The Newest Threat to Oil

I feel for Emmanuel Kachikwu. You probably don’t know him; there’s no reason you would. He’s head honcho in Nigeria’s oil ministry and OPEC’s outgoing president. He also happens to be on the most quixotic of modern quests — tilting not at windmills but at oil rigs. He wants the oil cartel to consider cutting production to arrest the decline in oil prices that has been so destructive to OPEC member countries.

Bless his heart. Emmanuel’s intentions are in the right place … he’s just banging his head against an intractable wall. The Saudis have less than zero interest in letting prices rise. They want Russia to suffer, given that Putin backs Syrian President Assad, whom the Saudis hate. And they want to crush America’s high-cost shale industry.

All to preserve Saudi market share, given that Saudi Arabia, outside of oil, has little economic potential.

Alas, Emmanuel’s hopes for higher prices seem stillborn.

But … higher prices are a very real risk for another reason that no one wants to see: the expanding conflict with Saudi Arabia and Iran.

A few weeks ago, the Saudis, demonstrating the infinite tolerance that the Wahhabi brand of Sunni Islam preaches, beheaded a Shiite cleric who, through peaceful protests, had for years called for regime change in autocratic Saudi Arabia. Funny thing about autocrats: They hate when their self-declared power is called into question.

Well, that beheading incensed Shiites in Saudi Arabia, and particularly in Iran, the world’s largest Shiite nation. Iranians torched the Saudi embassy in Tehran (Iran’s capital). Saudi Arabia responded by cutting off diplomatic relations with Iran and booting Iranian diplomats and their underlings out of the country. Iran then banned all Saudi imports.

It’s a tit-for-tat grudge match between the Shias and Sunnis, and it’s just the latest — and certainly most heated — confrontation between the two Middle Eastern powers in decades. But it’s not just playing out directly in Riyadh (the Saudi capital) and Tehran. The two countries are also waging proxy wars for control of the region, each backing opposing sides in Syria and Yemen.

As big a threat as ISIS is to the world oil market, this escalating pissing match between the Saudis and the Iranians would make anything ISIS does seem junior league. ISIS has the capacity to cause some significant damage through an orchestrated terror attack on a Saudi oil facility … but Saudi Arabia and Iran possess a significant arsenal of missiles capable of taking out multiple production facilities at the same time. And what better way to cripple one another than taking out petrochemical installations that account for more than 80% of each other’s economy?

This is the newest, biggest threat to oil.

ISIS remains a significant problem, as I first laid out more than a year ago — and, I would argue, the ISIS threat is even greater today than it was. But if the Saudis and the Iranians start lobbing missiles at one another, anyone who relies on oil — i.e., all of us! — face a world of hurt in our wallets far more painful than I originally predicted.

When I wrote about the ISIS threat in January 2015, I said oil could spike to $200 a barrel and gasoline here at home would surge past $6 a gallon. I thought that was a bit sensationalist, though easily justifiable based on the criticality of Saudi oil production. But now an expert in oil finance and Islamic economics at the George Washington University says that in a general Saudi/Iranian war, oil could easily race to $250 a barrel overnight … and if the combatants start bombing oil facilities, “we could see oil spike to over $500 and stay around there for some time, depending on the extent of the damage.”

Of course, no one wants to believe that in the more enlightened 21st century, a devastating war could erupt simply because a cleric was beheaded and an embassy torched. Then again, no one in Europe, amid what was then a 20th century so much more enlightened than the 19th century, wanted to believe that the Continent would go to war because an archduke was assassinated by Serbian nationalists seeking separation from Austria-Hungary.

History is paved with such decisions.

Throw in some centuries-long religious animus, and enlightenment is meaningless. If emotions or religious hatred rule the day in either Iran or Saudi Arabia … you’re going to want to own exposure to oil simply as an insurance policy in your portfolio. I know we were stopped out of National Oilwell Varco on Friday, but we will soon enough re-establish a position in oil. The oil market is a highly unstable beast these days, quite like a quiet volcano no one expects to explode. And, who knows? Maybe it will never explode.

But this is the Middle East. It’s oil. It’s political and religious intolerance and a burning desire to exert hegemony over the region. Fuses are burning. Will rational thinking extinguish them ultimately? Or will long-burning hatreds and a push for certain geopolitical destinies write a different history?

Before I sign off, I want to say a quick bit about some economic data that arrived Friday morning:

  • The Producer Price Index, which measures the prices manufacturers receive for their goods, fell 0.2% in December.
  • The Empire State Manufacturing Index, which measures manufacturing activity in the important and manufacturing-heavy New York region, plunged to minus 19.37 for the January reading from minus 6.21 in December.
  • Factory output fell by 0.1%, and total industrial production fell a larger-than-expected 0.4%.
  • And the big one: Core retail sales, which most closely reflect the consumer component of GDP, fell an unexpected 0.3% in December after having advanced 0.5% in November.

These numbers come on the heels of:

  • The Atlanta Federal Reserve, with a history of noteworthy accuracy in its economic estimating, announcing that fourth-quarter GDP will likely come in with growth in the 0.7% to 0.8% range, well below the 2.7% the economists predicted when the quarter began.
  • The ISM Manufacturing Index declining for six consecutive months and having now spent the last two months in recession territory.
  • The Association of American Railroads reporting that freight volumes in America have been declining at the fastest pace in 15 years, outside of the Great Recession.

I was wrong in December when I said the Fed was likely to hold off yet again on a rate rise. But now I am absolutely certain that the Fed was dead wrong in implementing that rate hike. The data back then — both in the U.S. and globally — did not support a rate hike. And they most assuredly do not support a rate hike today. Moreover, there is absolutely no way the data support additional rate hikes going forward.

This is not a healthy American economy. America is an economy on its knees, wheezing and begging for oxygen.

Until Washington, D.C. gets its head out of (I’ll be polite and say) the sand and reduces debt in America and rolls back all the anti-business regulations that are hamstringing the economy, America’s economic future is dark and soggy.

Let me be the first to tell you that anyone telling you that interest rates in America are going higher is a fool incapable of connecting very large, very obvious dots. The Fed’s next move, as I write about in your upcoming February issue, will see Yellen & Co. reverse their December rate hike. Far from rising from here, interest rates are going lower … and with them the dollar’s strength.

In dividend news … Goldcorp (NYSE: GG, buy up to $20) is dropping its monthly dividend of $0.02 into your account on January 22. Nampak (South Africa: NPK, hold) is paying us 0.92 South African rand on January 18 for its semiannual dividend.

Until next week, stay Sovereign…

Jeff D. Opdyke
Editor, Sovereign Investor
January 17, 2016