Striking Oil

As oil prices in New York rose over $92 per barrel for the first time, I guess it’s understandable that everywhere I turned this morning there was a story on oil that caught my eye. In the first (hat tip: Memeorandum) a group of oil experts agree with me that an attack by the U. S. on Iran is unlikely:

A U.S. military strike against Iran would have dire consequences in petroleum markets, say a variety of oil industry experts, many of whom think the prospect of pandemonium in those markets makes U.S. military action unlikely despite escalating economic sanctions imposed by the Bush administration.

The small amount of excess oil production capacity worldwide would provide an insufficient cushion if armed conflict disrupted supplies, oil experts say, and petroleum prices would skyrocket. Moreover, a wounded or angry Iran could easily retaliate against oil facilities from southern Iraq to the Strait of Hormuz.

The second article that caught my eye was this one from the Financial Times on the link between oil and the dollar:

After a generation on the sidelines, the US dollar has re-emerged as a central issue in the pricing of oil. Since the credit crunch in August, when the dollar has gone down, oil has gone up, by an average ratio of more than five to one. Since August 21, the greenback has declined 4 per cent versus the euro; West Texas Intermediate crude, the global oil benchmark, meanwhile, is up 25 per cent.

Why are commodities traders fixated on the dollar? Like other oil market puzzles, the answer may lie in Saudi Arabia.

With a booming economy and inflation ticking higher, some speculators worry that Riyadh will de-peg its currency from the dollar. And they see such a step as having the effect of re-pricing oil in euros and yen.

That is because if Saudi Arabia de-pegs and does nothing else, it will be sitting on two rapidly depreciating assets: $20,000bn in oil reserves and $800bn in US dollar reserves.

But if it were to diversify its currency reserves or oil pricing regime, then it is almost certain that the dollar would weaken. As a result, oil prices in dollar terms would have to jump to keep oil demand growth from Asia in check. For speculators with this mindset, oil at almost any price looks cheap, especially when the market is pricing in another dollar-weakening Fed cut this month. Speculators do have it right that the US and Saudi business cycles are increasingly out of sync, and that it will become more difficult for Riyadh to maintain its currency peg to the dollar without exacerbating inflation. Inflation has crept higher, from 2.3 per cent in 2006 to an annualised 3.8 per cent this July.

Hat tip: John Burgess

As I read that article it occurred to me that among the things the KSA and China had in common were an interest in oil and large holdings of dollars. James Hamilton in an excellent post (lots of interesting charts and graphs) on the reasons behind the rise in the price of oil rounds the circle:

Total global production may have stagnated, but demand has not. Demand for oil from China has continued on its exponential trend, growing more than 8% in 2006. Whereas Chinese consumption accounted for 3.4% of world demand in 1990, it now represents 8.6%. And if Chinese consumption has increased with global production constant, that means oil use by all the rest of us must decrease. For example, U.S. petroleum consumption fell 200,000 b/d during 2006. And what persuaded Americans to do that? Higher oil prices.

James’s main point is that prices are rising because supply is static while demand is rising. To that I’d add that with the dollar falling high demand allows the Saudis to raise prices so that their oil continues to maintain its value in real terms and that China is key in both the high demand for oil and the falling dollar.

Does that sound to you like a positive feedback loop? It certainly does to me. Let’s remember that the consequence of an out-of-control condition of positive feedback is a collapse of the system.

6 comments… add one
  • Larry Corbett Link

    Is it at all possible, that the “threat” of expanding the war, a political move by the GOP to create fear in the hearts of Americans that having a woman leader, president, would be a big mistake?

  • Jules Link

    Unfortunately, I don’t quite share your optimism that sanity will win out with Dubya & Cheney calling the shots in the White House. With all their rhetoric about not leaving office with Iran on the brink of a nuclear weapon – I don’t think these guys can countenance being seen as sissy-men by not doing anything can they?

    Surely not.

    I predict that President Bush’s State of the Union speech in late January next year, 2008, will be the rocket the oil price, and the world’s economies don’t need. Get set for some serious ratcheting up of pressure on Iran between now and then – with oil perhaps spiking over the next 3 months to $130/$130 a barrel – and then just watch as Dubya delivers some ultimatums to Iran in his speech – with all the Republicans, and maybe Democrats too, clapping away, and just watch the oil price go a little crazy after that – amongst other things, like a dropping dollar.

    Believe me, China & Russia won’t take an American attack on Iran lying down – watch for Russia to apply energy pressure on Europe to effectively isolate the USA – and watch for China to start dumping dollars to undermine the US economy.

    2008 looks set to be the year of living dangerously for the world’s economies.

  • I’m rarely accused of being an optimist, Jules. I guess I see it less as optimism than as a) listening to all of the rhetoric and b) that we can’t achieve our objectives by attacking Iran.

    There’s been at least as much rhetoric about relying on diplomacy and economic sanctions as there has been saber-rattling coming from the Bush Administration. I’m not defending the Administration (far from it). Just being evenhanded.

    And, as I’ve posted ad nauseam here over the last three or four years, attacking Iran is extremely unlikely to achieve the results we might want and is almost certain to have consequences we don’t want.

    So I don’t think we’re going to attack Iran. I doubt that Iran will attack us, either, but it’s possible that some eager beaver there could provoke something that nobody wants to see. Anything could happen.

  • Well, other than being generally pleased that I am involved in some early venture endeavours in ‘alternative energy’ it does seem to me that China and KSA will not take any of the over-the-top actions envisioned.

    However, Chinese pressuring and noise may have an influence to the extent the American Administration understands the meaning of China’s reserves.

    However, their moves on Iran tend to indicate not – as in the financial sanctions, which may end up cutting Western banks out of Iranian financing action, but will have no influence on state investment funds….

    It appears Americans don’t quite understand the queer damage Mr Bush has done to the US finances and by extension, its powerbase.

  • BTW yes, mate, it does sound like a potentially nasty feedback loop. I do rather hope the next US administration has some fiscal conservatism or the dollar might look rather like Sterling in the post-war period.

    Actually, come to think of it…

  • Lounsbury:

    We’re having a hard time keeping track of all the “queer damage” Mr. Bush has done. It’s a full time job.

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