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

 |  Includes: BP, COP, CVX, GLD, RDS.A, SLB, STO, XOM
by: Michael Fitzsimmons

(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 (NYSE: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 (NYSE:BP): -36.1%
  • Chevron (NYSE:CVX): -20.7%
  • ConocoPhillips (NYSE:COP): -41.3%
  • ExxonMobil (NYSE:XOM): -14.8%
  • Schlumberger (NYSE: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.