Geopolitical Energy: Centered on the Caspian Sea (Part 2 of 2)

(For Part 1, click here.)

The US’s oil centric foreign policy agenda is apparently to irritate the two major powers in the Caspian Sea region: Russia and Iran. With the USSR’s disintegration in 1991, all the former Soviet states in the region were being eyed for their energy reserves. At the same time, Russia still considers these former states as within their “sphere of influence”.

Instead of joining with the Russians in mutually beneficial energy projects, technology transfers, and contracts, the US instead decided to take the opposite approach: it first propped up a government in Georgia irritating the Russians. Then the US supported NATO membership for former USSR countries Ukraine and Georgia. The US also proposed missile defense systems on Russia’s western borders, further infuriating the Russians. Russia finally had enough and acted in Georgia as George Bush was attending the Olympics in China. Russian actions put exclamation points on the obvious – it can take out the BTC pipeline any time it wants, and is resentful of American military meddling in its backyard.

The prior secret agreements between Putin and Bush to fight the mutual “terrorists” foes appear to be in the distant past. Recent activities involving Russian natural gas transports through Ukraine underscore the vulnerability of Europe’s energy supplies. Europe currently imports some 40% of its natural gas from Russia, and this amount is bound to increase in the future. This further complicates the puzzle by placing US actions at odds with supposed allies in Europe.

With respect to Iran, the US has military forces in Iraq, Afghanistan, Uzbekistan, Kyrgyzstan and elsewhere in the region – completely surrounding Iran. The US has further tried to isolate Iran (to the dismay of the Europeans who vitally need Iranian energy) by imposing economic sanctions on the country. Iran was one of three countries with distinguished membership in George Bush’s “Axis of Evil”. These US actions have left the Iranians no choice but to develop nuclear weapons in order to protect themselves against the same kind of American aggression they have witnessed elsewhere in the region.

Meantime, flawed US/Israeli policy, combined with Israel’s recent activities in the Gaza strip and the powerful Jewish lobbying efforts in the US for military action in Iran, seem to increase the odds for more conflict in the region.

Have US foreign policy moves in Central Asia been successful? Yes and no.

One bright spot is Iraq. Iraq was always the priority in “the war on terror”, not because the terrorists were there (they are now…) but because Iraq holds the world’s second largest oil reserves after Saudi Arabia. Many of Iraq’s oil fields also have the important advantages of being sweet crude (high quality), are shallow, and are under pressure, making Iraqi production costs very low – in the neighborhood of $10/barrel. For those who actually believe the US government’s marketing job of WMDs, “freedom”, etc. as a pretext for invading Iraq, please note the recent announced that Iraq’s oil resources are now “open for business” and up for bidding. Western oil companies such as BP, ExxonMobil, Chevron, and Royal Dutch Shell (RDS.A) stand to benefit handsomely in Iraq while at the same time boosting the country’s oil production by some 2-3 million barrels over the new few year. So, Iraq can be considered a US success story assuming security is maintained and the oil can reach the market. A big if, but time will tell.

The BTC can also be considered a success. It has operated fairly reliably, and has shown to be a fairly secure source of Caspian Sea oil. This was a huge project, and many people in the oil business doubted its success and completion. But it’s up and running today and survived Russia’s recent invasion of Georgia. That said, the BTC’s continued success is extremely dependent on maintaining security in the area.

Now it’s time to head to Afghanistan and take care of business over there. Boy-oh-boy is that going to be one tough nut to crack. The Afghan/Pakistani issue is so deep I can’t even begin to cover it in enough detail to do the subject justice. Those who believe the US motives in Afghanistan are simply “terrorism” or “freedom” should take note that the US fully supported and funded the Taliban when it was decided they were the best option with respect to getting the Central Asian pipeline built. Unocal sponsored the Taliban on trips to Houston to stay at 5-star hotels and visits to NASA. It was only later when the Taliban wouldn’t “play ball” that the US stopped their support and labeled the Taliban terrorists. Even the US installed Afghani President Hamid Karzai worked as an advisor and consultant to Unocal during the initial Central Asian pipeline feasibility studies.

So, US policies have had some successes in the region as far as oil is concerned. From a humanitarian aspect, well, I’ll leave that up to the reader to figure out on his or her own. From an economic standpoint, one would have to make a detailed analysis of military spending versus the economic benefits in order to come to any conclusions. Perhaps I will write an article on this some day, but for now, I’ll sidestep that question as well.

For the US, I am not such an idealist to think for one minute the symbiotic “Pentagon-Petroleum” relationship will change anytime soon. Further, as a realist, I also understand how important the game being played in Central Asia is. I am aware of the actions the US and other world powers are taking in Central Asia in order to acquire the energy reserves they need to power their economies. My eyes are wide open.

What I continue to struggle with is why the US directs so many resources and dollars toward these overseas strategies while at the same time almost completely ignoring what steps could be taken to reduce our foreign oil requirements by adopting some fairly simple and obvious policy changes. It, quite simply baffles me. Even a cock-sure trader hedges his bets now and again. The most amateur investor knows some diversification is prudent. So, why does the US continue oil centric policies which are certain to lead to more conflict, more debt, more trade deficits, and a weaker economy and currency?

Most readers are very familiar with my proposed energy policy, but I will add the link yet again in the hopes that someday, someone out there with a bit of power and influence will read it and make it happen.

So what does all this have to do with investing you ask? In a word: everything. Where can US investors put their money these days? Financials? Consumer cyclicals? Auto makers? I think not. Despite current low oil prices, the recent strength in the US dollar, and the subject matter of this article, I continue to believe the best opportunity for US investors is to participate in energy companies and to buy gold. Now, I know that some of you who read my articles earlier in the year and went out and bought my recommended stocks got a hurt, and hurt bad, right along with me and everyone else. I’m truly sorry, and feel bad if my advice caused you any pain (at least realize I felt the pain as well!). That said, let’s look at the 2008 returns for some of my picks:

• British Petroleum (BP): -36.1%
• Chevron (CVX): -20.7%
• ConocoPhillips (COP): -41.3%
• ExxonMobil (XOM): -14.8%
• Schlumberger (SLB): -57%

Not awfully bad, considering these returns (from this weekend’s WSJ) do not include the nice dividends some of these companies' payout and the S&P500 was down 38.5% in 2008, its worst year since 1931. At the same time gold held up rather well, gaining 7% in the course of the year.

The bad news was some of my theme picks didn’t do well at all. Energy services, which at one point in 2008 were my “number one investment pick”, simply got hammered. Likewise, my advice to get into strategic metals via Vanguard Precious Metals (VGPMX) was a disaster as the stocks in this fund were sold off big time during the great leverage unwinding.

Making matters worse was the huge distribution VGPMX made at the end of the year which just infuriated me. I actually called Vanguard and asked them how a fund which lost over 60% for the year could possibly justify making a year end taxable distribution that equaled roughly 12% of the fund's entire NAV?! I mean, if you sold enough to make such huge gains, why the hell is the fund down 60%? If you didn’t sell, and watched the stocks go down, why not sell the losers so that the losers and gainers cancel each other out so that no taxable distribution takes place? I was told I simply “didn’t understand”. They were right, I don’t! Seems to me even a moron could manage a fund better than that. The loss in the fund's NAV I can understand. The huge year end distribution is simply inexcusable.

What I learned during the year is this: if a person wants to invest in precious metals, buy gold, take personal delivery of it, and bury it in the backyard and forget about it. Sure, people flock to the US dollar in times of crisis, but did anyone see the action in US treasuries last Thursday and Friday, as well as the headline in Barron’s this weekend? The financial mismanagement by the US government, Treasury, and Federal Reserve combined with the lack of a strategic long-term comprehensive energy policy must lead to a long-term weakening of the US currency. So, buy oil, buy gold. When inflation comes back, it will come back very quickly and these hard assets will once again take off like a rocket. I mean, how can the economy not re-inflate with the Federal Reserve printing US dollars as fast as the presses will print them?

My picks for 2009 are as follows: XOM, BP, CVX, COP, SLB and gold bullion, in particular American Eagles and Canadian Maple Leafs.

Goodbye 2008! Indeed, very soon we will be saying goodbye to George W. Bush as well. Let’s all hope that 2009 will be better than 2008. It won’t take much! Let’s also hope that the new administration hedges its foreign policies bets with a bet on the American people and what we can do at home by enacting a strategic long-term comprehensive energy policy. In the meantime, buy Kleveman’s book The New Great Game, enjoy, and learn. The last paragraph of the book sums up my feelings perfectly.

Comments

[Brahm:]

Good analysis, but perhaps somewhat skewed in parts. You failed to mention that besides the oil/gas concessions in Iraq for BP, Exxon, Shell and Chevron, the current Iraqi govt has also given concessions to Chinese companies and others. Future Iraqi governments are unlikely to skew their energy policy, especially issues on exploration and production rights, solely in favour of Western companies. Other nations' (state companies) have not been aggressive bidders yet due to fluid and unsettled circumstances in Iraq currently.

As Europe's dependence on Russia and Central Asian energy increases with time, a divergence in approach to Central Asia and Iran will most likely increase between the US and the Europeans. One can see the nuances of this divergence even now.

Jan 05 11:24 AM

[The Proclaimer:]

Thanks for the Articles, I like your picks except for gold, that one is too easily manipulated. I hope that you checked out my one pick, this one promises returns that have never been seen before. I believe that they have tapped into "King Solomon's Carbon Mines". Don't know if you have kept up with my Proclamations, you should, I was recently given the OK to make references to the Patent Office and broader possibilities. I am sure that we will be seeing this one in the News very soon!

Jan 05 12:18 PM

[isaac the t...:]

Thanks for the book review. I will definately read it. I would ask you to read a short article by a very intelligent commentator Charles Krauthammer- he makes some very good points that you may want to take to heart (and no, I do not condon Isreal policy to Gaza. i think they ought to just send one missile into Gaza for every missile that comes their way (average of 6 /day in the past three years).
www.washingtonpost.com...
Anyway,
Thanks for the great article.

Jan 05 12:19 PM

[nerfer:]

Good article, good food for thought. But I disagree on the Talibans - I think they were considered our friends while they were fighting Russia (there is the line of thought that the bankruptcy of U.S.S.R. from low oil prices during the Reagan years and their military defeat in Afghanistan is what allowed Poland and the Communist Bloc countries to break free of Russia). Once we no longer needed the Taliban to fight Russia, we lost interest (see Charlie Wilson's war), in the subsequent vacuum they joined up with Al Qaeda and bin Laden. They always treated their women and history badly, but only after 9/11 did we agree they were really terrorists and actually enemies.

Jan 05 04:36 PM

[longoil:]

Fitz,

I will definitely check out Kleveman's book.

Another interesting book that revolves around oil geopolitics is "The Oil Card" by James R. Norman.

The premise of the book is twofold:

1) The US engineered the collapse of the USSR by manipulating oil prices downwards between 1985-1991 and drying the primary source of income for the USSR.

2) The book also theorizes that the US is currently restricting Chinese growth by manipulating oil prices upwards.

I don't agree with the conclusions of the book, but he backs up his argument very well with good references.

Jan 05 07:15 PM

[Michael Fit...:]

Brahm: thank you. i didn't mean to insinuate that all the iraqi oil contracts would go to western oil companies. that said, i'd be shocked if the majority don't. i might disagree with you that with US troops there securing the oil resources that the policy won't be skewed a bit, but time will tell. that said, regardless of who gets the contracts, increasing iraqi oil production to the world markets benefits the US more than anyone else (since we suck up 25% of world oil production and love our SUV's, well, at least some do).
totally agree with you on europe. in fact, i have to give n. sarkozy of france some credit when he (the first european leader) finally called BS on bush's agenda of deploying the "defensive missile shield" in europe which antagonized russia so badly (supposedly they are too protect europe from iraqi WMDs.....errrr...sorry :) .....iranian nuke missiles). narkozy said it won't happen, and besides it doesn't work. this is a big indication when the acting head of the EU says something that blunt to the US president...and you know germany supports that position as well.

the proclaimer: thanks. wrt gold, it cannot be manipulated if i own it and it is buried in my backyard. name me another financial asset like that? that's why gold is, well, gold. oil will someday be much more valuable, but who can store it securely (other than the SPR)? i keep waiting for you to start your new business on your proclamation...let me know when i can purchase a unit...

issac the great: yeah, it's a good book. i have probably spent a good hour or two just looking at the maps on the inside front and back covers. fascinating area of the world, and so many complicated players. i will check out charles K., whom i have never heard of before. wrt israel, my opinion is that US/Israeli policy is almost guaranteeing the destruction of israel. just look at what has happened since rabin was assassinated. would any objective person believe israel is more secure today than if they had followed rabin's path? sad. very sad. so, israel levels the west bank on bush year 1, and they level the gaza strip on bush year 8. wonderful way to make peace huh? it's a failed strategy imho.

nerfer: thanks for the compliments. wrt taliban, if your theory is correct, then how do you explain the courtship of the taliban leaders in houston by Unocal and other US big oil? the friendship of the taliban at that level was for one purpose and one purpose only: gaining a secured pathway for the central asian pipeline. you should read the book - perhaps it might sway your opinion. i do agree with you that the taliban was always scum...but the US has a long undistinguised record of supporting scum (taliban, sadam hussein, noriega, i could go on and on). and for those who said i never criticize clinton, it was during clinton's roost in the 90's that we supported the taliban, even after russia bailed.

Jan 05 07:16 PM

[Mythbuster1:]

Just read your proposed energy policy. Do you guys have a central Liberal website like Wikipedia that you reference to copy and paste identical "solutions" to the energy supply problem?

In 20 years we will still be using fossil fuels to provide 80% of our energy needs no matter what we do. How about getting serious about finding domestic fossil fuel sources while we develop alternative energy?

Getting more domestic energy means we will have fewer foreign flails to obtain the energy we need to survive as a nation.

Jan 05 08:18 PM

[Michael Fit...:]

Mythbuster: perhaps you cannot read - my energy policy certainly supports US oil exploration and production as well as leveraging US natural gas reserves (now).

do you mythbustes have a website where you go to in order to figure out how to transfer the wealth of america to the saudis, russians, iranians, iraqis, and venezuelans as efficiently as possible? because that is exactly what you are proposing by thinking that the US, with only 3% of the world's oil reserves, can fix our 70% dependence on foreign oil by domestic sources only. this is simply the same old oil-centric flawed strategy that has led to the decline of the US economy, our currency, and our standard of living while at the same time enriching the same countries that i am sure you hate (those damn muslim arabs! i can hear you talking now....). what an idiotic energy strategy.

Jan 05 10:07 PM

[john s. gordon:]

you say iran's nuke weapon is a response to u.s aggression.

iranian theocratic dictatorship has made it clear their intent is to use nukes to eliminate israel.

this means syria jordan iraq etc. will receive the fallout.

the present rulers of iran departed from the civilized community of nations when they siezed the embassy & took hostages in 1979.
> jack

Jan 06 09:14 AM

[Skip Olinger:]

Well done article. Regarding physical possession of gold, the only problem is that you have to buy coins at a large premium to the quoted price per oz. I doubt the world will come to an end so what is wrong with owning GLD?

I would also buy domestic oil and gas and some pipelines. While the US is the 3erd largest oil producer in the world, we consume about 3x as much as we produce, which is way above any other country's consumption. I doubt we will be able to significantly eliminate oil from our economy any time soon and I doubt conservation efforts will reduce the price of oil on a permanent basis. Therefore I think we have a unique opportunity to buy some really beaten up companies and MLP's. With the MLP's, if I am wrong about how soon oil and gas prices rebound, you get paid to wait. I own LGCY, LINE, ETP and ETE. I would also look at XCE in addition to the majors. I would concentrate on the company's balance sheet and be sure they have committed lines of credit for the next couple of years. Commodity prices are occasionally very volatile so you want to know the company has adequate funding.

While I own COP, i am very nervous about its stake in Lukoil. It could be confiscated as well.

Your thoughts?
Best regards,
Skip

Jan 06 09:30 AM

[Michael Fit...:]

john s. gordon: the iranians took hostages because they were tired of the CIA and the US installed shah ruling their country. let's switch the roles for sake of debate. let's say the US had no nuclear weapon, and china invaded mexico and canada and installed a ruler in the US. what would our response be? we'd probably overthrow the ruler and start working on a nuclear bomb. right? it's all action and reaction, and it's all based on US military imprerialism and agression in the middle east and central asia in order to satisfy our foreign oil addcition. the unholy alliances the US has made with terrorists in the past (shah of iran, sadam hussein, bin laden, uzbekistan dictator, i could go on and on), is quite simply a failed foreign policy, and will fail in the long run as an energy policy. imho.

skip: wrt GLD, i suppose it's ok short term. in the long run, my paranoia about the financial markets leads me to want to buy and hold the gold coins in my hot little hands. sure the coins have a mint premium, but that premium holds fairly constant as the price of gold goes up and down, and also holds if you want to sell them. wrt pipelines and MLP's, i agree with you - there are some great high yielding opportunities there, and i kick myself for not buying more of them in late december. wrt COP, everything i read is that the relationship COP has with lukoil and the russians is very symbiotic and beneficial to both partners. COP brings technology and management, and obviously russia brings the resources and manpower. from what i have read, COP and the russians want to expand their cooperation. i like the relationship - it goes to show what can happen if americans are so damn arrogant. the russians even made statements to the effect that COP CEO Mulva (i think the best CEO in the oil patch) wasn't arrogant like most big oil CEO's. he's regarded as a problem solver. anyhow, you are correct to point out the risk, but looking at COP's price, it appears to be priced in. COP was not long ago selling at a price in which the yield was about equal to the PE (!). i still think COP is a strong buy. thanks for the comments.

Jan 06 12:59 PM

[Skip Olinger:]

Thanks for the response. Is there a way to get in touch with you out of this forum to discuss fly fishing and alternatives to living in CA?


On Jan 06 12:59 PM Michael Fitzsimmons wrote:

> john s. gordon: the iranians took hostages because they were tired
> of the CIA and the US installed shah ruling their country. let's
> switch the roles for sake of debate. let's say the US had no nuclear
> weapon, and china invaded mexico and canada and installed a ruler
> in the US. what would our response be? we'd probably overthrow the
> ruler and start working on a nuclear bomb. right? it's all action
> and reaction, and it's all based on US military imprerialism and
> agression in the middle east and central asia in order to satisfy
> our foreign oil addcition. the unholy alliances the US has made with
> terrorists in the past (shah of iran, sadam hussein, bin laden, uzbekistan
> dictator, i could go on and on), is quite simply a failed foreign
> policy, and will fail in the long run as an energy policy. imho.

>
>
> skip: wrt GLD, i suppose it's ok short term. in the long run, my
> paranoia about the financial markets leads me to want to buy and
> hold the gold coins in my hot little hands. sure the coins have a
> mint premium, but that premium holds fairly constant as the price
> of gold goes up and down, and also holds if you want to sell them.
> wrt pipelines and MLP's, i agree with you - there are some great
> high yielding opportunities there, and i kick myself for not buying
> more of them in late december. wrt COP, everything i read is that
> the relationship COP has with lukoil and the russians is very symbiotic
> and beneficial to both partners. COP brings technology and management,
> and obviously russia brings the resources and manpower. from what
> i have read, COP and the russians want to expand their cooperation.
> i like the relationship - it goes to show what can happen if americans
> are so damn arrogant. the russians even made statements to the effect
> that COP CEO Mulva (i think the best CEO in the oil patch) wasn't
> arrogant like most big oil CEO's. he's regarded as a problem solver.
> anyhow, you are correct to point out the risk, but looking at COP's
> price, it appears to be priced in. COP was not long ago selling at
> a price in which the yield was about equal to the PE (!). i still
> think COP is a strong buy. thanks for the comments.

Jan 07 01:47 AM

[Ferdinand E...:]

Interesting and useful article, provoking just the kind of comments we need, to include those from the author.

Jan 07 05:48 AM

[nerfer:]

Fitzman, I haven't read the book, altho it definitely sounds interesting, so I don't know the timeline of talks with the Taliban. I'm sure funding for Afghanistan dropped significantly after the Russia pull-out however, and we couldn't ignore the terrorist aspect after 9/11. For the years in between I need more information.

WRT Iranian nukes, it's probably a combination of motivations. Close neighbors (including Israel and Shiite-run countries) are definitely part of it, but upsetting the U.S. would be a good side-affect for them.

Mythbuster - We will still use fossil fuels in the future, but the idea that the U.S. can support its current rate of use by North American supplies (let alone just U.S. supplies) is a dangerous fallacy. Efficiency and conservation are the first two steps we should take for immediate improvement, then renewables, including geothermal and improving the grid to handle varying loads of wind power. Recharge electric cars overnight. Battery R&D. These are things to improve the American economy, not thinking that drilling is our only solution.

Jan 08 12:58 PM

[User 283977:]

I got the book. I was hoping for more of a synthesis approach. Anything like that out there?

Jan 11 04:50 PM