World Recovery Is in the Hands of OPEC

In a recent interview posted here, Professor Nouriel Roubini said:

I worry that oil is going to go up above $100 for reasons that have nothing to do with the fundamentals of supply and demand. Oil at $100 would have the same negative effects on the global economy as oil did at $145 last year.

Last year, when oil was at $145, the global economy was still growing. Right now it has collapsed, and is recovering. Oil pushing above $100 would have nasty, negative real trade effects and real disposable-income effects on all importing countries: U.S., Europe, Japan, China, India; all the countries that were hit by the oil shock last year. So that’s an element that is in my view totally speculative, and dangerous to the global economy.

I agree with every word of that.

Except that the danger to the world economy is much more than those mild words suggest. Roubini has made warnings before, he is accused of being a broken clock that is right twice a day and he is lampooned as “Dr. Doom”.

I recall the reaction that he got after his presentation at the IMF in 2006 when the moderator made a joke after his presentation, “Well I think we all need a stiff drink after that”.

And everyone had a stiff drink, or three, and that presumably "solved" the problem, for a while, as stiff drinks always do. But that was serious, and what happened next was that “Armageddon was avoided” (time for a few more stiff drinks – in celebration of a “”near miss”).

This time it’s very serious. Time for a whole bottle of Vodka perhaps?

An unintended consequence of the low Fed Base Rate and the carry trade that spawned is that the speculators have the funds to pump up a bubble in the price of oil.

The correct price of oil now is $75 a barrel.

At that price, the buyers pay enough so that they don’t waste it, but economic activity is not unduly constrained and the cost of commodities is not unduly affected (a large part of the cost of mining and agriculture is the cost of gasoline or diesel to haul materials), and at that price also it also makes sense to look for more oil and to develop new capacity.

It also makes sense to invest in alternative sources of energy, particularly to power transportation.

But when you are looking at the number for an investment in a nuclear power station, a wind farm, an electric car or other technologies, even technologies that improve oil extraction, uncertainty over the future price of oil constrains investment.

So what number are the people who do the calculations on those very long-term investments that our children and grandchildren will need, putting into their spreadsheets?

When you do those calculations you do a “base” case, a “stretch case” and a “low case”, the stretch case is (ought to be) what the bonuses and incentives are based on, the low case is where you just avoid getting wiped out. If you run the numbers and they show that you do get wiped out on the low case, you don’t do the project (if you have any sense).

These days many people who have to make that call are putting $50 oil for the low case 10-Year “planning assumption”, some are down to $40, that’s too low to get the sort of investment that is required now.

What next?

There is a very real chance of a speculative bubble in oil, there is as Roubini correctly points out a “wall of liquidity” chasing fewer and fewer assets classes. The tragedy now is that long-term long-horizon investors have been hammered, and they are in risk of getting hammered again, and the only people who can make money in the unfolding uncertainty are speculators.

That’s back to square one, or worse, that’s what caused the credit crunch and if that is allowed to get out of hand again the next crunch will be worse than the last one.

Forget about all the economic jargon that manifestly failed in the past, “fiat money”, “gold standards”, “inflation targeting”, “quantitative easing”, that’s just more of the same that didn’t work last time.

One thing has to happen to bring stability to the world economy, is that the world’s largest consumer of oil (America) needs to reach an accommodation with the world’s largest supplier of oil (OPEC).

There are only two viable options, either America can use its military might and invade and conquer the OPEC nations and dictate the price and production of oil; or it must negotiate.

I have no doubt that if America and its allies decided to seize the world’s supply of oil, then they have the resources to do that. That’s what wars were fought for in the old days, from camel raids in the Middle East to cattle raids in Africa, that’s what kept the Roman Empire going; why the Conquistadores invaded South America, and that was Hitler’s idea. A war fought for “spoils” and pillage makes perfect sense.

One thing is for sure, the worst way to conduct military operations is to be half hearted, for example the invasion of Iraq and Afghanistan with pitifully too small a forces to "win".

There are two options in war, you win, or you lose, getting tied down fighting an insurgency before slinking out the back door with your tail between your legs is, losing. There is only one thing worse than going to war, and that’s going to war and losing, or at least not bringing back “pillage”.

The only other option is negotiation (muddling through is increasingly not an option).

But to do that USA needs (a) to be prepared to offer concessions if it is to get what it needs ($75 for the next five years and a formula for adjusting in the future, nothing else), and (b) to clearly demonstrate that it is serious.

By "serious" a start would be to stop trashing the dollar, and making a believable commitment not to do that, being in control of the worlds reserve currency has benefits, and responsibilities too.

And just saying “trust me” doesn’t hack it; the other side has to truly believe that the other side is serious and that it will stand by its commitments.

The “threat” of sanctions, or war or nuclear bombing raids way (however viewed), is not serious. America brushes off the concerns of the nations that it has labelled as its enemies with disdain, that is not a good start.

OPEC has the power to control the price of oil below a certain level, it’s not hard to work out what that level needs to be.

America has the power to limit the activities of speculators, it also has the power to sell oil from its strategic reserve which would curb speculation, particularly naked speculation, in an instant.

"Ah", you say, “That oil is only for an emergency”.

Well this is an emergency, the biggest one America ever faced. The choice is yours Mr. Obama, Plan B is a world run by rampant bands of half-naked speculators covered in war-paint crying "free-market-rules" while they manipulate it from behind.

Those are the barbarians at your gate, they are the real terrorists, and don’t under-estimate their power to destroy your world.

And as an investment strategy if that happens, my advice be prepared for chaos, put at least 30% of your money in the hands of the barbarian gambles who are gaming the system, for the rest gold, and guns. Whatever you do, don't make any long-term investments.

Disclosure: No positions.

Comments

[User 353732:]

1. The West may have the military and logistical sources to seize Mideast oil supplies but it has no will to do. Moreover, outside the US, the West has simply no ability to project military power and sustain a prolonged occupation. Australia and Canada have no motivation to do so since they objectively benefit from $100 or $150 oil(on the net: both are important energy exporters and can be even bigger exporters as they develop their tremendous endowment of hydrocarbon resources).
Finally,the Global South( especially China) will be forced to ally itself with the MidEast and Russia and the ensuing trade, capital , talent and multiple low intensity shooting wars would lead to a decisive defeat for Japan and the EU, leaving the US isolated , humiliated and shrunken.

2. It is not OPEC that is driving up the price of crude in nominal dollars but the Regime in the US . The debasement and corruption of the dollar is not caused by OPEC but by the WashDC-Wall ST CoDominium. Oil and other real assets are merely responding to this willful debasement. The enemy of the American productive(i.e.. Middle Class )economy is not OPEC but the US Regime.

3. Blaming the "Outsider" and the "Other" is a sure sign of intellectual and moral bankruptcy and cowardly denial of self inflicted tragedies and social pathologies.
The West has the physical, technological and financial endowment to be net neutral in energy trade. It CHOOSES to be dependent on tyrants and despots and hostage to terrorists.

OPEC does not and cannot prevent the US from doubling natural gas production in 10 years( and displacing oil directly and indirectly) , building a new nuclear plant every month for a decade if it really wanted to, constructing an ultra high voltage power transmission system and developing technology based alternative energy supplies. Neither does Russia. Neither does China or India or Brazil.
It is the US Regime that thwarts America, no one else.

Oct 25 12:27 PM

[Dave Wrixon:]

So you want the Arabs to buy your inflation?

What happened to free market ideology. The freedom to sell what you wish, when you wish and at the market price?

Also, let face it, anyone but a fool can see the Americans would rather steal the oil than pay for it. You have just said as much yourself. The problem being that they cannot actually see how that would work. So they instead they want to negotiate in good faith. Your having a laugh.

Allies? If Obama went for invasion of the rest of Middle East after all he has said, his only likely ally would be North Korea.

Oct 25 01:34 PM

[Tee. Maharaj:]

Roubini is correct about High Commodity prices being chased by Speculators. There is a huge bubble in commodities, while there is no signs of inflation. Chasing commodities will surely cut off Global Recovery and put the world at risk for far worst than what we experienced last year in World Markets crashing.

Oil have never traded on its fundamentals, until that start happening the Arab wolrd would make sure that the USA does not be what was it was as World Leader. The Speculators and the Arabs have every country economy in their hands.

It is pitiful that the US Government are allowing this type of manipulation, and not investing in Oil Exploration to counter what the Arabs wants to see. "AMERICA

Oct 25 02:45 PM

[ryanclarke:]

World Recovery Is in the Hands of OPEC ... which is why the world is not going to recover. On a global macro basis what's going on is a power struggle between three major players. Player number 1 is ChinaAmerica ... which will play together in competition for oil resources until the U.S. defaults on the debt owed to China. Player number 2 is EuroRussia which will satisfy the Russians so the Eastern European former Soviet bloc countries will continue to pay their debts to the Credit Suisse, Deutsche Banks ,etc. of western Europe .. to the degree Russia wants to price their oil in Euros and participate in the WTO. Player number 3 is the rest of BRIC ... namely Brazil and India ... neither of which currently have the military power to enforce their new found place in the world. The three players I mentioned could easily become 6 which could become 12 etc.etc.etc. In other words, look for increased transportation costs to do away with whatever "advantages" globalization has brought to the world. This is a world of finite resources with non finite demand ... which is why capitalism will win regardless of the current U.S. attempt at socialism ... because capitalism mimics mother nature's laws.

Oct 25 05:13 PM

[Rokjok777:]

This is not really a serious post. That America would/could somehow invade the MidEast and seize oil is a fantasy left over from WWII. For starters, we would have to borrow the money to do so. From whom? Would China sanction this? Japan? The Saudis perhaps?

Oct 25 05:26 PM

[davidbdc:]

What about the option to stop using imported gas? You know the one where we build 50 nuclear power plants, develop battery technology to use that energy, and stop sending $250 Billion to the Middle East every year!!!

Oct 25 06:52 PM

[The Geoffster:]

Eliminate the leftists and you wouldn't have to steal anyone's oil fields. We have vast untapped oil reserves in the U.S. We have massive coal deposits. We could light the world with nuclear energy. All of this would provide cheap fuel while alternatives are developed but the left wants to cripple America as a world power.

Oct 25 07:21 PM

[upndown1313:]

We can be free from foreign oil in 20 years. The technology and US resources are already here. All we need is the leadership Obama should have focused on this first instead of healthcare and set the vision for the future. This would have driven jobs and made our Arab enemies impotent.

Oct 25 09:34 PM

[keithfeather:]

Rokjok must be right, this article has to be tongue in cheek. Ultimately, davidbdc has to be correct, too. I have come to the conclusion, however, that our government scientific minds were trained in liberal arts.

Oct 25 09:49 PM

[derryl:]

The "wall of liquidity" that is chasing all asset classes, including commodities like oil, is interested not only and often not even primarily in making speculative gains. A lot of this money is just pension funds and ETF retail investors like you and me trying to preserve the value of our wealth as the dollar devalues. Yes this 'speculative' money holds the price of oil higher than oil market supply and demand would indicate, but how do you tell all those people that you're not allowing them to put their wealth into commodities to preserve it against devaluation? (I own oil stocks but not ETFs, though I sympathize with ETF commodity 'speculators')

And again, as much as speculator money pushes up prices beyond market clearing levels when it buys into commodities, that same money pushes down prices to below market levels when it sells those commodities. Speculation creates a demand spike at the front end and a supply glut at the back end. It's a zero sum game. Some speculators can 'win', but only at the expense of other speculators who lose. But as long as a fairly constant amount of speculative money remains in a commodity market producers benefit from the higher prices caused by that demand externality being in their market, and consumers pay the price.

Could the US and OPEC make a 5 year deal for $75 oil? OPEC has been talking to China, Russia, France and others about cutting the US$ out of their oil transactions. I don't think OPEC has enough faith that the US can or will halt dollar devaluation. I think OPEC is more focused on diversifying away from exports to the US than in locking into long term contracts with a country that has been and needs to devalue its currency. I think if anybody ends up getting compelled to make a sweetheart oil deal with the US it will be Canada and the oilsands.

Oct 25 10:40 PM

[Dean M:]

I wish oil would go to $1000 so we would stop using it, we have plenty of energy sources right here, the domestic energy producers just don't own politicians like big oil. Lets see Iran and Venezuela try to compete in the world economy on innovation instead of the dumb luck of sitting on massive oil reserves, that would be fun.

Oct 25 10:51 PM

[Ferdinand E...:]

One thing is very wrong here Mr Butter, and that has to do with fundamentals. OPEC IS PART OF THE FUNDAMENTALS - the most important part!! I just gave a lecture on this in Italy, and EVERYBODY understood. You can't talk about fundamentals unless you talk about OPEC. They are now the key operator on the supply side.

As for Mr Roubini's theories about speculation, he's just ignorant. Now listen Mr R: and everybody else. WHEN THE PRICE OF OIL WENT TO $147/b, Prez. Bush did not go to New York and tell the 'masters of the universe' to stop speculating and get with his program, or else - which they would have done, thanks to the 'or-else' - but to Saudi Arabia where he kindly asked the King to lend a helping hand.

I hope that I don't have to tell you what the king said.

And as for somebody putting the blocks to US energy independence, I hope that I dont have to remind the colleagues that that was George W. Bush. The money that went into the war in Iraq would have bought a large slice of energy independence. And if America needed a war, there is always Afghanistan and Canada.

Oct 26 08:20 AM

[PastTense:]

Doesn't anyone remember the 1973 oil crisis?
en.wikipedia.org/wiki/...

That was 36 years ago. Back then there was a strong consensus that the United States shouldn't be held hostage by the Middle Eastern dictators. Jimmy Carter started this country on the path to energy independence. What happened? America decided it preferred cheap oil now, rather than prepare for the future.

The problem now is not OPEC; the problem is peak oil--the world is running out of cheap oil. Plus there is a vast, increasing demand for oil from places like China and India--they are now rapidly buying autos...So energy costs are going to explode.

Oct 26 09:56 AM

[Dave Wrixon:]

The biggest problem is the over consumption by America of a very finite resource that belongs to the entire World not just them. America must reduce its dependence on oil. Thankfully the market will sort that out. And by the way, do not get distracted into thinking that military power will enable you to hijack the oil supply. That is just naive stupid thinking that can only be a consequence of an American education, if that is the right word.

Oct 26 10:56 AM

[jerrydd:]

All the US needs to do is put the full cost of oil in it in it as a tax. That includes all the subsidies both direct and socialized like depletion allowance, tax breaks, health care costs from pollution, pollution, Persian gulf military, oil wars, etc.

This revenue would go 1/3 to a tax cut, 1/3 to helping switch to more ef, alt fuels, mass transit and 1/3 to balance the budget which it would do in 10 yrs.

This would double the US gas/oil costs which would trigger very fast switch to more eff cars and alt fuels in the US This would drive down the price of oil so OPEC, big oil would pay most of the tax as they should.

With this we would be independent of imported oil in 10 yrs or less cutting $500B/yr in the trade deficit, creating millions of new jobs, balance the budget, get us out of oil wars and let the Arabs, Persians kill each other instead of our soldiers.

Those who think we can drill for enough oil here are ignorant of that process.

We can switch semi's, trucks to NG, cars to EV, PHEV's and chemical feedstocks to yard, crop, forest waste biomass along with cutting vehicle weight, better low drag tires can be done in 5 yrs.

Obama's cap and tax, not congress' cap and trade, is the way to make our national economic and security great or we can be broke, stay in oil wars.

There are no technical reasons this can't be done, it's big oil, coal, repubs and a few oil/coal state dems that are destroying our country for a few $. They are traitors as far as I'm concerned. My, Obama's way is the true fiscal conservative way with little regulation, gov needed.

Oct 26 11:42 AM

[Ron2008:]

The problem is you are treating oil as an asset class and not a commodity. Thus more dollars are chasing to the long side of oil than normally would.

If all of the specs who wanted to preserve the value of their wealth would buy precious metals, then you would have your safe haven and the economy wouldn't be ruined by the specs buying a commodity that affects the world to such a huge extent.

I hope you realize how big a "tax" the inflated prices of oil and gasoline, caused by your speculation, are to the US economy.

The US uses about 14 million barrels of oil a day, right now. If there is $20 of spec premium added to the price, that is a $280 million dollar per day "tax". $8.4 billion a month. $102 billion a year.

By speculating to preserve your wealth, you are on the other hand causing the price of everything you purchase to cost more. Are you really gaining anything?

On Oct 25 10:40 PM derryl wrote:

> The "wall of liquidity" that is chasing all asset classes, including
> commodities like oil, is interested not only and often not even primarily
> in making speculative gains. A lot of this money is just pension
> funds and ETF retail investors like you and me trying to preserve
> the value of our wealth as the dollar devalues. Yes this 'speculative'
> money holds the price of oil higher than oil market supply and demand
> would indicate, but how do you tell all those people that you're
> not allowing them to put their wealth into commodities to preserve
> it against devaluation? (I own oil stocks but not ETFs, though I
> sympathize with ETF commodity 'speculators')

Oct 26 01:21 PM

[Tony Daltorio:]

This article is so wrong in so many ways.....

1) Even considering the use of military force to seize oil assets around the world is why Americans have become more & more unpopular globally.

2) The problem isn't OPEC or "speculators" - it's end of cheap oil, the rise of the emerging world, and vast overconsumption by the United States.

3) I'm so sick of hearing about the bubble in commodities. There are TWO bubbles right now - the US Treasury and stock markets.

4) Finally, there is no comparison between the rampant speculation going on in stocks right now as compared to the minor speculation in commodities. It's like comparing the light of the sun to the light of one firefly.

Oct 26 04:10 PM

[Jason Rines...:]

That comment is like comparing coke and pepsi? Which one do you like better? The progression of US politics was socialism, now Fascism, soon to be Communism, Despotism and the cycle will end in Capitalism and a true new spirit of hope.


On Oct 25 07:21 PM The Geoffster wrote:

> Eliminate the leftists and you wouldn't have to steal anyone's oil
> fields. We have vast untapped oil reserves in the U.S. We have massive
> coal deposits. We could light the world with nuclear energy. All
> of this would provide cheap fuel while alternatives are developed
> but the left wants to cripple America as a world power.

Oct 26 07:44 PM

[G. L. Turner:]

The SECOND Best article in a while...both here today....

I have been faxing the Obama Admin and CFTC and key Senators weekly for almost two years now, especially my friend Mike M showed us the reality in the futures markets...

We are in a hell of a bind...here at home with our domestic speculators (GS, JPM, MS) ready and willing undermine our economy and future for thier own gain, and then whole new market giant (Asia) available to OPEC. (See Ron Hera's Article here today...)

We had better wake up and get our act together with reform/regs here and with a cogent, government led commodity trading policy that deals with securing oil (and other resources) for us, pronto...or we will see another speculator come after our economy - that of the Dragon, just as soon as they get the rest of the world to shift off the petrodollar as the reserve...

The future will be interest, with nowhere to hide....

Oct 27 12:03 AM

[The Dark Years:]

Tony:

You are spot on in your precise observation. The real problem is that the world is dealing with a realization that Peak Cheap Oil is upon us. America is the most profligate user, and with our 300 million population we use about twenty or so percent of the entire daily world supply. Our competition for what remains is in large measure is China (and others) with six billion or so people. Accepting and acknowledging the realities of pending crisis like Peak Cheap Oil, Potable Water, and Peak Food Production will help ease our transition from a Super Power to a more humble lower tier player.


On Oct 26 04:10 PM Tony Daltorio wrote:

> This article is so wrong in so many ways.....
>
> 1) Even considering the use of military force to seize oil assets
> around the world is why Americans have become more & more unpopular
> globally.
>
> 2) The problem isn't OPEC or "speculators" - it's end of cheap oil,
> the rise of the emerging world, and vast overconsumption by the United
> States.
>
> 3) I'm so sick of hearing about the bubble in commodities. There
> are TWO bubbles right now - the US Treasury and stock markets.<br/>
>
> 4) Finally, there is no comparison between the rampant speculation
> going on in stocks right now as compared to the minor speculation
> in commodities. It's like comparing the light of the sun to the light
> of one firefly.

Oct 27 09:28 AM

[cyclingscholar:]

Can china drill for oil off the US coast? YES THEY CAN!

Can venezuela? YES THEY CAN
Can cuba? YES THEY CAN.
Can Amerika? N'Obama NO HOW!

Oct 27 12:09 PM

[Andrew Butter:]

1): I wasn't seriously proposing that that USA take over the world's oil supply (not that I personally would have any objection), I was simply suggesting that if that is not an option then there is only one other option.

I think the "unpopularity" of America has more to do with their steadfast support for Israel than their appetite for oil.

But you don't need to be popular if you are super-power, although it can be expensive; but then of course America is rich so it can afford it, that's why 50% of the world's expenditure on armaments and standing armies is funded by American taxpayers.

2): According to me oil at $75 today is the historical trend-line of neither cheap nor expensive.

3): I agree US Treasuries (10-Year and 30-Year) are a bubble, I do not agree the US stock market is a bubble.


On Oct 26 04:10 PM Tony Daltorio wrote:

> This article is so wrong in so many ways.....
>
> 1) Even considering the use of military force to seize oil assets
> around the world is why Americans have become more &amp; more unpopular
> globally.
>
> 2) The problem isn't OPEC or "speculators" - it's end of cheap oil,
> the rise of the emerging world, and vast overconsumption by the United
> States.
>
> 3) I'm so sick of hearing about the bubble in commodities. There
> are TWO bubbles right now - the US Treasury and stock markets.<br/>
>
> 4) Finally, there is no comparison between the rampant speculation
> going on in stocks right now as compared to the minor speculation
> in commodities. It's like comparing the light of the sun to the light
> of one firefly.

Oct 27 01:12 PM

[anarchist:]

GW was able to do it so I imagine Obama could scare up a phony crises to justify invading Saudi Arabia (maybe for "their protection" wink, wink), Iran and Kuwait. May Obama can bring on board another Bushite like Ashcroft to plan this event since he did so well with the last US military adventure-Obama likes those Bushite losers. Maybe Powell can take his show to the UN again, that seemed to work pretty well.


On Oct 25 05:26 PM Rokjok777 wrote:

> This is not really a serious post. That America would/could somehow
> invade the MidEast and seize oil is a fantasy left over from WWII.
> For starters, we would have to borrow the money to do so. From whom?
> Would China sanction this? Japan? The Saudis perhaps?

Oct 27 04:13 PM