're lucky if we've even found five. So the word's entire energy infrastructure is stretched to the limit. That is the message the markets have failed to recognize. I want to go back to an interview we did at the beginning of the year with Stephen Leeb. Leeb wrote a book, The Oil Factor, which was a strategy of how to profit from rising energy prices. I remember at the beginning of the year he had a new book coming out, and it was called The Coming Economic Collapse. What surprised Leeb, as it has many others, is the complacency around the globe regarding energy. The world doesn't get it. Let's listen in as to why Leeb wrote a sequel to The Oil Factor. Stephen, I have to admit, in 2004, when you wrote The Oil Factor (which was an investment guide), I really became curious several months ago when I saw your new book title The Coming Collapse. What changed in the two years since The Oil Factor was written? STEPHEN: Well, Jim, you're right. I didn't expect to write another book. You know, as I said in the preface to the book, I did not want to write another book for oil. And as you wisely pointed out, the oil factor was really meant to be an investment guide. I felt at the time that I was writing it that supplies were getting scarce relative to growing demand and that oil prices were low and were likely to go a lot higher, and that there was a real good investment opportunity. But I also thought, at least in the back of my head as I was writing the book, that surely people would get it, that if we saw oil over $15 a barrel, people would begin to understand that this was a very, very serious problem. But when oil did go over $40, $50, now over $60 a barrel and still no more than lip service paid to this issue, I became totally alarmed because this is a major issue. It's something that really could cripple the US economy. But what was frustrating about the whole thing, it's not something that we have to be passive about; it's not something that we have to hope goes away. But rather it's something that we can deal with if we basically are willing to roll up our sleeves and do something about it. There are solutions out there. It's just that it's going to take a lot of oil, a lot of money and a fair amount of sacrifice. But we're not going to even approach these solutions or begin to address them if we don't realize how incredibly critical this problem is. And it really is a critical problem. JOHN: You know, Jim, it's interesting because this complacency we seem to have when it comes to energy was really demonstrated after the hurricanes last year, Katrina and Rita that brought such disaster in the US. Now, you would think if you just gave it some thought here that after all of the damage they did to the energy infrastructure (looking at how stressed the infrastructure already was just to keep up with daily demand not counting disaster), you would have thought this would have been a wake up call. And by the way, that can be expanded to a lot of our infrastructure – no one seems to be waking up to this at all. But back to oil, instead politicians bashed oil companies and after the prices finally came down in the months following the storms, things were back to normal until prices began to rise again at the beginning of this year. So you asked two of our guests Leeb and Matt Simmons exactly why there was this complicity, and then what they had to say. JIM: Matt, the last time that we spoke was last August and little did we know a few weeks later our whole energy infrastructure would be devastated by a good series of hurricanes. MATT: Yep. JIM: I would have thought that the hurricanes would have been our sort of 9/11 or energy wake up call, and yet I was surprised by the lack of response. And since then we've done very little. I believe we still don't understand the gravity of our energy situation. MATT: You’re precisely right, and ironically you could argue that they were almost the reverse. There was this general sense by too many people that the only reason we have these temporary problems is because of these abnormal hurricanes. I’ll tell you a very odd story. I was on a BBC global radio program and it was the Tuesday afternoon after Katrina. They had a senior professor emeritus from Erasmus University on, who’s written a book called Hydrocarbon in the 21st Century [Peter Odell - Why Carbon Fuels Will Dominate the 21st Century's Global Energy Economy], and he claims we’ll be using twice as much oil in 2100 as we are today because oil in fact is renewable. And so both of us were asked, since oil prices were at $70, “do you think now this is the ultimate oil crises?” And the professor said, “Oh, no, no, no. This is just a series of exogenous events, and within about three months it will all be corrected and then oil prices will go up $35.” And they said, “Mr. Simmons, what do you think?” I said, “first of all, I don't know what exogenous even means, but I think what Katrina did was actually bomb the Gulf of Mexico the same way they bombed Pearl Harbor. And we're not even through the hurricane season yet, and I think we'll be very lucky if in three months we even know the extent of damage. And I think it will be a miracle if we have everything fixed before the next hurricane season starts in the summer of 2006.” And it turns out that I was unerringly right. But the fact that as soon as we had very funny oil statistics that came out when all of a sudden people couldn't drive, and we had no way to count barrels in the areas where most of the storage was, and it created the illusion that the high prices had really brought demand down so we had a price collapse. [17:44] JOHN: That was Matt Simmons. Here is Stephen Leeb. JIM: What really struck me is after Katrina and Rita – when you had virtually almost one third of our energy production taken off line – that this issue was not taken more seriously. STEPHEN LEEB: It has continually surprised me over the last 12, 18, 24 months how little attention is paid to this issue and remains and how the issue, despite some lip service, and I was very happy to hear President Bush at least mention it in his State of the Union Address – but still, if you look at Wall Street, basically what you'll see is there is not one firm out there, not one, who expects oil prices to be higher in 2010 than they are today. Even Goldman Sachs which has gotten a lot of publicity for forecasting, triple digit $100 oil believes that if we get to $100 we'll immediately come back down, almost immediately come way back down to maybe even $35 or $40 oil. No one, in other words, really believes oil is a in a sustained uptrend – that there is a chronic mismatch between our ability to grow supply and growing demand. And that's the mind set that we've got to attack, and we've got to break. And if everyone believed that oil was going to $100, let's say, over the next five or six years, you know what, we'd probably not have a problem. At least they'd be able to think of solving what was a problem, and it wouldn't be that much of a problem. The real problem in today's world is that no one believes it, and once they do realize there's a problem, it can take five, six, seven years to really develop or put up the infrastructure to solve it. But at least they'll have a fighting chance. JOHN: You know, I find it absolutely amazing that year after year in this new decade we have seen oil prices climb, but every time they climb higher, we're told why they are going to be lower. So what we've seen as we keep going from crisis to crisis, we saw oil prices spike higher as we did in 2003, but we were told that was because of the Iraq war. And then in 2005 after hitting $70 a barrel, we were told it was because of the hurricanes. And then in 2006, we saw oil prices finally hit $80. And what we deep doing is stair-stepping our way to higher and higher prices, but the reasons seem to be a process of offloading on to some other blame because Wall Street keeps telling us why they are going lower. JIM: The reason, John, I think they are heading higher and not lower is that we've reached a tipping point in energy, something that one of our guests Peter Tertzakian mentioned on our show in April. [20:13] PETER TERTZAKIAN: I believe that the two trends that are in play – basically demand growing relentlessly combined with the increasing difficulty and cross limits of bringing new light sweet crude oil to the market – is causing a situation that we're seeing today manifested in higher prices, and a high degree of vulnerability to the world's oil supply chains. And that will become more acute over the next few years, and whether it's by geopolitical tensions or whether it's by environmental tensions such as hurricanes or similar. We will reach a point where governments of the world, people will say enough is enough, we have to do something about this. And it's at this type of point that we see historically where a transition begins. And the fuel mix, the energy mix starts to change and people say, “Ok, I'm going to have to switch away from oil and start thinking about other ways of driving to work.” Unfortunately, it's not going to be as easy this time as it has been historically. JIM: In your book, you have a diagram of the energy evolution cycle. I wonder if you might just review that briefly for our listeners. PETER TERTZAKIAN: Sure. At the top of the cycle, there is what I call the growth and dependency phase. You know I looked at this cycle over the course of the last 300, 400 years since the industrial revolution and the pattern is the same. Society grows by using a fuel. Say in the earlier centuries, they would use, for example, whale oil lamps were common in the 17 and 1800s to light our homes and our factories. And the factories can work at night now, they can produce more goods, which means that you need more light and more whale oil. So there's a cycle of economy and energy that goes hand in hand and eventually we become dependent on the fuel. The next phase that occurs is what I call the pressure build up phase. The fuel starts to get a little bit scarce. The demand is growing a little bit too fast. The pressure starts rising. And on top of that, often times there's political influences, sometimes there's environmental influences. And so the pressure buildup phase ultimately gets to a point where there's what I call the break point, or as you called it the tipping point. It's at that point where, as I said before, whether it's the governments or the individual or the corporations they say, “enough is enough, we have to do something about this, this is just being too costly.” So what happens next is there is what I call the rebalancing phase, which has historically always been facilitated by what I call in the book a magic bullet or technological savior. So in the case of whale oil, the savior was crude oil. Fortunately for the whales and for mankind, we found oil in 1[8]59 in commercial quantities and it was an easy transition. So as we left whale oil, we became dependent on rock oil or crude oil as we call it today, and the growth and dependency and the addiction – as President Bush calls it, more recently – starts all over again and the cycle begins. [23:07] JOHN: I know, Jim, you obviously believe that oil prices have been heading higher because you've been writing about this all of the way back to 2001 and there's no change in your belief. You're pretty firm on that today. So let's get to the fundamentals for the benefits of our listeners as to why you really do believe that oil prices are going to go higher – just the opposite of what the voices on Wall Street are talking about. JIM: I think it boils down to essentially an inventory problem. You start with existing reserves, or what we can call beginning inventory. Added to that are new additions, essentially what it is we are discovering each year that can be added to existing reserves. Then we subtract from inventory the amount we consume each year, and then you get ending inventory. That is a simplified view of oil, but it doesn't get more complicated than that. You have existing reserves in the ground, then you add to these reserves the new oil that is discovered each year, and then you have to subtract what we consume. The major point that stands out here is that discoveries aren't replacing what we consume. It has been that way since 1985, so what we've been doing is living off our energy savings without replacing those savings with enough newly discovered oil each year. It is one reason global spare capacities disappeared. Jeremy Leggett talked about this in his book The Empty Tank. JIM: Let's boil this down to some key decisions or I guess, as you pointed out in the book, the trillion dollar question. The three key points; existing reserves, reserve additions, and the speed to which the new additions could be brought to the market. Let's address these issues. JEREMY LEGGETT: Well, existing reserves – you just look at what BP are telling us. And they produce The Statistical Review of World Energy every year as the Bible to people who study and research energy – journalists use it everywhere, students use it. And it would tell us we’ve got 1.1 trillion barrels, and they just put that down as proven reserves. And you look at the small print, and you find actually that these aren't BP’s figures at all. They are figures used by OPEC and compiled from official sources. And many of us believe that OPEC has been systematically exaggerating the size of its reserves for many years – particularly since they started fixing the sizes of their production quotas based on the size of the reserves. And I think it's really out of order for BP to reprint those statistics which just look so suspicious to so many of us, and do it in a way that allows people to cite them in newspaper articles, and student essays, and whatever, time and time again, as though they were proven reserves. They'd never stand up to scrutiny in any court of law. [25:57] JOHN: I believe one reason why there is a large degree of complicity out there is that we just assume OPEC's reserves, especially Saudi Arabia, are so huge that they are going to be able to supply all of the world's oil needs. But there are a number of experts now questioning that assumption. Matt Simmons is one expert who has questioned this. He wrote a book about it called Twilight in the Desert. But there are others, including Jeremy Leggett from whom we just heard, who was a petroleum geologist. JIM: Here's the remarkable thing regarding that BP statistical review because it is considered the Bible, journalists refer to it, commentators on TV. And if you zoom in on global oil reserves, they grow immensely, between the years 1985 and 1990, almost by 300 billion barrels. What's wrong with those numbers? JEREMY LEGGETT: Well, I think they’re false. I am struggling to find a polite word here. I think people have been filing political numbers not real numbers – and that’s the issue. JIM: Isn't it strange – I've seen the BP Statistical Review it doesn’t matter, how much OPEC produces in terms of its oil output, their reserves or inventory levels never fall. Now, if I was running, let's say, a retail company (a public company), and I told you that each year these were my sales, I was selling widgets or whatever, and my inventory levels never went down, wouldn't that strike you as strange? JEREMY LEGGETT: Yeah. Absolutely. That's another facet of the debate, and of course it's been noticed, to be fair, the G-8 Summit this year, the finance ministers had little sentence in there that said to OPEC, “guys, let us in to verify how much you have in the way of reserves. You know, our economies are all geared to these figures that are being quoted as being true. And if they are not, you know, we might have a few problems. So please, let us in. And we need to check. And they can do that very easily. You know, the 100 biggest oil fields could be surveyed in a couple of months, and there's no sign of the OPEC governments loosening up and allowing that to happen. (Matt Simmons interview) JIM: I want to come back to your book Twilight in the Desert where you talk about a lot of the larger producers have all peaked – recent evidence with Mexico and Cantarell, even Kuwait with Burgan. In your research in Twilight, you're talking about this approaching peak and it seems like everything whether you're talking about the EIA or the IEA, everybody looks to Saudi Arabia – they’re the ones. And yet, I don’t know, maybe they believe this themselves – they’re going out and saying, “well, we're going to invest this much and we're going to take our production up to a certain level.” But I get from reading Twilight you doubt if that's possible. MATT SIMMONS: First of all, it is not possible. I've had the luxury now of an enormous amount of feedback, including some really senior people from within Saudi Aramco that have the guts to say: “I really loved reading your book. You accurately described the unbelievable challenges we are dealing with.” I think part of the problem that some people there have is they have heard for so many years through our experts that they can produce 25 million barrels a day that they say, ”well, sure we can, everyone has told us that.” JIM: You know, whether they can do that in taking a look at their difficulties but these are some serious assumptions. MATT SIMMONS: There are some unbelievable assumptions. When you have gentlemen like Dr. Sadad al-Husseini who has his PhD from Brown University, and he was Executive Vice-President of Saudi Aramco in charge of E&P, and Dr al-Husseini and I have been on two programs together in England, and he’s been quoted in the English papers as saying the West is deluded to rely on Saudi oil. He’s basically said, “over 12 million barrels a day, it just isn’t in the cards.” And he was known in the '90s as the brains of Saudi Aramco, and he’s a fabulous human being. [29:54] JOHN: Over the years one point that you have made as many of our experts did was that we simply aren't replacing the oil that we consume every year. And this gets back to your inventory issue: if you aren't replacing what it is you consume each year then eventually you're going to have a problem. Any mishap out there geopolitically or with weather and then all of a sudden you're going to see this price spike because there's no backup for it. We aren't replacing our reserves. And yet the experts tell us there's plenty of oil out there to be found. It's simply a matter of spending more money. And when you interviewed him last summer, Jeremy Leggett addressed this very issue. [31:00] JIM: In addition to existing reserves, which we know are questionable, especially that $300 billion increase between 85 and 90 in OPEC, what about reserve additions? What are we finding? Each year we know we consume a lot but what are we replacing it with? JEREMY LEGGETT: Well, your additions are coming from enhanced recovery techniques of which there are many and very impressive, but you have to look at the down escalator of US oil production since 1970, and every known enhanced recovery technique has been thrown at the challenge of trying to arrest that down escalator. It hasn't made any difference at all, and it just keeps falling and falling steeply. So why is the world pattern going to be any different? And then you look at reserve additions from unconventional oil – you have the tar sands and other heavy oil deposits – and there, your problem is simple: the constraint is from the fact that you're not dealing with liquid oil. You've got to melt the tar and do so for most of the deposits that you're recovering underground, by pumping super heated water down, burning gas and heating water. And it’s just a very difficult business. If every dollar that's been invested in the Canadian tar sands – where it's true there's tons and tons of oil underground is going to bear pay dirt by 2015, we'd still only be pumping an extra three million barrels a day. And right now, we're at 24 million barrels a day and going up by two to three million barrels a day of capacity every year in terms of demand expansion. So it's very difficult to see how that gap is going to be closed. [32:47] JIM: Economists will argue, Jeremy, that given a high enough price, enough supply will come into the market. JEREMY LEGGETT: Sure. They do JIM: But if you take a look at the globe today, what part of the globe has not been explored for the potential for oil? In other words, is there someplace either in the deep ocean, someplace in the Middle East or Antarctica where there's the possibility that large oil reserves lie underneath the ground? JEREMY LEGGETT: The arctic hasn't been explored that much, but the surface of the planet was fully explored way back in the 1960s. And with sub-surface seismic techniques we've been able to at least at a reconnaissance level peer into every petroleum bearing basin on the planet outside of Antarctica. And you combine that fact of frontier exploration being pretty far advanced with where we're discovering the diminishing number of major oil fields, and you see it's in Kazakhstan and Sakhalin and far-flung places, and you think to yourself, it really does look as though we found all of the elephants and now we're just finding mice. And that's the truth of it. The industry has found all of the big oil fields, and if you talk to people within the oil companies, they'll tell you this. They might not say it on the record in public, but I've had people in impossibly high places in oil companies say: “Yeah, it's true. We’ve found all of the big ones. We won't find another province. We won't find many more billion barrel oil fields.” [34:21] JIM: You know, there's also the myopic belief that technology is going to save us. Technology will either allow us either to get more oil out of the ground, or discover vast amounts of new oil. Leeb addressed this issue when I spoke with him in March. JIM: I looked at this issue and I just wonder, having come through the nineties, the big tech boom that we saw, maybe in the back of their minds people are saying, when we ran out of whale oil, we got kerosene, and then we had coal replace wood and then we got oil. Somehow, maybe there's this belief that technology is going to rescue us. But this isn't something that technology can invent and you put in place and this can be done overnight. STEPHEN LEEB: No. You know, as far as technology goes, and again, this is another belief that we have that technology can solve everything, and that technology will find a lot more oil in the ground. But again, what's the most technologically technical country on the earth right now? It's the USA. And despite all of our technologies, oil production has been declining for over 35 years in this country. So I mean technology has its limitations. And we're staring at them right now. So I wanted to make another point too about this issue of oil dependency because we've sort of been talking about it, and again, I don’t think it's something that Americans have really woke up to. [35:44] JOHN: We've been talking about fundamentals so far, but what really amazes me as I watch this day in, day out, month in, month out is that the financial media and Wall Street focus on inventory levels. But as we pointed out here on the program, and a number of our guests as well, these inventory numbers are wet finger analysis. They are just guesses – nobody's out there measuring the level of inventories with a dipstick. But instead of focusing on the real issues such as, say, for example, depletion, the lack of new discoveries and demand outstripping supply, we absolutely seem excessively fixated on what the government reports in inventory which comes out every Wednesday and Thursday. JIM: Two of our guests have addressed this issue a number of times. I've talked to Matt Simmons. He's talked about these. These are computer guesses very similar to when he was in the Pentagon with a number of oil experts and the Pentagon was looking at where oil supplies would be, and these people started rattling off all of these numbers: “Well, China will be producing this, somebody else will be producing that.” And Matt asked these guys, “where do you get those numbers?” “Well, they are in our computer model.” Let's go to some of the interviews of Matt and Peter Tertzakian, because they comment on this issue of inventory and bring up some very relevant points. [37:04] JIM: One of the things that I think is also creating a problem (and you've written on this numerous occasions and commented about it) is that our energy gauges are broken. When people hear on Wednesday or Thursday the inventory numbers, and you hear the analysts say, “Boy, we've never had this kind of a supply,” – but as you and I have discussed in previous interviews, people aren't out there with a dipstick each week sticking it in the tank. MATT SIMMONS: Those have got to be almost entirely they’re paying some clerk who’s been given the assignment of: “oh, it’s Friday morning, it’s time to basically email to the DOE our stock numbers. Let’s see what we think they’ve changed over the last week.” And then we take those numbers, which are at the EIA’s admission a sampling of less than 50% of the total holders, and gross them up as an accurate reflection of the United States. And then analysts assume that that’s a pretty good proxy for the world. JIM: Equally almost as absurd is how the oil markets trade off that data. You would think that the oil traders – and there’s some pretty smart people on Wall Street – would say, “wait a minute, these numbers, we don’t know if they are real or not.” And yet you can see these large gyrations that we were talking about earlier in the interview all play off just because of some inventory number. MATT SIMMONS: It’s incredible. It’s like a peak at a racing form of a race that hasn’t happened yet. [38:24] (Peter Tertzakian interview) JIM: You talk about in your book This Time It's Different, if we take a look at oil prices, Peter, being in the industry for a number of years if you were an analyst, if you knew where inventory levels were going to be or had a good feeling for it, you had a pretty good idea where oil prices were headed. Here we hear reports that inventory levels are at record levels, but, you know, I don't think anybody has had a handle on prices. I mean you've got a lot of analysts that are still talking about $35, $40 oil. Where in the heck are they getting that number? PETER TERTZAKIAN: Well, the inventory levels are full in the United States and in other parts of the world, and so the question is what's the panic here? Well, those are inventory levels that are like your gas tank. The issue is not in the inventory. The issue is in the ground. We can turn it around and say that we should be hoarding oil. The inventory should be full because there's trouble ahead. And maybe the market is thinking that way and I believe it is. The issue is in the ground, it's not in some storage tank. The issue is not only is it in the ground, it's very concentrated in parts of the world that have got some serious geopolitical issues, be it Nigeria or Venezuela or places in the Middle East like Iran and Iraq. These are places where when things are tight as they are today and demand continues to grow that they can set price spikes in motion in a heart beat. [39:45] JIM: Well, just as relying and focusing on inventory levels keep us distracted from the real issues of peak oil, another issue we face is our inability to identify the problem as lack of supply, an aging energy infrastructure, and the fact that we now have to import so much of our oil from areas of the world that are unstable and from countries that don't like us – not to mention the fact that we now have a lot more competition for oil coming from the developing world. Each one of our experts all had strong opinions on this subject. It seems that rather than deal with the problem, it's much easier to blame someone. In this case, every politician's favorite whipping boy is the oil companies. Let's listen in to what our experts had to say about this issue. This is what Leeb, and Tertzakian had to say on the topic. [40:35] (Stephen Leeb interview) JIM: The thing that is also surprising and maybe it’s going to take a real crisis to get beyond this Stephen, but if you take a look at what followed Katrina and Rita when they paraded the oil executives before Congress, I still don't think Wall Street or the media get it. But it did sound simple: “Uh-huh, oil prices are high because people at Exxon want to make more money off of us.” I mean that's a very simple solution and it's a very easy one to buy into – but it’s a false one. STEPHEN LEEB: It couldn't be more false in every which way. And I don’t want to sing the praises of the oil executives, there’s a lot they could have done and lots they could be doing. One thing you could not blame them for was the energy crisis. They are basically just passive. They don't control the prices. They sell oil at whatever price the market dictates. To blame them is ridiculous. This is a problem that we've had to lay at the doorstep of politicians in this country over the past 35 years. It's a non partisan issue. This is an American issue. No one is to blame. We are all to blame. You know, to blame and try to scapegoat the oil company executives is baffling and crazy, and it's totally misleading. JIM: It almost sounds like we're in these various stages, Stephen. But it seems like we're in the “pain, complain and act insane stage” – is what I call it. STEPHEN LEEB: That's a great one. No. I had not heard that before, but it certainly does seem to totally characterize where we are today. [42:00] (Peter Tertzakian interview) JIM: Peter, if we were to look back, let's say, 50 years ago – before a lot of the oil companies got their properties nationalized – the big oil companies controlled the oil market. But today, I think what do they account for? – about 5, 6% of the world's oil production? PETER TERTZAKIAN: That's right. MATT: That's no longer the case today. And yet, when we have a crisis, we look to the oil company as if they are behind it. PETER TERTZAKIAN: That's right. There is still sort of this hangover from the 70s oil price shocks and the collusions and things. I mean the oil companies can never seem to be favorable in the eyes of the public. In fact, it's a very dangerous situation today with the profitability of these companies. In effect, what are we doing? We're biting the hand that feeds us. We don't recognize that it's companies like Exxon-Mobil and Chevron that are out there duking it out in this great scramble too against the Chinese national oil companies (which by the way are bigger), and the Russian oil companies which are bigger than Exxon Mobil. Certainly, Exxon Mobil if not the largest oil company in the world, is maybe the second largest after GE – I don't know, they go back and forth. But the point is that doesn't make them the biggest oil company in the world. In terms of size of reserves they are about number 12. So we are in a dangerous situation here where this profitability thing is unfortunately taking away the spotlight from the real issue, which is securing supply for the years to come. [43:20] JOHN: You know the amazing aspect of all of this is every time an energy crisis does interrupt, aside from blaming the oil companies for the higher prices, all the politicians seem to want to do is to tax the oil companies. Now, it was a dumb idea back when they did it in the late seventies when we didn't have this type of energy situation. It would be absurdly stupid to do it today. It does nothing to solve the crises that we face. JIM: In response, however, to these higher prices over the weekend, we had two Senators, one Democrat, Carl Levin of Michigan and Arlen Specter, a Republican of Pennsylvania. They proposed a windfall profits tax, and in Specter’s case anti-trust legislation. And some congressmen are talking about price controls. What would these proposals do to alleviate our current energy problem – if not exacerbate them? MATT SIMMONS: Well, price controls are really stupid because then that basically just artificially encourages consumption. I think at some point I’m a little – I hate to say this because it’s so counter to anything I thought I would ever say – but to the extent that the major oil companies can continue to advertise that they’re really not making much money, and that they’re doing everything possible and that these are just temporary, and the cash builds up, and builds up, and builds up, and builds up, the governments of the world are going to basically take it away from them. Now, whether they should or not is a whole different reason. But I think had the companies been more forthright and maybe they had done their homework a little better and said, “we are in a jam now, and we’re not quite sure how we get out of it,” then it would be easier to defend these prices. But what they’ve done is exactly the opposite, “and this is just very temporary, oil’s a cyclical thing, what goes up comes down, over 15 years we’ve spent all this money.” And you know it won’t be long before one of the major oil companies has $100 billion of excess cash on the balance sheet. [45:23] JIM: You know instead of treating our national oil companies as a national treasure (as the national oil companies are treated by their host company countries), we vilify them. I did an interview with Stanley Reed of BusinessWeek this summer. The magazine did a cover story on Big Oil and why we should be worried about our big oil companies. Let's play a few extracts from that interview that have great bearing on that issue. JIM: This week’s cover story of BusinessWeek features a story about why you should worry about big oil. Beyond the fat profits the giants are surprisingly vulnerable worldwide. That’s bad news for business, and consumers. Joining us from London is Stanley Reed, he’s the London Bureau Chief for BusinessWeek. Stanley, why should businesses and consumers worry about big oil? STANLEY REED: Well, despite all the profits that they’re making they are having a hard time reinvesting those profits, finding new oil and gas and so on. And eventually that’s going to tend to make the market tighter and make us even more vulnerable to OPEC than we are now, because the big oil companies despite their faults are basically interested in finding, extracting and distributing oil. OPEC and so on have other agendas. JIM: You know the job of providing us with energy is getting more difficult. There’s technical challenges in terms of where you have to go to get the oil; there’s competition from national oil companies; and I guess maybe another factor Stanley, is governments are getting hostile, just look at what’s going on in Latin America. STANLEY: Right. Essentially what’s happening is with the price high, governments are taking a very different attitude. A few years ago with you know you had the price in the teens per barrel, governments were desperate to get the big companies and develop resources, and gave them very good incentives. Now, with the price where it is the governments are saying, “whoa, we don’t have to do those deals anymore, so let’s ratchet up taxes, let’s take a larger stake in concessions,” and so on. And so that’s what’s happening. You know, we see that in Ecuador, we see it in Venezuela and in Bolivia now. [47:45] JIM: Production at the majors and also their reserve replacement is getting more difficult. You believe that it will fall over the next, let’s say, four or five years. STANLEY: That’s the general projection that overall it will fall. And we’ve already seen in the last few years that some of the big companies, for instance Shell, not being able to replace their reserves. And that’s actually how I started out on this story. As you may recall a couple of years ago Shell revealed that they had been way overstating their reserves. And as it turns out they’re only covering maybe – I’m being rough here – but maybe 80% or so of the oil they sell each year. So that’s a very serious situation because if it continues they essentially go out of business. JIM: You know, so much of the global oil patch is off limits. If you take a look at where the oil’s located – whether it’s Russia, the Caspian, the Middle East – a lot of these governments are reluctant to allow the majors in at all. STANLEY: That’s true. I think roughly 80% of the world’s oil reserves have a lot of restrictions on them. The places with the really major reserves – Saudi Arabia, Iran – are very difficult if not impossible for the western oil companies to get into. Russia is getting tougher. Again, they’re another example of a country that gave pretty good terms in the mid-90s, but much tougher now. So, it’s really going to be national oil companies that produce most of the oil, and the western companies are going to have to find ways to you know joint venture with them and cooperate with them– that’s going to have to be the way they make their way in the world in the next decade or two. [49:31] JIM: To put this in perspective as you point out in your article, in the 1960s, 85% of the world’s known oil reserves were open to the international oil companies. Today that’s only about 16% that remains open – that is significant in itself. But in 1979, US and British oil companies accounted for almost 28% of the world’s oil and gas production – that figure is just 14% today. That’s a telling figure. STANLEY: Right, it just shows how this game is changing. And I think it’s what’s happening in a broader way in the whole world, that this is no longer a world that’s completely dominated by American and European business or consumers – it’s big Middle East producers like Saudi Aramco which is the biggest producer in the world. And India and China are really coming into their own as consumers. And that means their national oil companies are also playing a role. They may not have a lot of oil themselves, but they’re out there in places like Iran and Nigeria in trying to lock up reserves and are competing against the Exxon’s and Chevron’s of this world. [50:45] JIM: As we look at this too to put this in perspective, more production and reserves today are controlled by governments rather than individual corporations. And these governments have more of a political agenda than a commercial objective. Stanley, I wonder if you might address that and what it means for those of us in the West that depend on oil? STANLEY: Well, it means that the people who control most of the oil are not necessarily interested in people in the West getting it at what they may consider a reasonable price. I mean, look at Venezuela where I was recently. They’re more interested in having control of their national oil company, and keeping prices high, and not necessarily in producing as much oil as they can. The production of the national oil company which is called Pedevesa which produces most of the oil in Venezuela has actually gone down during the time that President Hugo Chavez was there. And they’ve managed to get away with that because prices have gone up so much. But that’s a country with huge reserves, and it’s certainly not playing the kind of role that we in the West would like them to. But again they have a different agenda. They want to be good citizens in OPEC, and you know that sort of thing. They don’t care that much about the Western consumer. [52:17] JOHN: As Stanley Reed pointed out, most of the world's oil is controlled by these NOCs, and this is something that our politicians or the media don't seem to understand, and if they do, they are not talking about it. Back in July of this year, Jim, you interviewed Dr. Valerie Marcel who wrote a book about the new oil titans which really are the national oil companies. JIM: Valerie, in all of the most important and nationalized. 90% of the world's oil reserves are entrusted to state owned companies. How has this changed the oil markets over the last 50 years? VALERIE MARCEL: Well, the big change was really in the seventies, where there was the big movement for nationalization. And we've been sort of digesting that change ever since. The oil majors have really been more and more involved in the refining and the big producers (the national oil companies) have been involved in controlling the reserves and developing oil – increasingly on their own. JIM: Let's move to when the energy markets changed, as you talk about in your book, as a result of states asserting their sovereignty over their national resources – especially in the Middle East and Africa, which are very important producing regions of the world,. VALERIE MARCEL: I think the sovereignty issue was one that was really one that was very important in the early days after nationalization. So the result was that you had governments of predicting companies taking back oil from the oil majors ( which were called in those days the Seven Sisters). And these companies controlled everything. They controlled oil production. They controlled oil prices. They were really cartels that were accepted as cartels by governments because they were doing their job properly. So as the producers took back these rights they had to develop the oil to be in charge of how much oil they wanted to develop at one time, controlling prices to the extent possible. There really was a big change in the balance of power. And so I think now the issue, as maybe 30 years down the line, it's not so much one of sovereignty and these countries trying to keep sovereign control of their resources. It’s much more about “what kind of job are we going to do with the reserves now.” A more responsible attitude as companies really, I think there has been a process of maturation. [54:35 ] JOHN: As we summarize the oil issue, the fundamentals which our oil experts have elaborated upon tell us that the oil prices are heading much, much higher. So this oil issue is not going to go away despite some efforts it would seem to be of putting it to bed. It's also clear that we have done very little about the energy issue. In fact, it becomes obvious that the US has no real energy policy. So given the facts that we're headed into this energy situation of much higher oil prices, and no policy, Jim, what do you think is going to happen next? JIM: You know, I believe it's going to take higher oil prices. And I simply don't know what that threshold will be. Will it be $100 oil, $150 oil that finally gets our attention? John, I simply don't know at this time. I would have thought, however, that $80 oil would have done it, but oil prices quickly fell back down to $60. So everybody has forgotten about the energy issue, although the US government is now studying peak oil. Perhaps $100 oil and oil that remains above $75, $80 a barrel will do it. But it's definitely going to take a serious crisis before we develop a serious energy policy and do something about it as a nation. If we don't, then the US will turn into another banana republic. [55:56] JOHN: Maybe that's not too bad if we have the weather, the climate, maybe the nice Caribbean Seas. But in reality, we do have a banana policy when it comes to energy, Jim, BANANA standing for build absolutely nothing anytime near anybody. So despite the fact that we import more and more oil and gas into this country every year, or the fact that our energy production declines each year despite the advances in technology which we're being told is going to save us, we've done very little in the way of rebuilding the energy infrastructure in this country; we are not advancing alternatives at the rate they need to be; we're not drilling for new oil or gas. So what should we do? JIM: I think the best thing we can do is profit from the market's misconceptions. This takes me back to the 1970s, a period very similar to what I think we're going through today. You had the Fed printing money, inflation was on the rise, there were conflicts in the Middle East, oil prices along with gold prices rose in steps throughout the whole decade. In fact, I think if you want to know where we're heading, look back at the 70s, and multiply that by a factor of three to five. Even Bank Credit Analysts has commented that the next mania area for the markets is going to be energy in this decade. This is a thought Stephen Leeb expressed on our show back in March. [57:20] JIM: Given the situation that we have, making the best of it in terms of conserving in our own lives but also profiting from the crisis. STEPHEN LEEB: Well, we do have to talk about that, and it's going to be, I think a world in which most really suffer and unfortunately suffer a lot. But there will be a very small percentage of people that get, I think, tremendously rich. I think the only genuine historical parallel again we have is the 1970s. And the 1970s, believe it or not, was the worse decade this country has ever experienced for investors. Returns on bonds and stocks adjusted for inflation in the 1970s were worse than in the 1930s. It was the only decade where investors lost money on both stocks and bonds in a ten-year period. But it was also a decade in which there were fabulous fortunes made. It was a decade in which energy stocks – in particular oil service companies, drillers, companies that were leveraged to the energy patch – compounded about 25 or 26% a year after inflation. It was a decade in which gold and inflation had just compounded at 25 or 26% a year after inflation. So it was a decade in which, if you had the right investments, you became very, very wealthy. But for most investors, those whose investments they correlated the S&P 500 or those investments that followed the bond market, they in many cases lost a substantial chunk of their savings. And a lot of things can make it even worse this time around in that so many people are close to retirement. At least in the seventies, the demographics were a little more favorable in that a lot of people who were losing money had time to recover it. But this time around, it could be much, much tougher. I really think it's important for people to realize that the world is different, and if you're thinking retiring or any kind of investing, you just cannot passively sit back and put your money into an S&P index fund. That could really be the worst investment or one of the worst investments you make. Or just say, “well, I'll put my money in good old US government bonds because they are the safest investment in the world.” Well, they are safe in the sense that you're not going to go bankrupt, but they could be a very bad investment. Rather, I think most people that are close to retirement have to consider allocating some of their funds to precious metals; and I think overweighting energy stocks in order to have a chance getting through these next 10 years or so. [59:49] JOHN: So what Stephen Leeb was saying, is there really are great opportunities to make money in the energy sector. JIM: The markets, John, I don't believe get it yet. We've done a number of shows this past year on how underpriced the energy sector remains. You have a lot of these companies selling at five and six times cash flow. The markets, I think, are pricing energy as if we've reached a cyclical peak. The economy is slowing down. Therefore, there's going to be less demand for energy, so oil prices will be heading lower which means lower profits. They ignore this sector which is why it remains underbid. But slower economic growth or recession doesn't mean lowered demand for energy. Demand is still growing here and especially elsewhere in the world such as China and India. Tertzakian pointed this out in his book One Thousand Barrels a Second. [1:00:36] PETER TERTZAKIAN: The opening words in my book are, "We are not running out of oil." One just has to recognize it's getting costlier and costlier to bring the oil to market, especially in the context of maturing geological basins and the geopolitical issues and the concentration of the oil in certain parts of the world. So it's just getting more and more difficult to bring that extra barrel of oil onto the market. And that’s something key to understand. And tying that back to what you said – the first part of the question – is that global economic growth is linked hand in hand with oil demand and growth. And a key point that has to be brought across to people is that 1000 barrels a second is just like a sign post, but it's not going backwards. Every year, year after year, oil consumption goes up. The question is by how much? We're not going back to 995 or 992 barrels per second. We're going forward. And under normal growth situations, it's going to be growing by about 1 1/2 to 2% per year. If the economy slows down into recession, so let’s say the global economy instead of growing at 4% starts to slow down and grow at 2%, oil demand will still have to grow to meet that 2% growth. The last time we actually had a economic contraction, world GDP went to a negative back in World War II. So it’s definitely a misconception that if we go into a recession that the problems of oil are solved or demand goes down. It doesn't go down. It still goes up, it's just by how much. [1:02:09] JOHN: This sounds like the whole argument about did a certain company make or beat estimates? “Well, yes, they hit their estimate goal.” “Did they make a profit?” “No. They lost money.” And it's the same thing here. We're told it's so much better because the demand growth say in 2005 was 1.5%. This year it went down to 1.1%. Hurray, hurray. But wait a minute, the demand is still growing. It's just a question of how fast the boat is filling with water. So then talking about opportunities for investment, given where we're going, where are they? JIM: I believe investors are going to do well by owning energy stocks. If you've owned energy stocks in the last three or four years you’ve made good money. I think you are going to make good money going forward. However, I think the areas that are going to outperform are the national oil companies, and oil companies that have reserves in politically safe areas of the world. Also, I think companies that can replace their reserves [will do well], because if you look at some of the big companies, they are having difficulty doing that. Then I think there are oil service companies. These companies have everything going for them. They've leased out everything they can lease out. Many companies have contracts that go out three to five years with price escalations. And that's one thing I think the market has missed out in terms of valuing these companies. One company we own is going to see their large drill ship rates nearly double next year. So the service sector is so undervalued that you have many of these companies selling at four and five times cash flow. Opportunities like that just don't come around that often. [1:03:43] JOHN: Well, as we conclude this segment, I have a feeling that, let's say, the year end show for 2007, when we come to this time next year, you and I will probably be talking about energy again – how high the price went. What else? How well the energy stocks performed? And then obviously something is going to happen geopolitically. There's going to be some geopolitical crisis that's going to have an impact on energy prices. We're going to handle geopolitical crises as a separate topic. This was an important topic though, because energy was certainly one of the top stories of the year. And that's why we spent so much time on it – especially when energy prices peaked out at about $80 a barrel. But it's time to move on to our next topic here.
JOHN: Our next topic today on our year end wrap up of what happened as far as the economy and geopolitics is related to the topic of energy. It’s what author Michael Klare has called the resource wars. If you look around the globe at the major Western powers you’ll find energy security has become the top foreign policy priority. Everybody seems to know. In the US it defines our Middle East policy, and it is backed by the presence of our large carrier battle groups that guard the Persian Gulf. In Asia it’s the Shanghai Cooperative. You can see it develop in Chinese foreign policy as Chinese officials scour the globe in search of strategic resources. We interviewed Michael Klare here on the show in the past, he joins us this year in one of our Other Voices segments of the show. [1:07] JIM: The British author, Rudyard Kipling, called it the Great Game: the geopolitical chessboard where the great powers of whatever powers of whatever era are at play. It has become a commonplace but that great game is being played today. To discuss that, joining me on the program is author Michael Klare, he’s written a book called Resource Wars and his most recent book Blood and Oil. Professor, let’s talk about the Great Game because it seems like we’re right in the thick of it again in the 21st Century. MICHAEL KLARE: You’re absolutely right. Now, Kipling wrote about the Great Game in the 19th Century, and it was about the struggle between the British Empire (then based in India), and the Russia Empire (based in what’s now Central Asia) about the territories in between – particularly Afghanistan. This is the area that’s now once again the pivot of geopolitical competition between the United States, Russia and China – a tripolar chessboard. But it’s the very same area that Kipling was referring to all those years ago. [2:17] JIM: For the British it was trade and controlling their empire. I think if we look at this area today, of greater significance is its holding of the world’s strategic petroleum reserves. MICHAEL: That’s right. The area of the Caspian Sea in Central Asia is thought to have some of the largest untapped oil in the world. It’s also a major center for natural gas. And we should talk about natural gas, because as oil becomes more scarce we’re all going to be relying on natural gas to make up the difference – and Central Asia has a lot of it. So, it’s importance can only grow.[2:55] JIM: You have the US which is building bases, along with the British, throughout that area. But there is another organization that’s also growing in importance in that area – that’s the Shanghai Cooperative Organization (SCO). Explain the significance of this. MICHAEL: This is an organization – the SCO – that was established by the Chinese. Their first meeting was in Shanghai, that’s why they call it the Shanghai Cooperation Organization. It’s a body that includes Russia, China, and the Central Asian republics – the former Soviet republics of Kazakhstan, Kyrgyzstan, Uzbekistan, and Tajikistan. And originally this was formed supposedly as an anti-terrorist organization, or more specifically an anti-separatist organization, because all of these countries have various ethnic groups that want to set up their own homelands: Chechnya for the Russians – although that’s not in Central Asia, but like that. So they all ganged up together to mutually suppress their separatist movements. That’s the SCO’s origin, but it has evolved over time into a regional security organization a little bit like NATO. And its purpose seems to be to consolidate Russian and Chinese domination of this area, and to try to exclude the influence of the United States – that seems to be the way it’s developing. [4:28] JIM: Let’s talk about this tripolar chess board and let’s put Iran in the Great Power context. What’s going on with Iran? MICHAEL: Iran of course is a source of friction with the United States because of its alleged pursuit of nuclear weapons, and there’s a crisis brewing about that. It’s been brewing for quite some time, but it seems to be coming to a head. But Iran is also a powerful piece on this tripolar chess board between the United States, Russia and China. That’s because China and Russia have fairly close relations with the current regime in Iran – the clerical regime. Both China and Russia have sold weapons and military technology to Iran; the Chinese rely on Iran for oil, and they want to buy into the Iranian natural gas industry; Russia is building a nuclear reactor there. So Russia and China want to keep the current regime in place. And they don’t want to see the United States overthrow that regime – you know, conduct regime change – or attack Iran because that would deprive them of an important ally. And it would also make them look weak, which in a sense they are, because they don’t have the power to stop the United States. And from the US position Iran is a threat not only in its own right but also as I say because of its ties with Russia and China. So Iran sits in the middle of this increasingly tense relationship between the US, Russia and China. [6:07] JIM: The Iran issue certainly played in to the oil markets this year. There were times throughout the year that Iran moved the oil markets. Iran has been defiant in its response to the West regarding its nuclear program. And what startles the market are the speeches of its President who is claiming that Israel’s days as a nation are numbered. Now, John, I don’t think Iran’s President is uttering these threats just to get his name in the paper – I believe the Iran issue is one issue that is going to play out next year. For it now appears that we’ll have to wait and see what the President says in January in his State of the Union speech, but US and allied troop strength is going to be increased next year. There’s also growing talk about reinstituting the draft. The US military is now overstretched: we’re mobilizing the National Guard and pulling troops out wherever we can them. It reminds me – when I think of the draft – of a good friend of mine whose son is in the Navy. He’s an instructor on the Phalanx gun you see on these aircraft carriers – he’s an instructor here in San Diego. We’re so short of troops and they need those combat troops either in Afghanistan or Iraq. They pulled him out of San Diego and now he’s doing guard duty at Gitmo. So it just goes to show you how short and overstretched we are and I believe some time either at the end of this decade or next decade they will reinstitute the draft. [7:41] JOHN: Especially if we’re going to continue acting as the world’s police force and/or continuing the thrust to ensure our own energy security around the world by use of military force. But there are other maneuvers going on in the geopolitical sphere – both with the Russians and the Chinese. There’s a movement within Russia and Iran to replace the dollar for pricing oil. At this stage of the game it’s sort of a rumbling I would think, Jim. It really hasn’t – like a volcano about ready to blow and actually take some action – quite gotten there, but it’s certainly an object of movement shall we say. In fact, there are many who contend that this was the real issue of the Iraq war. William Clarke spoke about this issue in his book Petrodollars. [8:21] JIM: The purpose behind the invasion, as you contend in your book of Iraq, was two fold: to gain control of Iraq’s oil supply; two, to convert the petroeuro back to petrodollar. And the result was to maintain the dollar as the reserve currency. Explain. WILLIAM CLARKE: It seems there was a long strategy going back to the late 1990s to have gained control over Iraq’s oil fields. I think principally because beginning around 1997 the world community began to realize that the sanctions would soon be lifted. And so Saddam was approached by the government of let’s say France and China and Russia for oil exploration contracts which he agreed to from 1997 up until 2002. About two-thirds of Iraq’s oil was committed with production sharing agreements (PSAs) with these various countries – thirty countries in fact. However, the United States was missing from that list and so was Britain. But what I think was the final nail in Saddam’s coffin was when he switched to the euro as the oil transaction currency in November 2000. And he came out in September 2000 and said he was going to do this even though the euro at the time was as low as 82 cents to the dollar. So people were scratching their heads saying he’s was going to lose $400 million a year in oil sales from making the switch. But he made it nonetheless. And there’s a whole history to petrodollar cycling that began in the early 1970s that most people really don’t understand. In my book I try to explain the importance of petrodollar cycling regarding the power of the world reserve currency, and what it means, and the fear I think by the Federal Reserve and the Bush Administration that other OPEC countries such as Iran – with possibly even Russia – would move to the euro as the standard in oil transactions and oil pricing. And what the first thing the Bush Administration did after toppling Saddam in May of 2003 was in fact to reconvert Iraq’s oil transactions from the euro back to the dollar – even though at the time the euro was worth about 17% more to the dollar. So basically the Bush Administration whacked out 17% of Iraq’s savings account – which was the oil for food program – and redenominated it back into dollars. So it had a very adverse impact on Iraq’s ability to rebuild its infrastructure. So I think if you follow the money very carefully and understand how these things work it becomes fairly clear. [10:45] JIM: Over 75% of the world’s oil reserves are contained in the Middle East and in Russia. The U.S. and the British are building military bases throughout the region in what is becoming the 21st century’s version of Kipling’s Great Game. Clarke mentioned this when I interviewed him back in January. [11:02] JIM: Another goal of the Iraq war was to install numerous military bases in Iraq for purposes of strategic dominance. It’s my understanding, Mr. Clarke, that today the US has something like 14 bases now in Iraq? WILLIAM CLARKE: Yes, that’s correct. The United States has been building 14 very large military bases. In fact, near the Baghdad airport under construction called Camp Victory which when it’s completed will be the largest overseas military base in the world. It’ll be twice the size of currently the largest base which is Bondsteel in Kosovo. This base will hold I believe around 14,000 people and have the largest PX. It has a Domino’s Pizza, it has a Burger King – it has all kinds of stuff. But yes, we are building these massive military bases at a cost of $4.5 billion. That was really more money than what was spent on the so-called reconstruction of Iraq. So the $18 billion that Congress allocated, most of that was spent for security reasons and enhance the security for private military contractors. The only real reconstruction going on in Iraq were military bases. And I don’t think the American people really understand that the Iraqi people know about these military bases. And if you read the foreign news they’re very upset that these massive military bases are being built all over Iraq to hold about 120,000 troops permanently. [12:26] JOHN: You know it’s interesting listening to C-Span over the holiday period because a lot of interesting programs…once you get Congress off of C-Span it actually gets interesting. But there was a panel discussion with representatives of various think-tanks out there, looking at what we’re going to do with Iran. And you have to understand that since the elections we have been in a big sea change driven largely by the policy of the Council on Foreign Relations (CFR) which has shaped a lot of our foreign policy for almost 50 years in this country. And that’s because in fact back in 2004 the CFR did a roundtable panel on this shared by none other than Zbigniew Brezhinski and Dr. Robert Gates who is now our Secretary of Defense. And it basically is the script for what’s playing out in Iran right now. It’s almost like we have a one-two punch going in Iran. But during this panel discussion, in which you had people from the Center for American Progress, and the New America Foundation, Colonel Sam Gardiner who is a US Air Force retired colonel made a most interesting, and what I thought, astute observation about the future of our situation in the Middle East. And here’s what that conversation sounded like on C-Span. [13:42] CIRINCIONE: Let me turn to Colonel Gardiner here because the reason we rejected that is that we weren’t interested in negotiating with this regime. The view was we could overthrow the entire regime. Remember, in the spring and summer of 2003, the Iraq War was going well and there was a feeling that we could just run the table – next stop Teheran, Damascus. We could do it. It didn’t work out that way, and the balance has now shifted. The Iranians, I believe, think that they’re going stronger and we’re growing weaker in the region. And as a result of the November elections the military option might be completely off the table – that we can’t actually afford to attack them and that we’ve lost the will to do that. How do you see that, Sam? COL. SAM GARDINER: Wrong. No, in fact I would even disagree with the Ambassador a little bit. The military option is not on the table – probably inappropriate to say. The military option is on the Vice President’s desk. That is not normal military planning. Plans don’t go to the executive branch until things are getting close. I don’t think the election has affected that. What I have done most of is try and explain how the administration has got where I think they are. And there are about seven truths they hold as self evident: 1. One of them, that Iran is developing nuclear weapons. That’s probably true. 2. The second is that Iran ignores the international community on a lot of things. Clearly that’s true. Iran supports Hezbollah and Hamas – got that. That’s true. 3. Iran is increasingly inserting itself in Iraq and more in Afghanistan – certainly true. 4. The people of Iran want a regime change – probably not. 5. And the final assumption is that sanctions are not going to work – and they believe that to be true. And so once you go through those seven truths – and you can’t negotiate with these people – you are left with the military option not on the table, but on the Vice-President’s desk. CIRINCIONE: Well, wait a minute. On the Vice-President’s desk. What does that mean? SAM GARDINER: Literally, from press reports – good journalists – we know that the military have done their thing with the plan and the plan has gone to the Vice-President’s office. CIRINCIONE: Wait a minute, but the plan, that’s – they’ve got plans for lot’s of things. SAM GARDINER: Right. CIRINCIONE: Are you saying this is different? SAM GARDINER: This is different. Plans don’t go to the Vice-President as a normal course. CIRINCIONE: So you’re view would be there’s at least a faction of the Administration that wants to attack Iran? SAM GARDINER: Yes, clearly. And I think there are a couple of parts of it we have to understand. One of them is – and again, I would disagree with the ambassador – we’ve got to remember – and we’re been told this in a number of books that have been released about the administration thinking – this is not about the Iranian nuclear program alone. In fact, that may be just the cover, as it was in Iraq for other things. This is about the Iranian involvement in Iraq – talk more and more about that, recently. It’s about the Iranian support of Hezbollah. I would argue, even if we found a solution to the Iranian nuclear enrichment, we would still find the administration not be willing to go that down that road because (as we know from things written about the way the Vice-President thinks) when anybody attacks the United States – Iran has done that in numbers of cases, they’re doing that right now in Iran – they have to be punished or others will follow and do the same thing. So I think this is clearly top of the list. CIRINCIONE: Okay let’s follow that out. Could we do it? What does that military option look like? You’ve war gamed this. You did a number of war games both professionally in service and out of service, and you did – the most famous of which was the series you did for the Atlantic Monthly with James Fallows. That was two years ago now. What do you think the plan looks like now? If we were to push it, what would we do? SAM GARDINER: One of the reasons why the option is relatively attractive is because it’s easy to do. It’s not an invasion. It’s not the kind of thing that people had talked about at one time. It’s not certainly like a thunder run to Baghdad. What we read about is that it’s probably four or five nights – I say nights – of attack on the facilities in Iran. Nights – I say that because it will be done with cruise missiles and B-2 bombers – very few penetrations of Iranian airspace and I would bet the president has been advised very low casualties, or no casualties. Am I starting to make it sound attractive? It will punish Iran. Now, Flynt said we can’t – and the Ambassador. We don’t know where the targets are. We don’t know the unknowns. But if you understand the objective is to punish Iran, not just deal with the nuclear program, you don’t need to know where the targets are because it is the purpose of showing you can’t treat the United Stares this way. And one of the arguments – I think it’s going to become more and more apparent because we are going to see more and more stuff released about the Iranian involvement in Iraq. And it will start with that argument – that they are the part of the problem we have there now. They are. But it’s going to become more and more apparent and the pressure is going to grow to put that out. CIRINCIONE: So we do that. We do – lets say that if it comes to this we do five nights – you’ve talked about 750 aim points. The problem is what happens next? Ambassador Pickering was talking about this. What do the Iranians do on day six? SAM GARDINER: The Iranians have a notion that really – I’m sure they wouldn’t use this word but that goes back to the Cold War, which is what we used to call horizontal escalation. In other words, if you can’t take on the bad guys directly, you take them |
First Hour
Introduction
