Iran’s window of opportunity

The presidents of Iran and Russia have both recently been critical – as the collapse in the oil market benchmark price has continued to and even through US$60 per barrel – of what is perceived as being economic warfare conducted through the oil market by the Saudis and the United States. But sometimes all is not quite as it appears.

I was honored in November 2011 to be a plenary speaker at a conference convened in Tehran by the Institute for International Energy Studies (IIES). I outlined – to a politely disbelieving audience – precisely how the global oil market was being financially manipulated and by whom.

Moreover, I forecast then, and many times subsequently, that the oil market price would inevitably collapse to, and probably temporarily through, a price level of $60 per barrel.

Merely to say that I was right would be worthless vanity adding nothing to the discussion. I mention my forecast only because I believe it gives my views some credibility in respect of constructive solutions for the predicament in which oil producers such as Iran, Russia and Venezuela now find themselves.

The greatest market manipulation in history
With a background in the regulation and development of markets and market instruments, I have considerable experience of the subject of undesirable market practices.

If there is one thing that the history of commodity markets tells us it is that if dominant producers can support prices at a high level with other people’s money then they will. This behavior has applied from diamonds to cocoa; from tin to coffee, and above all in a 10-year-long multi-billion-dollar copper market manipulation by Japan’s Sumitomo and their copper trader, Yasuo Hamanaka. But all of these pale into insignificance by comparison with the manipulation of the crude oil market of the past decade.

Market events 2004/2008
From around 2004 onwards, a major oil company began to enter into “oil loan” transactions whereby it would lend oil to investors – via a major investment bank with which the oil company was effectively in partnership – through sale and repurchase agreements. These passive investors were fearful of inflation, and wished to ensure that their capital retained its value by investing directly through prepayment for the intrinsic value of crude oil.

The outcome for the oil company was that it could lock in the dollar proceeds of oil production and protect itself against price falls, while also obtaining an interest-free dollar loan from investors. The outcome for investors was that they were linking their investment to the price of oil through prepayment for crude oil, and therefore – as they saw it – they were protecting their capital against inflation.

These financial investors entered an oil market with limited spare production capacity and which was and remains tightly controlled by a very small number of oil traders over the North Sea oil Brent/BFOE benchmark price. The oil price inflated first gradually, and then dramatically over a period of four years, culminating in a “spike” in price to $147/barrel in July 2008. This bubble in the oil market price then rapidly collapsed until by late 2008 the market price had fallen as low as $35/barrel.

This caused considerable pain to oil producers generally, and to OPEC and Saudi Arabia in particular, who had cut production by some 1.5 million barrels per day to no apparent effect.

Wall Street to the rescue
Geopolitical bargains between Saudi Arabia and the US are nothing new, and for decades the US has guaranteed the continuation in power of the current Saudi government in exchange for the Saudi denomination of oil sales in dollars, and more importantly Saudi investment of dollar proceeds in the US.

President Barack Obama, who has always been very close to financial interests in the US – whereas his predecessor George W Bush was very much a president very close to the interests of “Big Oil” – was elected in November 2008 and took office in January 2009.

In my view, a geopolitical agreement was reached by the US with the Saudis at that point that the US would consent to oil prices at a minimum level satisfactory to the Saudis budgeted expenditure (perhaps $80/barrel) while in return the Saudis would act to ensure that US gasoline prices did not exceed a maximum level at which President Obama’s chances of re-election were threatened – about $3.50 per US gallon.

Viewing events through the lens of such a geopolitical deal to peg the oil price explains the rapid price reflation in 2009 achieved through a massive influx of prepay financial purchases of oil by risk averse funds.

It also accounts for otherwise inexplicable Saudi market behavior such as shipping massive amounts of (prepaid) crude oil to the US in 2012 when the market price elsewhere was $20/barrel higher and for strange movements in US oil inventories. It also explains why OPEC meetings through the period were an exercise in tedium, where journalists assembled in Vienna to hear how “comfortable” Saudi oil minister Ali bin Ibrahim al-Naimi and OPEC secretary general Abdalla Salem el El-Badri were with the oil price.

2014 price collapse
It is said the cure for low prices is low prices, as high-cost producers cease production, and that the cure for high prices is high prices. The high oil prices ruling from 2009 to date have seen the entry into the market of new high-cost oil production, notably US shale oil, while we have also seen, perhaps not quite so visibly, considerable destruction in demand, as consumers use substitutes or simply become smarter.

As a result, the physical oil market quietly became increasingly oversupplied, setting the scene for a fall in price. However, the price collapse when it came was in my analysis precipitated by the US government’s decision to cease a long program of creating and pumping new dollars into the US economy – so-called quantitative easing (QE). This cessation, combined with a flow of investor funds from non-income-generating commodities into income-generating financial assets, meant that the flow of financial purchases of commodities necessary to keep the oil price supported came to an end.

As I have long predicted, we are now seeing the oil market going through the “bust” phase of the boom/bust cycle, which has been made worse through being delayed for several years.

So in summary, the US and Saudis between them have in my analysis been responsible for a five-year oil market manipulation which has in fact massively benefited oil producers everywhere, including Iran and Russia, to the tune of literally trillions of dollars.

It is even possible that both the US and Saudis believed that this manipulation was sustainable indefinitely.

But whatever they believed, the reality is now that oil producers are revisiting the painful conditions of late 2008, as I predicted. The current public position of the Saudis essentially rationalizes after the event the failure of a strategy that was never sustainable in the long term.

So, what can be done about the current market crisis?

A modest proposal
Iranian President Hassan Rouhani set out one element of the solution in Davos earlier this year when he advocated new global multilateral institutions involving both producers and consumers.

It is possible to imagine an international energy trade association consisting of what is essentially a consortium of producers in partnership with a consortium of consumers. The key is to ensure that the new institution includes no intermediary middlemen, the reason being that, unlike producers and consumers, middlemen have a vested interest in price instability and lack of transparency.

A transition is not only necessary but is under way from a market paradigm of “energy-as-a-commodity”, where market participants compete for transaction profits, to a market paradigm of “energy-as-a-service'”, where participants collaborate to maximize shared surplus energy value. Ironically, the Saudis and US have, through opaque use of oil prepay instruments, unwittingly demonstrated the other element of the solution.

It is open to producers such as Iran and Russia to collaborate by transparently creating and issuing – within a mutual guarantee and accounting agreement known as a “Clearing Union” – prepay energy credits. These would not be prepay crude oil credits (which are of no use to retail consumers) but would be returnable in payment for retail fuels such as gasoline and heating oil, or retail energy such as electricity, heat or power.

Provided crude oil is no longer sold through exchange transactions, but is instead supplied on the basis of production-sharing agreements with refineries, it will then be possible for consumers to invest directly in flows of value from “energy-as-a-service” by using prepay energy product credits.

For developed nations in the European Union and for the US, there will be a multi-trillion dollar business opportunity from the exchange of intellectual value of technology, know-how and knowledge for intrinsic value of energy saved.

So my modest proposal to Presidents Rouhani and Vladimir Putin is to begin bilateral discussions for regional collaboration in respect of the creation of new energy market infrastructure commencing in the Caspian region. If successful, the resulting neutral market platform would then be extensible to the EU and to Eurasia as a whole.

Such a Caspian initiative will enable the funding of a new Caspian Energy Grid as proposed by Azizollah Ramazani, the head of international affairs of the National Iranian Gas Company (NIGC), at a recent UN-sponsored Energy Charter forum event in Ashgabat on the subject of “Reliable and Stable Transit of Energy”.

In this way, Iran may take the first step on a journey of transition to a resilient and stable energy economy of abundance from the current unsustainable and unstable dollar economy of scarcity.

By Asia Times


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