The initial excitement that sent the Saudi Arabia market up 3% on Saturday, March 12, (Saturday is the first day of the work week) was not based on what the “experts” were suggesting - that oil demand associated with Japan’s reconstruction after the earthquake and tsunami, especially with the added injury caused by the blowout of the nuclear plant. The market reaction was driven by the Arab League’s unexpected and very surprising statement.
Let’s look at Japan and the U.S. first for a quick view of the energy landscape. First, nuclear power replaces mainly coal and natural gas, not oil, and many know that. In the United States coal is the main resource used in electricity generation - and has stayed somewhat constant - while natural gas grew from 14% to 23% between 1998 and 2009. Oil’s contribution dropped from 3.5% to slightly less than 1% during the same period (source: EIA).
Japan uses more oil than the United States in electricity generation, but “the country's aging oil-fired power plants are used primarily as extra capacity to meet peak demand, and less than 10% of electricity produced currently is oil-generated,” according to a EIA report (pdf) dated September 2010. If nuclear power is to be reduced in the future, the main beneficiary will be natural gas.
The same report includes the graph above depicting overall oil production and consumption in the land of the rising sun, showing a constant decline way before the global crisis started, and mirroring the U.S. pattern.
Furthermore, the rate of increase in electricity demand has actually declined year-on-year in the U.S., as shown by the graph above, despite the added demand caused by all the gadgets that we have become so fond of. The EIA offers its explanation in the report (pdf) “Annual Energy Outlook 2010,” which revolves around one key word - efficiency.
Electricity demand increases in response to population growth and economic growth and fluctuates in the short term in response to business cycles and weather trends. Over the long term, electricity demand growth has slowed progressively in each decade since the 1950s. After growing by 9.8% per year in the 1950s, electricity demand (including retail sales and direct use) increased by 2.4% per year in the 1990s, and from 2000 to 2008 it grew on average by 0.9% per year. The slower growth continues in the AEO2010 Reference case, as increased demand for electricity services is offset by efficiency gains from new appliance efficiency standards and investment in energy-efficient equipment.
Japan’s culture breathes and lives “efficiency” and the country’s energy usage patterns are very similar to the United States. The EIA stated in its Country Analysis Brief for Japan, dated September 2010, that “although Japan accounts for the most electricity consumption in OECD Asia, it has one of the lowest electricity demand growth rates in the region, projected at an average of 0.7% from 2007 through 2018 by the Federation of Electric Power Companies of Japan.”
Unfortunately, the situation is extremely fluid - it doesn’t seem like the Japanese people can’t catch a break - and as far as Japan’s economy is concerned, the amount of damage is still unknown. And I wouldn’t jump to any conclusions yet, although a short-term reduction in production and consumption is a given.
But back to the Saudi market reaction over the weekend, and truly the wild card as far as oil is concerned. The recent news that the Arab League supports a no-fly zone over Libya speaks volumes about the current state of mind of those in power, and that statement truly propelled the Saudi market, for it appears that the autocrats see the writing on the wall, and are looking to ease out of their positions without leaving their countries in a state of chaos. The end result was a complete surprise, especially for those that anticipate a great ball of fire, or World War III in the making. The “day of rage” in Saudi Arabia turned out to be a no show, as reported by Bloomberg, and the continued silence and absence of Al Qaeda and extremists in general is extremely surprising, if not very telling.
Some will point out that Iran wasn't there, and that is because Iran is not an Arab country. A good article in Slate explains the difference for those that are not aware.
What territory do Arabs inhabit? The Arab conquests of the seventh century spread the Arabic language and civilization from North Africa to central Asia. Under the Islamic caliphate, Arabic became the language of scripture, government, law, literature and science. Majority Arabic-speaking countries remain in southwest Asia, Egypt and North Africa. The Arab League includes Algeria, Bahrain, Comoros, Djibouti, Egypt, Iraq, Jordan, Kuwait, Lebanon, Libya, Mauritania, Morocco, Oman, the Palestine Liberation Organization, Qatar, Saudi Arabia, Somalia, Sudan, Syria, Tunisia, the United Arab Emirates and Yemen.
Note the absent country: Iran. Alone among the Middle Eastern peoples conquered by the Arabs, the Iranians did not lose their language or their identity. Ethnic Persians make up 60% of modern Iran, and modern Persian is the official language. (Persian also has official status in Afghanistan, where Dari, or Afghan Persian, is one of two official languages.) In addition, the majority of Iranians are Shiite Muslims while most Arabs are Sunni Muslims. So Iran fails most of the four-part test of language, ancestry, religion and culture.
As oil prices continue to vacillate between “We’re in Deep Trouble!” and “We’ll Be OK!” what the Arab League’s extremely surprising approval of a no-fly zone means is that 1.) Iran is increasingly isolated, 2.) the stage is being set for an acceptance of much needed reform in the Middle East/North Africa, and 3.) the autocratic regimes want the involvement of the international community to save their own skins, and ensure business continuity. According to Foxnews.com:
The Arab League asked the U.N. Security Council to impose a no-fly zone over Libya to protect the rebels, increasing pressure on the U.S. and other Western powers to take action that most have expressed deep reservations about. The 22-nation league said after an emergency meeting in Cairo that it was asking the United Nations "to carry out its responsibility."
In a separate report, also from Foxnews.com, the response by the Arab League was characterized as “surprisingly swift action and aggressive language,” especially when history has chronicled a more laissez-faire attitude toward conflict involving their own.
The 22-member Arab bloc said after an emergency meeting that the Libyan government had “lost its sovereignty.” It asked the United Nations to shoulder its responsibility ... to impose a no-fly zone over the movement of Libyan military planes and to create safe zones in the places vulnerable to airstrikes.
I never though that I would read such a statement from the Arab League. This gesture in essence turns Gaddafi over to the “authorities” as the culprit, while appearing to take the side of the people, and may be an attempt to redefine its images. But the door is wide open to welcome stability and prosperity to the region, while putting added pressure on the usual global suspects to change their behavior - Iran, Venezuela, even North Korea - and discrediting any opposition against a no-fly zone if the suggestion is made in the future regarding any member that chooses to employ Gaddafi’s tactics when dealing with their own uprisings.
But before we celebrate, we must wait and observe, and I certainly hope that the league’s statement wasn't a diversion. However, some voices are internal, and as reported by Bloomberg, “A member of the Saudi royal family, Prince Talal Bin Abdul Aziz, warned in an interview with BBC Arabic TV that unless King Abdullah introduces more political participation and human rights, Saudi Arabia may also see protests.”
Saudi troops were sent to Bahrain to ensure that Iran does not infiltrate the country because the majority of the population is Shiite, not Sunni like the monarchy, while everyone is waiting for a response from the United Nations. Thus far the process has been disappointing, with Russia and China not thrilled about setting a precedent for a no-fly zone enforced by the international community, especially when both have business interests in Libya, and may face their own “no-fly zone” dilemmas in the future. While the issue is debated, the dollar continues to give up some gains because of the realization that we may have Bosnia all over again, and the much vilified, self-appointed, international police will have to lead the effort once again. However, the current U.S. administration is less aggressive than the previous, creating the framework for someone else to take the lead on resolving international conflicts - and I leave the debate to the individual on whether that is a good or bad strategy.
The United Nations finally announced a draft to enforce the no-fly zone over Libya, but the organizations’ efforts may be too little, too late, as the rebels literally hang on for dear life. Reuters reported that the draft was circulated, and a summary follows.
It authorizes member states to "take all necessary measures to enforce compliance" and says countries implementing the ban would be doing so in cooperation with the Arab League and in cooperation with U.N. Secretary-General Ban Ki-moon. It could also open the door to military action beyond a no-fly zone. The draft explicitly "authorizes members of the League of Arab States and other states which have notified the Secretary-General ... to take all necessary measures to protect civilians and civilian objects in (Libya)."
The council will hammer out the details on Wednesday, and “British U.N. Ambassador Mark Lyall Grant said (that it) would be a ‘paragraph-by-paragraph’ discussion.”
Oil traders will be watching the United Nations closely, and a reaction to the outcome - if they actually accomplish anything - could drive prices violently either way, although the upside has been temporarily capped by the events in Japan. Apart from the large drop in oil prices, gold had a monumental decrease of its own and the word on the street is that the Japanese government started to unload the commodity, “turning illiquid assets into cash.”
The bigger unknown lies with the price of gold, especially in the presence of an increasingly unstable and unpredictable world, and its failure to clear the $1,440 level does not bode well in the short-term, although support exists at $1,390 - or $136 for SPDR Gold Trust (GLD). If gold fails to find its way north, $1,370 would be the next support zone, and Proshares UltraShort Gold (GLL) would the one to hold if the $1,390 support breaks - and it traded as low as $1,380 yesterday. Overhead, the $1,406 level is now resistance and overnight gold traded as high as $1,405.70.
The U.S. Oil Fund (USO), iPath S&P GSCI Crude Oil (OIL), Powershares DB Crude Oil Double Short (DTO), and PowerShares UltraShort Crude Oil (SCO) are all hanging between resistance and support as if they are looking for direction, although the April WTI contract is trying to climb the important $99 wall. At this juncture I still find these investments too volatile for my taste.
The yen rose considerably in anticipation of capital repatriation, and the strengthening of the currency is adding insult to injury, putting added pressure on the Bank of Japan to act in the currency markets, although the effect of interventions is always questionable and short lived. Thus the opportunity to go long on CurrencyShares Japanese Yen (FXY) may be a bit late in the game.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
