Russia and China: a Power House or Broken Home?

Russia and China seem pretty chummy of late. Both countries essentially head the Shanghai Cooperation Organization – an organization which frightens the West because it promotes cultural, security, and economic cooperation among China, Russia, and Central Asia. In the cultural arena, China has dubbed 2009 the year of the Russian language, and Russia will make 2010 the year of the Chinese language. To promote security, the two countries established a hotline between their heads of state.

Most recently, the countries displayed extraordinary economic cooperation. Russia secured $25bn in loans from China in return for supplying oil for the next 20 years. This deal is the largest trade financing agreement between the two countries to date: Russia desperately needs money and China desperately needs oil. Everyone’s happy, right?

Not exactly. Days after the historic agreement, a Russian warship opened fire on a Chinese cargo ship and sunk it. The two countries' foreign ministries blame each other. But Clifford Levy of the New York Times actually blames deteriorating bilateral relations. Why?

While both countries enjoy honoring agreements that are mutually beneficial (economic cooperation) or mutually benign (language exchange), Russia and China have a tendency to disregard cooperation when it affects domestic politics. Levy likens the sinking of the Chinese cargo ship to last year’s Russian-Georgian conflict. China didn’t support Russia because Russia recognized the autonomy of South Ossetia, and China didn’t want to encourage Tibet’s or Xinjiang’s calls for autonomy.

What's clear is that Russian-Chinese relations are only as simple as each country’s domestic politics, which is to say they're not all that simple. Notably, Russia and China don’t have an alliance or even an established method to resolve disputes and disagreements. They just have a mechanism for cooperation, which can be honored or ignored at either country’s whim. Hopefully, ignoring the cooperation won't lead to any more drowned sailors.

Double, double oil and trouble

Little publicized fact: the $787 billion stimulus bill that Obama signed last week contains $16.6 billion for the Energy Efficiency and Renewable Energy (EERE) Office of the Dept of Energy. This increases the EERE’s budget tenfold, and it’s yet another signal that Obama is serious about alternative energy. That’s good.

Also this week, crude oil dipped below $40 for the first time in 2009, which has caused a stall in new energy projects. That’s bad. Oil prices are low because the economy is in terrible shape, which stifles demand. But the longer prices stay low, the harder it will be to commercialize advanced biofuels, which by one estimate will need an oil price of $80-$120 in order to be competitive in a reasonable timeframe.

This is a paradox worth watching as it plays out over the next 25 years. Ideally, you want clean and cheap energy. But that's still a ways off, and for now it seems like you can mainly have one or the other. Which is more important? How do you balance the two demands?

(photo from ifijay's photostream)

I Drink Your Milkshake!

Venezuela, an archetypal petro-state, was bound to suffer when the price of oil collapsed late last year, but the situation has worsened rapidly, I think even faster than most expected. The government looks to be scaling back its ideologically-motivated ambitions to divert exports from the US to China. They can't find state-owned oil companies willing or able to carry out new developments, so are turning to the same private foreign firms they spurned in recent nationalizations. PDVSA, the massive national oil company, and big private service companies, are rumored to be cutting thousands of jobs to save money and deal with OPEC output reductions. Production is slowing as the government is falling behind in its billion dollar plus debts to oil service firms.

These signals are especially surprising given that oil prices are still relatively high, between $35-$40 a barrel for Venezuela's unusually heavy crude, compared to about $7 when President Hugo Chávez came to power in 1998. And the country should have a bigger cushion after a year of $100+ prices. Also, the government may be holding more bad economic and employment news until after Chávez's February 15 referendum on eliminating presidential and other term limits.

So what does it all mean? Chávez's second decade in power (which begins today after a hastily-called national holiday) may be much rougher than his first. He no longer has his handy foil, and efforts to stir things up with Obama don't seem to be catching on, for now. Without the slush fund from off-budget oil profits, Chávez is hard-pressed to fulfill his generous foreign aid commitments, and he may start to get the cold shoulder from fair-weather international friends. At home, Chávez is prioritizing social programs over oil production or investment, but he can't continue that downward spiral for too long and any reduction in benefits will erode his somewhat fickle power base. It's no surprise Venezuela relies on oil, but under Chávez the dependence has reached the point that it accounts for over 90 percent of export revenue and a huge chunk of the budget. Now it appears that well is running dry.

(photo from rhaaga's photostream)

The Great Resource Guessing Game

Petroleum Intelligence Weekly has published its influential annual ranking of the world's top oil companies. The most notable and widely reported aspect of the report is the global power shift from the traditional private oil majors to national oil companies. 27 of the top 50 oil companies are now majority state-owned. China's CNPC leads the surge, having surpassed both BP and Shell according to the report's metrics. Exxon Mobile is the only majority privately owned company remaining in the top 5.

The impact of a global oil market dominated by state-owned firms on both international growth and security is immense. The recent Global Trends 2025 report published by the US National Intelligence Council, and Patrick's farming piece below, highlight the high probability of future inter-state conflicts over increasingly scarce resources like oil. Energy security has risen to the top of both national and international agendas, and the threat of countries using the "energy weapon" for geopolitical leverage has lead many Western states to move in the direction of resource nationalism.

Beyond military and economic conflict, market uncertainty is the biggest effect of greater state control of natural resources. Reserve and refining capacity statistics are classified as state secrets in many countries with nationalized energy sectors. As Western majors are kicked out, and given the press restrictions in countries such as Russia and Iran, it will be increasingly difficult to obtain an accurate measurement of global supply and capacity (you can find my take on Russia's energy industry here). The hysteria surrounding "peak oil" (due in part to the realization of "known unknowns") last year probably contributed to the record run up in oil prices. The inability of traders to estimate and match long term supply and demand will drive up the speculative risk premium in oil prices, particularly if over-the-counter markets remain unregulated (an issue that has dropped off the political radar since the commodity bubble burst). This will only exacerbate inflationary pressures, political instability, and resource competition similar to what we witnessed over the past few years.

Information, transparency, property rights, and security are all central elements of an efficiently functioning oil market. Greater resource nationalization compromises all of these, and increases the probability of resource-driven political and economic conflict. As long as the trends outlined by Petroleum Intelligence Weekly continue, energy security will remain one of the defining issues of the 21st century.

(Photo: ifijay)

Why you should never forecast prices

We live in strange, rapidly changing times. Just trying to keep up with the latest news on the financial crisis is practically a full time job. Last week? Might as well be talking about last year. 3 months ago? It’s like the swinging 60s are back again!

In this spirit, I want to publicly admit that I was wrong. I’ve spent a lot of time writing about oil prices on this blog, and it’s plain to see that the prediction I made about a $100 price floor for oil was... quite misguided. I still think I have the supply and demand fundamentals right, but I realize now how remarkably little I understand about pricing in oil markets. A $100 floor, which seemed reasonable in July, now looks rather absurd.

I still intend to theorize on the fundamentals and whether they will shift prices, but I'm going to shy away from price predictions.

On Mandelson, money, and oil

I apologize for the light blogging as of late. I’m starting a new job next week and moving very soon thereafter, so I’m trying to get about a million things done before then.

Three thoughts. First, you’ve no doubt seen that Gordon Brown, in an attempt to shore up his eroding political position, has asked Peter Mandelson (his once arch-enemy) to join his cabinet. Mr. Mandelson was formerly the EU Commissioner for Trade (rough equivalent to the United States Trade Representative.) His departure is a serious blow to multilateral trade negotiations, and it makes it that much less likely that we’ll see a Doha deal in 2009. In my opinion, he understood how far he could successfully push the EU position to the inch, and he had no problems standing up to some of the more recalcitrant members. His departure also seriously diminishes the institutional memory of the major negotiators, which means quite a bit in trade talks.

Second, after tonight’s debate, we can probably start talking about the McCain campaign in the past tense. He looked worse than usual tonight: old, irritated and tired. Mr. Obama didn’t have a great night either, but you don’t need to shake things up when you’re in a commanding lead. Tonight was one of Mr. McCain’s last chances to do something, anything, to reverse that. Aside from proposing that the Treasury buy everyone’s mortgage (I’m pretty sure that was new) and simultaneously proposing a government-wide spending freeze, he didn’t do much. I think he’s toast, and I will argue, as I have done repeatedly in the past, that contracts for Mr. Obama winning the presidency are still undervalued on Intrade. Fivethirtyeight’s electoral projections give Mr. Obama a nearly 90% chance of victory, which strikes me as closer to the reality. His Intrade contract is trading for $7.20ish. Do the math. If you buy right now, and he wins on Nov 4th, you’re making a 39% return in less than a month. Did I mention that Intrade trades contracts worth Real Money?!? Now who said there weren’t good investment opportunities in today’s markets? It just depends on which markets you look in.

Finally, great post by my illustrious coauthor yesterday about the “black lining” (catchy!) of the current economic turmoil: oil prices closed below $90/barrel, although I think they went back above that mark today. Either way, they’re down nearly $60/barrel since July. The point is, commodities correlate well with economic growth: you need more oil, copper, and aluminum to make stuff when the economy is good and demand for ‘stuff’ is strong, so the prices of inputs (commodities) rise as well. Problem is, now that everyone thinks the economy is going to hell in a handbasket, commodities prices are tanking. Great if you want to buy into the market, not so great if you like strong economic growth. So while Nick is right that less oil revenue frustrates the plans of nasty petro-crats, I’d qualify this slightly by saying oil prices are low for the wrong reasons. We want prices to be low because a diversified energy portfolio means we’re demanding less oil, not because we simply can’t afford it. The foreign policy implications may actually be more, not less, dire than we imagined.

A black lining

Well the world is falling apart but there's a little bit of good news...Oil futures closed today below $90.

But as Brad Setser points out, the Gulf monarchies will feel a pinch in the coming year and that may spell even more bad news for the US economy. Sovereign wealth funds have certainly taken a hit in the recent downturn and exporters the world over are feeling the pinch from these losses; coupled with the downturn in prices, they probably won't be inclined to keep pumping money into Wall Street institutions.

The lower costs of consumption will most certainly be happily accepted by Americans given the coming winter. But the secondary implications for international oil exporters may also shape the next administration's initial foreign policy. Venezuela recently had to cut spending for the next year; Iran will probably be next. Domestic regimes who can no longer lavishly spend on their constituents will probably not be accepted as readily. Rogue leaders - weather in Iran, Venezuela, or Russia - may have trouble holding onto power when they can't continue propping up ill-designed economic systems with booming oil revenues. This is great news for the next administration - whoever is in charge.

An oily predicament

This sentence caught my eye in the dead-tree version of the Washington Post this morning:

"An oil drop of $30 a barrel is significantly more damaging to Iran's economy than UN Security Council sanctions," said Karim Sadjadpour, an associate at the Carnegie Endowment for International Peace. "That's a loss of about $75 million per day in oil revenue. A further drop in prices could play a decisive role in the June 2009 presidential elections, for it could deflate [President Mahmoud] Ahmadinejad's populist agenda."

Common sense, perhaps, but still quite powerful.

Lower oil prices make me nervous

I try to avoid making hard predictions on this blog, but regular readers know that I’ve recently made two high profile picks. I’ve argued more than once that political-economic fundamentals suggest that Barack Obama will win the Presidential Election in November handily. Admittedly, that’s looking a bit dicey at the moment, but I’ll still be astonished if Mr. Obama somehow manages to snatch defeat from the jaws of victory in the most favorable electoral climate in almost three decades. I will also petition that the Democratic Party disband and its leaders seek gainful employment in a completely different line of work. Further, I’ve argued that the new baseline for oil prices will be $100/barrel. In recent days, however, oil has crossed the Rubicon and is currently trading around $96. Does that mean I’m wrong?

It’s too early to say definitively, though I don’t think so. But there’s a larger problem: it could very well be a bad thing if oil prices continue to slip.

It is a fact that the global economy runs on oil. It is also true that right now there exists no substitute that could completely replace oil. Therefore, if the global economy continues to grow, which most people agree is a good thing, it also means that oil consumption will continue to grow, which most people agree is a bad thing. But without a substitute, the world will need more oil. 37.5 million extra barrels a day, to be exact, according to the International Energy Agency. That’s on top of about 85 million barrels consumed each day currently.

Without a substitute or sustained economic recession, that oil needs to come from somewhere. The problem, as I’ve mentioned, is that most of the ‘easy’ oil is already being pumped. In a fascinating article today, RI notes that most of the oil majors are pricing new investment projects at a cost of about $70/barrel, which they would like to sell at market for $100/barrel. Simply put, if the price of oil continues to fall, it is likely that they will delay these new investment projects, which could lead to a major supply gap in the future. Rather than a gradual rise in oil prices, we might see a disruptive spike.

Conversely, it is clear that in the face of accelerating climate change and higher energy prices, the world needs to develop renewable energy sources. Say what you will about Tom Friedman, he’s an ideas man and his new book looks like it highlights what will be one of the major political economy challenges of the coming era (n.b. I haven’t yet read it). However, as I’ve also mentioned, declining oil prices likely reduce the impetus for investment in alternative energies.

Understandably, oil companies want to keep selling oil for as long as possible. It’s what they know, it’s what they’re good at, and it’s extremely profitable. In Congressional testimony last week, the President of M.I.T. noted that oil companies invest less than 0.25% of their revenue in R&D, compared with 18% for pharmaceutical companies and 16% for semiconductor firms.

But this is ultimately unsustainable. Anyone interested in developing an energy substitute in a timely fashion must first acknowledge that the era of cheap oil is over. In my opinion, any prolonged forays below $100/barrel are just delaying the inevitable hangover, and very likely making it worse.

(Incredible picture by nzdave)

Slumping oil

It looks like Hurricane Gustav wasn’t the “storm of the century” (I think that one’s pretty much locked up), nor has it caused “rain of biblical proportions”. This is not to downplay the storm’s impact: it has done some significant damage, but relative to what was expected, I am relieved for the residents of the Gulf Region. From a commodities perspective, the hurricane has come and gone without doing much damage to Gulf energy production infrastructure. The result? Oil prices have tumbled about $10.

Last month, I wrote about why I thought oil prices would stay above $100 from here on out. However, some of what I’ve read in the past couple days suggests that Gustav could be a turning point for oil markets. Now that the largest natural disaster threat to prices has passed without causing much damage, the thinking goes, the price will continue to fall. I’ll note two things: the long term supply/demand fundamentals I talked about last month have not suddenly changed, and they still suggest a bullish price outlook on oil. Second, if oil continues to fall at this point, it suggests to me that the market thinks it’s still overpriced. I’m not sure that’s the case.

At this point, I stand by my assertion last month that absent a major change in supply/demand fundamentals, oil at less than $100/barrel is unlikely for any extended period of time. You’ll recall that I also wrote about the volatility of modern oil markets: perhaps we’ll see a dip, followed by the price rising back up.

Let’s all keep watching: like most everybody, I’m an oil consumer and not a producer or trader, so I’d be quite happy if my predictions prove to be wrong.

The death of the death of distance

Recently, there's been some chatter in the news and blogosphere about the how the high price of oil is putting some serious dents in the 'death of distance' theory, a subset Tom Friedman's ubiquitous 'flat worldism' (or is it flatism? I can never remember: I gave up trying to finish the World is Flat on my third try.) The gist of it is: high shipping costs mitigate the advantages you would get from delocalizing production, and if oil prices don't fall, we will see a reversal of a key component of globalization in the future.

Anyways, this is rather old hat - I remember reading a lot of doomsaying about transportation costs earlier this summer when it looked like oil was on a runaway train to $200. But the issue clearly still has traction, as oil prices are unlikely to drop signficantly anytime soon. Research shows that shipping costs clearly play a big role in determining trade volumes. For starters, we have the standard gravity model, which predicts trade volumes based on two variables: GDP size of the two trading nations and the distance between them. Perhaps unsurprisingly, as distance increases, trade declines. And for anyone who truly wants to get into the nitty gritty, I direct you to this NBER paper, which uses the gravity model to show how rising shipping costs helped destroy the last great era of globalization (give or take 1870-1914.)

My first thought is that the price of oil will have to get substantially higher to really reverse global integration. You don't create delocalized production chains overnight - they're the result of significant research and preparation, and they usually take the form of foreign direct investment. FDI, which often represents tangible physical investment, is by nature fairly illiquid. Also, shipping is still a fairly low portion of overall production costs, and certainly much less than labor costs. It would take very high shipping costs for the (cost of shipping + cost of labor in developing country) to exceed (cost of labor in rich country).

Still, there have been complaints that price-sensitive industries are under pressure. Chinese textiles and basic manufactures reportedly produced the slimmest of profit margins. This is a concern, but only if it's an industry-wide problem. In this case, the price of these goods will go up; if not, it will weed out inefficient producers very, very fast.

In my opinion, these concerns are most important in the 10-15 year outlook. If oil prices continue to trend upwards as they have for the past decade, what effect will that have on delocalized production? It's really difficult to make any sort of accurate forecast that far into the future, but one thing seems clear to me. If shipping costs become prohibitive, the biggest losers wouldn't be first-world consumers, it'd be third-world countries that rely on their comparative advantage in labor for economic development.

Don't let this keep you up at night (unless you happen to manage supply chain logistics for a living), but it's certainly something to keep an eye on. Both from a development standpoint and a business standpoint.

Lower oil prices ain't gonna happen... and that's not all bad

The price of oil soared this spring and earlier this summer. Remember that? Investors, journalists, and politicians were all sounding the doomsday whistle, and not a day went by without hearing some previous unthinkable news: Goldman Sachs says $200 oil is possible. For the first time ever, investors bet that oil would reach $300 by December. On July 11th, the price reached the dizzying heights of $147.25 per barrel. Then it suddenly lost steam and began to fall faster than it had risen. The price has settled for the time being in the $110-$120 range.

People who tend to believe that the spike in oil prices was the fault of speculative traders could be forgiven for thinking that the markets will continue to correct themselves and that prices will settle at even lower equilibrium, perhaps under $100. Unfortunately for consumers, this just isn't going to happen. You've heard it before, but it's true: the era of cheap oil is over. Markets, and especially long-term market pricing, are driven by supply/demand fundamentals, which don't look good for oil (unless you happen to work for Exxon, and if so can you please get me a job???) Supply capacity is strained, and demand is surging thanks to economic development in the non-Western world. We all know this part of the story.

Perhaps less obvious, bringing significant new amounts of oil to market is challenging. You can't think of oil reserves as an absolute number: you have to consider which sources of oil are 'economically recoverable'. This basically means whether or not the profit you make selling the oil is higher than your operating costs of pumping it. The really easy sources of oil to pump (say, the desert sands of Saudi Arabia) are going at near full capacity. The moderately-difficult sources of oil to get are also mostly tapped, and you increasingly have a scenario where you're looking at pumping oil in very inhosipitable places. Think oil sands in Alberta and deep offshore drilling. This kind of production ain't cheap, and the higher costs are built into the price consumers pay. According to CNN (although I can't independently verify this), the head of exploration for Conoco Phillips says that they need a long-term base price of about $100/barrel to make future investments profitable. Because of these higher production costs and the supply/demand fundamentals, I'm quite skeptical that we'll ever see oil again at less than $100/barrel for any extended period of time.

It's also important to remember that oil markets are probably more volatile than they've ever been, so large price swings in a very wide band are likely to be the norm. And for what it's worth, a number of analysts I trust think oil prices are currently sitting near the low end of that band. Don't be surprised if the markets resemble a roller coaster for the foreseeable future.

But there is an upside to high oil prices. It is the only way that large industrialized countries will ever seriously invest in alternative fuel technologies and actually sustain that investment. Necessity in the mother of all invention. Plus, oil prices closely track expectations about the economy: the main reason they collapsed in the last month was that markets perceived that the prices would be too high for struggling economies such as the US to afford. If prices continue to retreat right now, a large reason for that is weakened demand, which suggest the economy is struggling even more. At best, lower oil prices would be bittersweet.

Oil is fungible

FP Passport is drawing the wrong conclusions about the graphic accompanying today's story in the Washington Post about global oil production. (see right; source: Washington Post) FP writes: 

First, despite repeated calls to wean America off Middle Eastern oil, the United States actually imports most of its foreign oil from our friendly neighbors to thenorth and south. Also, while we hear countless warnings of China's impending rise and the impact growing Chinese demand will have on oil markets, the U.S. still imported nearly four times more oil than China in 2007.

There are a couple problems with this analysis. First, it doesn't matter who the United States buys oil from, because oil is a fungible commodity, which essentially means that all units of oil are substitutable no matter where they come from. Once refined, oil from Canada is the same as oil from Saudi Arabia. Thus, even if we buy our oil from Canada, another country that wants oil will have to get theirs from Saudi Arabia. Put another way, if Canada decided to stop selling us oil, it wouldn't harm the US as long as they sold it to someone else (let's say Australia.) This would mean that the overall global supply of oil remains constant, and the US could then just buy oil from another producer instead, perhaps whoever was selling to Australia before they started buying from Canada. Back in February, Hugo Chavez made this same mistake about his ability to play hardball when he threatened to stop selling Venezuela's oil to the US.

What does matter is how much oil is actually for sale globally (supply) and what proportion of this the US actually buys (consumption). Our consumption drives up the overall demand for oil, which includes demand for oil from the Middle East.

Second, of course the United States imported four times as much oil as China in 2007. We are the richest, most industrialized country in the world, and they are not. But they're growing rapidly, and the point is that as China industrializes, it increases the total global demand for oil, which creates upward price pressure. It also raises the future price of oil, as traders bet that China's oil consumption needs will grow as it further industrializes (that's a pretty solid bet.) In short: American oil needs + China's oil needs + future perceptions about these two countries' oil needs = higher oil prices.

Economics and cable news just don't mix

I've been watching more cable news than is probably healthy since I moved back to the US. What can I say: every day is a new struggle to put off writing my dissertation. Anyways, one thing that I've noticed in particular is that the cable news format is atrocious for discussing economic news. As is such, I feel compelled to comment on two issues that I saw today:

1. The price of oil: CNN's economic "experts' have been cheering as the price of oil continues to tumble. Light Sweet Crude for September delivery is trading around $124.70 on the NYMEX. Today, they even had a poll asking whether viewers would go back to their old driving habits now that the price of gas is falling again. Easy there, CNN: oil's price fundamentals are still pointing up and any reversals may well be temporary. These days, there is high volatility within oil markets and price swings within wide margins are likely to become the norm. Oil prices may be down temporarily, but there is no evidence at this point that they'll stay down. Don't buy that new Hummer just yet.

2. The budget deficit: All the major cable networks are giving a lot of play to the new US deficit figures, the largest ever at $482 billion. Democrats are screaming bloody murder at GWB. Republicans are blaming Democrats. I don't like to take sides on things like this, but this is an election year and the Dems are really overreacting. Don't get me wrong: deficits do matter, in the sense that they signify that the government is spending more money than it is taking in. But the size of the deficit as a percentage of GDP is more important than the overall figure. Right now, the deficit is at 3.3% of GDP, compared with highs of 6% in the early 1980s. By comparison, I borrowed roughly 100% of my "personal GDP" last year to finance graduate school. Granted, this was an investment in future earnings, but many people wouldn't bat an eye at credit card bills that were higher than 3% of their yearly salary.

However, the government's budget deficit in any given year is far less important than the overall national debt, which is the total amount that the government owes from all of the times it has borrowed money to finance expenses. Again, it's important to consider this figure in relation to the GDP and GDP growth. This metric suggests that the debt isn't historically bad or unsustainable at its current level (see graph above. Source: Wikipedia.)

Enjoy cable news, but please enjoy responsibly.

Trashing gas

I'm done with expensive gasoline, thank you very little. I've sold my car and am now the proud owner of a Genuine scooter. Bad boy gets 80 miles to the gallon: traded the van for it straight up. But I'm still concerned about gas prices: more so given what they reflect about the American economy, climate change, and the status of oil. The New York Times gave me a little hope today by outlining how garbage and waste may be the wave of the future. But please, we've all heard this before...



But seriously. This technology has been around for a while (I'm dubious of the claim that it has existed for decades) but still remains far away from perfection and economic feasibility on a scale of mass production. All the more reason to continue extending subsidies to more and more types of clean technology and renewable energy. Solving this new type of energy crisis requires far more than one "savior" technology (read: ethanol) and it is wise for the government to cover all their bases. The private sector needs to jump in as well and is doing so at a breakneck pace. Perhaps this is one side of the bubble needed to cure Wall Street's hangover.

There's gold in them thar... oil fields?

Barrick Gold (ABX), which I believe is the world's largest gold mining company by volume, announced yesterday a hostile bid for Alberta-based Cadence Energy (CDS. TO). The cash bid amounts to C$354 million, which is a 10 percent premium on Cadence's market value.

With the price of gold near record highs, why does Barrick want to buy a junior oil company? Unfortunately gold isn't the only thing that's expensive these days - oil prices have spiked nearly 50% this year, and 25% of Barrick's production costs are fuel-related. Cadence produces more than 3,500 bpd, which would help Barrick lock in fuel costs and hedge against further increases. 

Still, this is an interesting example of how the effects of expensive oil are reverberating through even very profitable sectors of the global economy.

 

Moratorium opprobrium

President Bush announced today in a Rose Garden press conference that he was revoking the presidential moratorium on offshore drilling.

The moratorium, originally enacted by his father, is not the only ban on offshore drilling. A congressional ban is also in place. Lifting the ban is largely a political move to place pressure on Democrats and presumably an intended boon to Sen. McCain, a new proponent of offshore drilling.

So what will the removal do? In short, nothing. Democrats won't lift the ban, despite record gas prices. And even if a bipartisan coalition did manage to allow new drilling, the oil would not hit the market for at least 5 years - little consolation to the present crisis.

Increases in oil production (whether from tar sands in Canada, protected land in ANWR, or increased Saudi output) will do nothing, regardless of how big the finds are, until new refineries are built. Oil producing states such as Nigeria, Iran, and soon Iraq are forced to export their crude to refineries to make gasoline. The world's top five refineries are in Venezuela, South Korea, Singapore, and India.

The removal of the ban, like McCain's plan to subsidize nuclear energy, is fiscally irresponsible and short-sighted. Increased drilling does nothing without more refineries but the plants take too long, are too expensive, and face far too much public opposition to relieve any current pressures on oil production and prices. Do we really want or need energy policy that will tie us to oil for another 15 years?

Hot commodities

Resource Investor has a great piece comparing returns on commodities from 1999 - 2007. While none of this is really new, it's still quite impressive to see the numbers behind the hype. Some choice selections:

• The price of crude oil increased by nearly 700% (1999-2007), or roughly 26% per year. Oil is up 46% this year so far.
• Wheat was the best-performing commodity in 2007 (77% gain). This will come as little surprise to anyone who's followed the global food crisis with even a passing interest. For anyone concerned about food supplies, you will be happy to know that wheat stocks are expected to rise dramatically this year due to more acreage planted and better weather.
• In comparison, the NASDAQ increased by 21% (1999-2007), with an annualized return of 2.1%. Small wonder there's so much money in commodities markets these days.

Trains, planes, and homes?

Every morning it seems oil hits a new record high. The economic and political results are reverberating throughout the world: corporations are restructuring their supply chains, car sales are shifting, subsidies are being slashed and politicians are posturing about "gas tax" holidays and suing OPEC governments. The stakes of this oil spike are as high as prices.

Much verbiage has been spewed about our addiction to oil and its coming end. Americans don't seem to realize that while this will most certainly be painful, proper policy may ensure the economy can gain some benefits from the necessary and unavoidable restructuring. The obvious changes will be in the energy industry, manufacturing and shipping. But the words oil, housing, and unemployment are rarely mentioned together.

Whether or not this is "peak oil", the American government must act swiftly and drastically to buoy the economy. As the housing market slumps with no indication of quick resurgence, unemployment is also on the rise. Proper policy would encourage restructuring that promotes long term growth while limiting short term losses. There is no doubt moving our country away from oil dependence will be expensive and painful. But there is no reason the end result has to leave us worse off. So what to do?

Tax, tax, tax. The sooner gasoline reflects the true price of oil (or ideally, more) we will begin to see the housing and labor markets, which are imperative to proper reconstruction, bottom out as workers move from "exurbs" and more homes are foreclosed. The spike will be a painful, short term symptom with a more efficient and fluid housing and labor market as the end result.

The process will most certainly hurt but knowing the true extent of the housing crisis quicker will help the financial industry glean their sheets honestly and encourage labor mobility - benchmarks for a "new economy".