AVA : Investment Analytics

Oil Games

Each day we continue to feel the damaging effects of high oil prices. And while oil has recently corrected down by close to 30% from record highs, it is still very high and is likely to make new records within the next 2 years. Yet, Washington refuses to respond appropriately, and has even denied that inflation has become a problem. As I have discussed in previous articles, Washington has many ways to hide inflation, GDP and employment data. But consumers are starting to realize something is fishy.

Apparently, the presidential candidates still think voters are brainless, as they continue their charade of deceit and distractions by proposing useless solutions like gas tax holidays, off-shore drilling, and windfall profits taxes for oil companies – none of which will solve America’s dependence on fossil fuels. In the future, I will address the pitfalls of Mr. Pickens’ proposed wind energy solution. Maybe voters are brainless because the seem to swallow everything they are fed by Washington and the media machine.

Fortunately, oil prices are correcting. But remember the effects of high oil prices are delayed in the economy by up to one year. In addition, the longer-term effects may be delayed by up to two years since inflation is a lagging indicator. Finally, if you think oil prices are going down for good you will be sadly disappointed. In fact, the current correction will soon represent a tremendous buying opportunity for those who understand that oil prices will go much higher than the previous record $150 mark.

Peak Oil

Those of you who do not believe Peak Oil Theory should first make sure you fully understand it. According to this theory, after a reservoir has been depleted by half of its total volume, the output begins to plateau or remain constant for some unknown period. At some later time (which is unpredictable) the output begins a permanent decline of variable duration (which is also unpredictable) until the remaining quantity of oil is no longer economically feasible to extract with current technology.

Therefore, Peak Oil Theory does not state that the earth is running out of oil per say. It states that the earth is running out of inexpensive oil, otherwise known as conventional oil – the high-grade oil that comes out by drilling on land and requires minimal refinement costs.

What this means is that we could have enough total oil (conventional plus non-conventional) say for the next 100 years, but that does not matter. What really matters is how much conventional oil reservoirs remain because this is the lowest cost oil to produce. In other words, Peak Oil is concerned with how much crude we can produce and refine per given day per dollar.

The United States reached its peak oil period in the early 1970s. Ever since that time, we have relied more and more on foreign oil imports. Interestingly, since that time we have also relied more and more on imported goods, while both consumer and federal debt have ballooned. According to many independent (and unbiased) oil experts, the world will soon have reached this peak oil period, causing even more dependence on exploration for non-convention oil.

Over the past two decades, new conventional oil finds around the world have been far and few. And what was once thought as large finds have turned out to yield much less than first thought. Throughout this period oil demand has continued to increase. It has especially strengthened over the past few years due to the rapid expansion of Asia.

As demand has increased and new finds have diminished, OPEC has fudged oil reserves data for many years, causing concerns about Peak Oil to remain hidden up until recently. As a result, oil prices have soared. And this has made exploration for non-conventional oil not only more feasible, but mandatory.

Consequently, over the past few years, we have become increasingly reliant on more non-conventional oil sources, such as tar, oil sands and deep water drilling. These are considered non-conventional sources because they require large expenditures of money to produce finished petroleum products.

Two variables – increased demand and decreased supplies of conventional oil have been the main forces responsible for record oil prices. Over the past year, oil has also risen due to the inflationary effects from the Federal Reserve, which has weakened the dollar. The dollar-oil link explains many things which you were probably unaware of.

Oil industry giants such as Exxon continue to insist that we have plenty of oil for decades, but then add that more investments are needed for offshore exploration. What they are really saying is that higher oil prices are due to Peak Oil – the decline in conventional oil reservoirs, which is forcing companies to focus on non-conventional oil.

They use word games to hide the truth because they realize any possibility of Peak Oil will cause a push for alternative energy, which would threaten their monopoly. OPEC plays the same game. Washington goes along with these fantasies as well for a much bigger reason – the preserve the dollar-oil link.

But alas, Washington has opened the door for the illusion to continue with the recent SEC rule change which now allows oil companies to book reserves from non-unconventional oil and gas and some deep-water projects, as proven reserves. In addition, the new rule now allows companies to report data on “probable” and “possible” reserves.

But this does not end with U.S. companies. It extends even to the big boys in Europe like BP and Royal Dutch Shell. The importance behind this is that companies will now report larger reserves although these reserves have a much lower possibility of being found. Ultimately, it will lead to larger reserves and calm the globe regarding concerns of supply constraints. As well, it will allow analysts to place a much higher valuation on these companies. This sounds like SEC-endorsed accounting fraud to me.

But why would Washington want to inflate oil reserves? Could it be perhaps due to increasing public awareness of peak oil – something that might create further momentum to replace oil as the energy of choice. You see folks, as long as the world is dependent on oil, the dollar remains backed by crude since you can only buy it with the dollar (with one rare exception to be mentioned shortly).

This dollar-oil link helps keep the dollar as the universal currency. And because the entire world must use the dollar, you can imagine how that dilutes the inflationary effects seen in America due to the Fed’s printing presses. Thus, the dollar-oil link ensures the Fed’s inflation machine is spread throughout the globe. Without the dollar’s link to oil, the inflation seen in America would be much more severe.

This is the secret that virtually no one realizes. It is not a conspiracy theory. It is a fact. And the few in Washington who realize it are never going to admit it. But you should consider why Washington has claimed good relations with the Saudis for many years.

In the early ‘70s, President Nixon negotiated with the Saudi Royal family to demand dollar payments for oil shortly after severing the finally link to the gold standard. Soon after all of OPEC followed suit. In exchange for the dollar-oil link, the Saudi Royal family was promised protection by the U.S. military. This is why the Saudis are rarely criticized by Washington. They have earned a blanket exception for virtually anything they do, including involvement in terrorism and yes, even including holding down oil output. The Saudis have a huge clout in Washington because they have a huge control over America’s economic fate.

The Saudis know well that they have a good deal of control over the fate of the U.S. economy. Given the fact that Iran has now created an oil exchange (Iranian Oil Bourse, March 2006) that accepts only the Euro, you should understand why they want nuclear weapons – for protection against a U.S. attack.

As Iran realizes, severing the dollar-oil link is the easiest way to destroy the U.S. And any nation that tries to do this will be dealt with accordingly.

Saddam Hussein tried to sell oil accepting only the Euro in 2000 and we know what happened to him. As well, any committed push to transition the U.S. into alternative energy threatens to destroy the global enslavement by the dollar-oil link. This explains why Washington has drug its feet in alternative energy for many years.

Alternative energy will come. But it will come slowly and Washington will make sure of this. Hopefully by now you are beginning to understand why Washington has so much interest in the Middle East. It’s not so much about the oil reserves as it is their control over the dollar and thus the fate of the U.S. economy. Incidentally, I discuss this as one of many critical topics in my book “America’s Financial Apocalypse.”

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