The Kennel

The “Oil Weapon” is Unleashed Against Iran

The Saudi moves to reduce the price of oil in order to put more financial pressure on the Teheran regime may, as Mr. Dorsch maintains, only be marginally successful, but the decline of Iran's oil infrastructure continues unabated. This is happening not just because the mullahs eschew western oil companies (and their technical know-how), but also because the government has created a negative feedback loop by mandating subsidized gasoline for domestic consumption thus eviserating any financial incentive to invest in maintaining or improving both E&P and refining operations in Iran with either private or public money. Iranian production is steadily declining, and as the government needs the oil export revenues to prop up their diseconomic policies, something has to give here.

Iran's best chance is to strike a deal with someone to [a] rescue their dilapidated E&P and refining infrastructure and [b] extend protection against the USA. What are the prospects of such a regime-saving deal?

The Russians are helping with nuclear technology - presumably hoping the USA will be goaded into attacking yet another Islamic country, thus weakening us still further - but don't need Iranian oil so they are not the answer. India wants the oil but is aligned with the USA. China wants the oil but has no practical way to get it -
neither Pakistan nor Afghanistan would allow delivery overland if the USA nixed it and the USN could easily blockade Iranian maritime traffic. So as things stand, it probably doesn't pay for the Chinese to invest a lot in the Iranian oil infrastructure.

So in assessing the likelihood of things getting hot in the Gulf - thus driving the price of oil back north - it really comes down to a question as to whether the Iranian regime's stubborn insistence on the primacy of religious principles over economic realities causes them to crash and burn domestically before they can develop nukes...or, more pragmatically, on the assessments of the US/Israeli intelligence services with respect to the outcome of this horse race. If the risk the nukes will win grows large enough, things could boil over in a hurry. Otherwise, the pot will likely just keep simmering until regime change in Iran throws a new ingrediant into the stew...at which point we will all need to reassess the menu.

Brad Hessel

Time To Buy Oil?

Todd Sullivan wrote:

> ...There are only so many centers in the U.S. to process the wood into blocks, so we have a finite capacity to supply the
> finished products despite growing demand (there are no plans to expand this capacity anytime soon and as a matter of
> fact, it has not been expanded in over 30 years)....

> ...Iran produces about 14% of the world's oil. We currently have 57 days of total U.S. imports in our reserves. If we import
> from Iran at same percentage as they produce for the world markets, what would their elimination of oil exports do to our
> reserves and how long could we go without? I will use this 14% for the comparison, the actual amount may be more or less
> but there would be vast debate on it were I to "assume" a number. If we released oil from the strategic reserve to eliminate
> the effect of Iran's stoppage, in 406 days the reserves would be empty. Iran's economy would have collapsed well before
> then. Translation? This threat is a non issue....

I agree with your conclusion that it is a good time to be long oil, but first of all, while it is true that there has not been a new refinery built in the USA in 30 years, it is decidedly not true that our refining capacity has not increased in that time. On the contrary, many refineries have been significantly upgraded and if you total the production increases, you will see that we have substantially more refining capacity in the USA than we had in the 1970s, despite the lack of new refineries.

Secondly, while again I agree with your conclusion that Iran is unlikely to withhold oil, if they did the effects would be much more dire than you allow. You are looking at this as if we live in a vacuum and the rest of the world is there for our convenience. In point of fact, everyone else would not all step aside politely so we could continue to import what we want (minus the Iranian portion) with no disruption. Rather, if 14% of production capacity disappeared off the world market, regardless of how much of that impacted oil production we were actually importing - even if it were zero - there would be a mad scramble for the remaining 86% that would swiftly drive the price/barrel up into triple digits for everyone, and possibly provoke a military reaction from some.


Brad Hessel
Manager, The Kennel

Crude Contrarian To the Extreme: Philip Verleger's At It Again

We have been debating Verleger's reverse spike prediction for the past several days over at The Kennel (where we are heaily invested in energy). The general consensus is that we would like to know what he's been smoking. However, to give the devil his due, your piece does not come close to doing justice to his argument.

Verleger's main point is that while the supply/demand curves point inevitably to higher prices on a strategic level, that tactically prices are extremely volatile, partly because of on-again, off-again geo-political factors and partly because of the influence of speculators such as hedge funds who are drawn to the "action" on the energy front. Combine a Kohoutek-like hurricane season, a NATO-force in Lebanon to cool down that flash point, and the prospect of successful negotiations with Iran on their nuclear program with extremely high inventory levels (we are approaching circa-1990 record highs), and it might be enough to chase the hot money out of energy in general, and oil futures in particular. If that were to happen, prices would fall hard and fast. Exactly how hard and how fast is anyone's guess, but once one of these momentum balls gets rolling, it is certainly feasible that the price could temporarily fall below sustainable levels.

The takeaway from Verleger's analysis is not that we could go back to $15 oil for the next five years, but that conditions are present the could result in a vicious reverse spike. If that happens, those with cash to buy in near the bottom will be happy campers.


Brad Hessel, Manager
The Kennel