Energy Independence: The Final Frontier

The commodities markets are in a record bull run, and oil prices are bungee cording higher as a result. Oil prices have risen 42% since January, and gas prices are veering toward $5, some say $7, a gallon, in some parts of the country. 

Energy independence is as vital as oxygen to the health of the US economy. Wind energy, solar energy, fuel efficient cars, (it took Congress 32 years to recently pass this bill), fuel cells, hydrogen power, all sorts of alternative energy must be at the forefront of government policy.

The US can do it, this country and other nations have the technological know-how. The US however has shown an astonishing lack of courage and leadership in this regard. China has a top-level, focused energy policy--the US does not.

Energy independence has been a problem that has been with the US for 40 years.

Who said the following?

"Our ability to meet our own energy needs is directly linked to our continued ability to act decisively and independently at home and abroad in the service of peace, not only for America, bur for all nations in the world."

Answer: Richard Nixon. Amidst Watergate and the Viet Nam War, Nixon said we need a top-level government focus on energy independence equivalent to the US's program to put a man on the moon.

Nixon also wanted more public funding to explore Alaskan oil and gas, offshore oil reserves, nuclear energy and synthetic fuels from coal and oil shale. The United States, Nixon said, should be independent of all oil producing countries, "including our Canadian friends," by 1976, saying that the United States must be independent in this area, and we can be." 

That shows how long this problem has been with us. But the US has dithered instead.

Supply and demand are the biggest problems behind high oil prices. As the oil pros have tried to drill through to those whose ears are consciously plugged against reality, supply and demand problems are the issue.  

Of course speculators too are a force here behind oil price spikes. And they must be stopped. But if you see precise dollar price-tags bruited about that purport to show exactly how much in dollars per barrel can be blamed on speculators, run.

Officials at the oil majors, at the New York Mercantile Exchange, at the Commodity Futures Trading Commission have all said that no one who has looked at the matter can offer with any degree of certainty any specific dollar amount for how much speculators are to blame.

However, there exists a way for Congress to stop speculators from whipsawing oil prices higher, now being debated in the corridors of the nation's capital.

But before we get to what to do about the speculators, we must first turn to Iran, the state of supply and demand, and the weak US dollar.

Oil is now careening around due to escalating tensions between Israel and Iran, notably due to Iran's missile firings, as some 40% of the world's oil supply passes through the Strait of Hormuz.

But as Dennis Gartman of the must-read The Gartman Letter, which tracks commodities trading, notes, the popularity of Iran's president, Mahmoud Ahmadinejad, is falling, Iran's more moderate forces are rising, with the rise of the newly elected speaker of the Iranian parliament Ali Larijani.

Gartman adds: "Iran knows it cannot withstand the full force of the US naval fleet in the region, and therefore will not take belligerent actions unless provoked. The military power that one aircraft carrier wing can effect is stunning, one carrier wing standing on its own is the equivalent of the world's third or fourth largest military advanced nation. Station two or three such in the gulf and the surrounding waters, the power is stunning. Iran's mullahs know that and they've no wish to provoke that power." 

Amir Taheri, an Iranian-born journalist and author based in Europe who has zeroed in on Middle East affairs and Islamist terrorism, notes that once Iran believes a military attack is imminent, Tehran could back down, "in accordance with three UN Security Council resolutions." Gartman adds though that "the wild card in the region is Israel," and its reaction to Ahmadinejad's intent to "drive Israel into the sea."

The last thing this country and the world needs is a fight with Iran. Pressure must be brought to bear to bring this dangerous saber rattling to a peaceful end.

Now, the dollar. OPEC's president, one of the more thoughtful in that body's history, Chakib Khelil, recently noted supply and demand issues are the major factors, and also added that "we have to follow the evolution of the dollar because a 1% fall in the dollar means four dollars more on the price of oil," as oil is traded in dollars.

Khelil is right, and as I've reported to you, David T. King, a former chief of the New York Federal Reserve's Industrial Economies Division, says that the recent oil spike coincides with the Federal Reserve's decision to open its  monetary spigots over the last five years, with the concurring collapse of the dollar exchange rate explaining at least half of the increase in the pump price of gas over that time.

King says that the day that the barrel price of oil in dollars was exactly the same as in Euros was in 2002, when both were about 25. Since then oil priced in Euros has risen by 50 Euros in the past five and a half years. It now stands at around 80 Euros, more than triple what it was then.

But check this out: in the US, the price of oil is hovering around $140, well more than five times what it was priced at in 2002, King says. Remember, in August 2007 oil was $70. The Fed gushed open the monetary taps to deal with the housing wreckage, and in turn the falling value of the dollar has caused the price of gasoline to soar. Just  the mere tough talk recently of a stronger dollar from the Treasury Secretary and Federal Reserve chairman Ben Bernanke helped ease oil prices.  

Also there is a shortage of sweet crude oil, cheaper to refine into gas, and a surfeit of sour grades, more expensive to refine and usually only good as heating oil.

That's why the oil futures markets, which trade light sweet oil, have been unimpressed by the floating storage of 30 mn barrels of Iranian heavy oil, as the Financial Times reports. While Saudi Arabia avows it will pump more oil, most of it is the sour stuff. And remember OPEC has manipulated oil prices in the past, as OPEC did back in 2000 when it adopted a policy of cutting production if oil prices dropped below $22 per barrel and raising production if it passed $28. 

Refiners are paying up to $5-$6 a barrel on top of current record prices to secure high-grade oil, traders said, double the level of a year ago, the FT says.

The mark-ups are four times higher than the 2000-2008 average. OPEC, for its part, says it plans to spend $160 bn over the next four years to increase production by 5 mn barrels a day. The world needs 11.3 mn barrels more a day by 2030, 22 years from now-50% more than the increased output over 26 years from 1980 to 2006.

What matters is Nigeria, which pumps the Bonny light crude that's easier to refine into gasoline, now down to just 1.5 mn barrels a day, its lowest in 20 years, due to rebel attacks.

With the world's oil supply cushion dwindling from 2.5 mn barrels a day to less than 1 mn after 2010, according to the think tank of the oil industry, the International Energy Agency in Paris, Nigeria's 2.9% share of the world's production of the 85 mn in annual crude matters greatly. Nigeria also produces 10% of the world's liquefied natural gas, crucial to Europe due to its erratic supply from Russia. Today the world consumes more than 86 mn barrels of oil daily. 

Also, in preparation for the Olympics this summer, China is likely hoarding oil, gas diesel to prevent embarrassing shortages. And what doesn't help too is that forty-six countries reportedly subsidize fuel prices.

What's also hurting oil prices is the fact that trustworthy, basic data is virtually nonexistent on crude oil demand, production, and inventories, including data on the availability of sweet vs. sour crude oil, usage and inventory data for Asia (particularly in China), extraction costs, and reserves (especially in Saudi Arabia).

The IEA is working on a comprehensive analysis of the world's major oil fields, but it won't be out until later this year. Watch to see what the IEA gathers, as the Mideast is notorious for manipulating its oil data as to not be in violation of OPEC quotas. Watch too for information on the state of the Sauds' oil fields.

Now on to the speculators in the oil futures market, speculators who are torquing the exceedingly vital price discovery mechanism that the futures market provides. They are doing so via swap trades, now annually in the tens of trillions of dollars.

Notably, the commodities index funds that usually invest long in oil futures, or paper oil barrels via swaps. The problem here is the fact that the swaps bought by funds are used for trading purposes and not to hedge the price of oil, as the airlines do.  Swap trades are essentially speculative bets about where oil prices area headed.   

The U.S. Commodity Futures Trading Commission is scrutinizing big U.S. investment banks including Goldman Sachs (GS), JPMorgan Chase (JPM) and Morgan Stanley (MS), particularly whether these swaps let traders evade crude oil position limits. The total value of the swap deals could be as much as $250 bn a year, the CFTC told Congress recently, though the agency added it has not found a "smoking gun" that link higher oil prices to speculation.

It's not news that the Commodity Futures Trading Commission has done little to stop these funds and traders from circumventing their position limits to make these trades. Though as Gartman points out:

"Few of the pension plans, endowments, insurance companies have ever reached the position limits in crude oil which are monstrously, fantastically, enormously hugely larger than the position limits in corn, or soybeans, or cotton, or base metals or any of the other commodities traded on exchanges here in the US."

Even so, what to do here? CFTC might ought to stipulate when swaps are and are not a lawful hedge. And CFTC could stipulate that any broker or bank who offsets these swaps they've sold to these long funds will not be given hedge status and will not be exempt from position limits, as Gartman advises.

Doing more to curtail the London loophole, a loophole that lets oil traders make unregulated energy trades offshore, would also help. 

However, experts say the bill is unlikely to bring much additional oil trading under the CFTC's purview. Only about 15% of futures trading on the benchmark west Texas intermediate crude takes place there, a report states. Most of ICE's OTC energy trading occurs in natural gas, whose contract price is pegged to the natural gas futures contract offered by rival NYMEX. OTC energy contracts cleared by the NYMEX are already subject to CFTC reporting and position limits.

What would also help too is to somehow safely, and with the least amount of environmental damage (likely a pipe dream unfortunately, pun intended) to get at the energy now sitting in federal lands in the West and off our coasts, holding an estimated 635 tn cubic feet of natural gas and 112 bn barrels of oil, one report says.

The US also must stop once and for all its insane tariffs on Brazilian sugar-based ethanol.

The US is pouring corn into gas tanks, corn fuel that needs to be expensively trucked around the country, using even more gas, as it can't be piped in because corn ethanol separates in transit via pipelines.

The US is making ethanol out of corn that takes a lot more in the way of energy inputs to create. Bio-diesel is vitally important, to be sure, but the country's over-reliance on US produced corn ethanol alone is a disastrous policy. It's also causing food prices to soar, as corn is redirected away from livestock, and also at a time when the world's poor grow hungrier by the day.