Nationalization – A Plan for World Domination - David Jonsson

by David Jonsson

"During times of universal deceit, telling the truth becomes a revolutionary
act." - George Orwell

We are witnessing how nation states are increasing using nationalization as a tool for world control of energy production, energy transportation, basic products and financial assets for control. It appears that the actions of Russia and China combined with pawns the Islamist states and the Leftist governments in Latin America are coordinated in their actions. Initially the nationalizations were occurring within the countries, and recently these actions have extended into the EU and the U.S.

In many cases the immediate result has the increased rewards to the sellers of EU and U.S. companies to the foreign state owned entities. The EU and U.S. investors, the populous and their compliant governments fail to realize the long term implications of the sale to the totalitarian regimes.

The funding of these foreign totalitarian Islamist, Marxist and Communist states has come from the disastrous financial performance – balance of trade, outsourcing and fiscal deficits and energy dependence on Islamist and Marxist states. The actions have been further facilitated by the banks and financial advisors seeking immediate financial gain. These actions have also led to acceptance of Shariah law applied to the financial sector as a step toward gradual Islamization of the countries.

Who are the players and what are the recent actions?

Living in Bubble Land

We live in a virtuous circle world predicated on the belief that credit will continue to sustain economic growth. The total outstanding value of all derivatives has surged to over $400 trillion in 2006; rising a third since 2005, from a total of $297 trillion, says the Bank of International Settlements. When a market grows almost 40 percent in a single year to $415 trillion, regulators are bound to get a little nervous. The guardians of financial stability are all too aware that many of these securities haven’t yet had to prove their ability to withstand a shock.

China’s Equity Bubble

Stephen Roach of Morgan Stanley commenting on the May 22 Jack Crooks Daily Forex Commentary:

“China’s equity bubble is an offshoot of this same problem. Washington’s China bashers appear to be drawing on the same game plan of forced currency revaluation that wreaked havoc on the Japanese economy in the 1990s. As was the case with the endaka (strong yen) of the late 1980s, Yuan appreciation is now taken as a given by domestic and international investors - only questions of degree and timing remain unanswered. There is an eerie similarity between currency-driven outcomes in the two equity markets. In both cases, one-way currency bets turned equities into the asset of choice for the “hot money” of liquidity-fueled investors. Is it a coincidence that China’s A-shares began their recent run only a few months after the pegged-currency regime was abandoned in July 2005? Similarly, was it a coincidence that the Japanese equity bubble emerged in the late 1980s in the aftermath of a Plaza accord that steered the yen/dollar cross rate from 254 in early 1985 to 145 in early 1990? Given the lack of alternative assets in a still undeveloped Chinese financial system, the equity bubble may be even more of a foregone conclusion in China than it was in Japan.”

Where is all this liquidity coming from? East Asian emerging economies are mostly creditor nations. Moreover, much of their accumulation of external assets is in official hands. By February of this year, the foreign currency reserves of east and south Asian countries had reached $3,280bn, up by $2,490bn since the beginning of 1999. If a substantial part of the world economy is generating huge current account surpluses, somebody else has to run offsetting deficits. The result will be toward increased protectionism. It also leads to the goal of the nationalization. Finally, it compels US monetary authorities to sustain easy monetary policy, in order to offset the leakage from domestic demand caused by the huge current account deficits. These trends are not desirable or sustainable.

Last year, for example, the biggest source was China. In the 12 months that ended in January, China accumulated $259 billion in reserves, bringing its total then to just over $1.1 trillion. Cash is flooding into the economy. Foreign-exchange reserves rose by a record $136 billion in the first quarter to $1.2 trillion, the most in the world, the central bank said. The rise in assets is fueled by exports that are so cheap that foreign exchange reserves are growing at a rate of $1 million a minute. The recycling of most of those reserves into U.S. Treasury bonds is a major factor keeping U.S. interest rates low. And that has helped the private-equity groups pursue a wealth of corporate operations that once might have seemed out of bounds.

BusinessWeek reports that there are worries in Asia, the Middle East and elsewhere that the U.S. has become an economic underachiever and the “weakest link in the global economy.” The International Monetary Fund went so far as to warn in its most recent World Economic Outlook that one of the biggest uncertainties is “whether the global economy will be able to decouple from the U.S. were the latter to slow down more sharply.” And this in part explains why such a close American ally as Kuwait feels the need to unhook its currency from the U.S. dollar, as the Persian Gulf emirate announced Sunday. That link has been dragging down Kuwaiti purchasing power as the dollar sank against the euro and other currencies, and the move to sever that dinar-dollar relationship is one other Gulf countries are thought to be looking at as well. Most Persian Gulf oil producers -- long allied with a protective U.S. -- are moving closer to China and its neighbors, a trend exemplified earlier this month by the East-meets-Mideast conference in Riyadh co-hosted by Saudi Arabia and Japan. The actions of Russian, Iranian and Central Asian players in the petroleum business have also raised questions about the dollar.

The Middle East - The Role of Islamic Finance

Not long ago, Islamic Finance was widely regarded as a specialized, if not obscure, backwater of global banking. On May 23, 2007 the Financial Times published an outstanding special FT Report – Islamic Finance. The lead article By Roula Khalaf and Gillian Tett, Financial Times was: Backwater sector moves into global mainstream.

The UK, now home to two Islamic banks, is vying to become a center for Islamic finance. Sukuks, or asset-based Islamic bonds, are being marketed to international investors.
The new demands for the recycling of capital flows caused by the rise in the oil price have fueled an unprecedented economic boom in the Middle East. These events have been met with innovation in the provision of Islamic financial products, offering ingredients, for the first time, for a larger scale industry.

The history of modern finance is littered with numerous examples of financial booms and busts, where financiers have dashed en masse into new immature, fragmented and opaque markets - producing subsequent scandals when it emerges that a host of shaky business practices underpinned this investment mania.

And while no major scandals involving the Islamic finance sector have come to light so far, the boom in the industry has occurred amid a much wider credit bubble in global financial markets.

“Right now we have a credit bubble - you can sell almost anything to anybody, including in the Islamic finance world,” says one investment banker. “People should certainly be asking hard questions about financial practices in the Islamic finance sector.”

Islamic Economics – The Hard Questions

In 2006 I wrote the book Islamic Economics and the Final Jihad: The Muslim Brotherhood to the Leftist/Marxist - Islamist Alliance in which I wrote about the history and expansion of the use of Islamic Economics as a weapon for world domination. The concepts for Islamic Economics were further developed in my article from the Global Politician on December 20, 2006; Islamic Economics and Shariah Law: A Plan for World Domination.

The Plan involves the incremental acceptance of basic tenants of Shariah law as applied to all aspects of life—the Islamic “Way of Life”. This implies the desire to incrementally change the laws and ultimately the Constitution of the U.S. It is already leading to the change of the laws in the UK.

Andrea Williams writing in the Financial Times on April 26, The implications of Islamic bonds are far-reaching, commented on the article in the Financial Times of April 23 UK to issue west’s first Islamic bonds. Shariah compliant bonds have hitherto been issued by the governments of Pakistan and Malaysia and also by corporate issuers around the world, but never by a western state.

“The [UK] government may be attracted by the prospect of money from Muslim investors, but it seems it has not considered the implications of using bonds that comply with Shariah law. Shariah law does not simply prohibit interest and finance speculation; it stipulates that money must not be used for a purpose incompatible with Islam.”

“This could include any number of areas of the financial market, such as alcohol and cigarettes, clothing, food, media (which produces gossip), and animal welfare (which promotes the welfare of non-halal animals). It would also mean this money could not be used in the furtherance of many individual freedoms, or in the promotion of any idealistic or political worldview other than Islam (including secular democracy).”

“The government appears to be overlooking the implications of allowing a proportion of UK government finance to be determined by a law not recognized in the UK. It is of particular concern that there has been no parliamentary scrutiny of this issue. For example, if these bonds are introduced, it is not clear who will be the arbiter of any disputes. The bonds are religious agreements, and disputes that arise will often involve a question of interpretation of Shariah law.”

There is no question that many Muslims whether they are Sunni or Shiite decry terrorism and are loyal Americans; however, most Muslims subscribe to the Muslim total “way of life” and desire to have the whole world under Islamic rule and the will of Allah. Combining a “way of life” into an economic system is proving to be more powerful than any other in having a global impact and spreading Islam on a global basis.

Islamic Economics is the stealth sword of Islam

Islamic Economics is the stealth sword of Islam. It is more powerful than the Weapons of Mass Destruction and terrorism. It is immune to negotiation. The stealth sword is being applied for the Islamization of the West and the whole world. The goal is to create the “Islamic kingdom of God on earth.” The implementation of Shariah law would have a dramatic affect on your life and that of the entire Western Civilization. Understand the nature of the evil and do not be blindsided.

The twentieth century has witnessed the emergence of an economic doctrine that calls itself Islamic economics. The doctrine is significant because it advances the sprawling and headline-grabbing movement known as political Islam, Islamic fundamentalism, Islamic Finance, or simply Islamism.

The movement is having a profound impact. The Islamic windows of major banks that incorporate the principles of Islamic economics represent the fastest growing sector. The banks, based on the principles of Islamic economics, raise billions of dollars in the form of Islamic bonds (sukuk) annually. Banking laws in Islamic and Western countries are changing to accommodate Islamic economic rules. The Dow Jones Islamic Stock Index and in April 2006, Dow Jones and Citigroup announced the launch of the first Islamic Bond Index. The Dow Jones Citigroup Sukuk Index is the first index that seeks to measure the performance of global bonds complying with Islamic (Shariah compliant) investment guidelines.

For a more complete discussion of the implications of financing with Sukuk bonds see my paper Structural Changes–Destruction Of The U.S. Dollar.

Mawlana Sayyid al Abdul-Ala al-Mawdudi - Islamic “Way of Life”

(Mawlana) Sayyid Abul A’la Al-Mawdudi (1903-1979), one of the chief architects of contemporary Islamic resurgence, was one of the most outstanding Islamic thinkers and writers of his time. Mawdudi is credited with bringing economics within the purview of religion in the mid-twentieth century. He had a broader goal of defining a self-contained Islamic order.

He sought to turn Islam into a complete “way of life.” In his voluminous writing, Mawdudi exhorted that Islam is much more than a set of rituals. It encompasses, he argued, all domains of human existence, including education, medicine, art, law, politics and economics. To support this assertion, he laid the foundations of several Islamic disciplines, among them Islamic economics. Sayyid Qutb (1906-66), an Egyptian, Muhammad Baquir al-Sadr (Mohammed Baqir al-Sadr) (1931-80), an Iraqi, and Professor Dr. Yusuf al-Qaradawi, an Egyptian, also made seminal contributions to Islamic economics.

The Role of the Muslim Brotherhood

The Muslim Brotherhood (al-Ikhwan al-Muslimun) was the main motivator behind setting up experiments in Islamic financing on a nationally and internationally workable scale. The theory and practical requirements needed to set up an Islamic banking system came from among the ranks of the Ikhwan.

“Allah is our objective. The Prophet is our leader. Qur’an is our law. Jihad is our way. Dying in the way of Allah is our highest hope.”—Muslim Brotherhood

The Muslim Migration

I might add that according to the May 23, 2007 article by Edward Luce from the Financial Times in the article: Muslim Americans in line with US values:

In a survey conducted by the Pew Research Center, one of America’s most respected polling groups, found that America’s 2.4m-strong Muslim community are far more assimilated and integrated into their adopted country than their counterparts in Europe.

“Nationalization by immigration” - Implications of Amnesty for Illegal Immigrants

Unfortunately, it shows that although American Muslims are assimilating and building prosperous lives they are not uniformly believers in America first. This has far reaching implications with respect to amnesty for Illegal immigrants. The protests, demonstrations and marches for granting amnesty include organizations from the Leftist and Muslim communities. “Nationalization by immigration” is by not uniformly believing in America First and is a form of setting up a nation within a nation.

People from 43 so-called “countries of interest” in the Middle East, South Asia and North Africa are sneaking into the United States, many by way of Texas, forming a human pipeline that exists largely outside the public consciousness but that has worried counterterrorism authorities since 9-11.These immigrants are known as “special-interest aliens.” When caught, they can be subjected to FBI interrogation, detention holds that can last for months and, in rare instances, federal prison terms.

The 43 countries of interest are singled out because terrorist groups operate there. Special-interest immigrants are coming all the time, from countries where U.S. military personnel are battling radical Islamist movements, such as Iraq, Afghanistan, Somalia and the Philippines. They come from countries where organized Islamic extremists have bombed U.S. interests, such as Kenya, Tanzania and Lebanon. They come from U.S.-designated state sponsors of terror, such as Iran, Syria and Sudan.

Are Muslim Americans Supporting Their New Land?

“What this survey shows is that Muslim Americans are largely assimilated, happy with their lives and moderate - mostly in contrast to Muslims in Western Europe,” said Andrew Kohut, head of Pew. “They also reject Islamic extremism to a much greater extent than Muslim populations elsewhere in the world.”

“Thirteen per cent of American Muslims believe that suicide bombing is justified in some circumstances, which is sharply lower than comparable findings among European Muslims and those in Muslim-majority countries. However, the proportion of Muslim Americans under the age of 30 who believe suicide terrorism is sometimes justified rises to 26 per cent, compared with 35 per cent in Britain and 42 per cent in France.”

Think about it: Thirteen per cent of all American Muslims believe that suicide bombing is justified in some circumstances. That is 325,000 of all American Muslims believing suicide bombing is acceptable in some circumstances. Then apply this to the EU and consider the potential risk to Eurabia. Remember 9/11. It was only 19 terrorists affiliated with al-Qaeda that hijacked four commercial airliners on September 11, 2001.

The Leftist propaganda would have you believe that the cause of Muslims believing that suicide is justified is because of poverty should further look at the results of the poll. “Forty-two per cent rated their personal financial situation as excellent or good, compared with 49 per cent of Americans in total. Only 2 per cent of US Muslims are in the low-income bracket, compared with 22 per cent in Britain and 18 per cent in France and Germany.”

“The survey, which screened 55,000 Muslim Americans, found the under-30s were far more likely than the older generations to describe themselves as Muslim first and American second and were far more likely to attend a mosque weekly.”

“It found that African-American Muslims, most of whom are converts to the religion, were more radicalized than other Muslim Americans. Only 36 per cent had a "highly unfavorable" view of al-Qaeda, compared with 58 per cent among Muslims as a whole. “African-Americans are clearly the most disillusioned section among Muslim Americans - and they are also much more skeptical of American values,” says Mr. Kohut.”

“Muslim Americans account for just 0.6 per cent of the US population, compared with 5 per cent or more in France and Germany.”

Jihad is considered a required religious duty for Muslims. Jihad is Islam’s normal path to expansion.

Nationalization of Strategic Assets

China’s $3 billion Trojan Horse

On May 21, Beijing announced a deal that surprised the finance community, and it didn’t involve commodities or the domestic currency. Instead, officials, on the cusp of creating an private investment arm, invested a significant amount in the private equity firm Blackstone Group LP. China will use $3 billion of its roughly $1.2 trillion in foreign-exchange reserves to buy a 9.9% stake in Blackstone, a move that coincides with Blackstone’s planned $40 billion stock-market listing, as the Financial Times and The Wall Street Journal report.

Central Huijin Investment Co., a state agency that has invested some of China’s foreign exchange reserves to recapitalize domestic financial companies, loaned the US$3 billion to the new investment agency. Central Huijin’s assets are expected to be merged into the State Investment Company, according to earlier reports.

According to the agreement, the investment in Blackstone will be below 10 percent of total shares in Blackstone after its initial public offering, which is expected to take place in mid-June.

“We don’t want to trigger any review or approval procedure by the US government,” said Jesse Wang, chairman of the China Jianyin Investment Ltd Co, which is owned by Central Huijin, the central bank’s investment arm.

With approximately $200 billion in reserves, the new state investment agency will likely take aim at notable bellwether companies, with stock issuances that are more liquid. This may include investments in key branding items with access and connections to US consumers and distributions through domestic stores. However, a bulk of sentiment continues to side with the notion of energy and internationally related companies as the preferred target. One thing is for sure though, with a heavy investment in Blackstone, Chinese officials will be able to reach out to other investments, taking advantage of the firm’s worldwide exposure.

In March, Oaktree Capital Management LLC Managing Director William Kerins predicted that private equity transactions in China will surge fivefold to an annual $10 billion in the coming years. Adding China to the shareholder roster means Blackstone, which hired former Hong Kong Financial Secretary Antony Leung in January, is better placed to grab a piece of that action.

The U.S. based on national security issues blocked the sale of Unocal to CNOOC, China’s biggest offshore oil producer. Hence China is using Blackstone as the Trojan Horse of Blackstone to accomplish the goal. Remember this is a government investment not just a foreign private company making the investment.

Citgo, owned by Petroleos de Venezuela S. A. (PDVSA), operates about 13,000 service stations in the United States. This is the company owned by comrade Hugo Chavez who recently nationalized the assets of the foreign oil companies.

Other nations might be tempted to emulate China’s Trojan Horse investment strategy. In December, Dubai’s DP World succumbed to U.S. pressure and sold six port terminals to American International Group Inc. for an undisclosed amount.

The terminals, in New York; Newark, New Jersey; Baltimore; Philadelphia; Tampa, Florida; and New Orleans, were uncontroversial while owned by London-based Peninsular & Oriental Steam Navigation Co.

After DP World paid $6.8 billion (using sukuk bond financing) for the U.K. company in February 2006, the coastal access points suddenly acquired strategic importance. Clubbing together with a U.S. financial firm might have enabled DP World to hang on to those assets.

Yet while one Dubai company may have given up on U.S. ports, another one shows no signs of quitting the U.S.—or of giving up a contract with the Navy to provide shore services for vessels in the Middle East. The firm, Inchcape Shipping Services (ISS), is an old British company that last January was sold to a Dubai government investment vehicle for $285 million. ISS has more than 200 offices around the world and provides services to clients ranging from cruise ship operators to oil tankers to commercial cargo vessels. In the U.S., the company operates out of more than a dozen port cities, including Houston, Miami and New Orleans, arranging pilots, tugs, linesmen and stevedores, among other things. The firm is also a defense contractor which has long worked for Britain’s Royal Navy. And last June, the U.S. Navy signed on too, awarding ISS a $50 million contract to be the “husbanding agent” for vessels in most Southwest Asia ports, including those in the Middle East, according to an unclassified Navy logistics manual for the Fifth Fleet and a press release from ISS.

General Electric Sells its Plastics Division to Arm of Saudi Government

Meanwhile on May 20, 2006 General Electric Co. (GE) and Saudi Basic Industries Corporation (SABIC) have reached an agreement for SABIC to acquire GE Plastics for a price of US$11.6 billion. SABIC has previously acquired DSM Petrochemicals business in Europe and the Huntsman Petrochemicals business in the United Kingdom. The government owns about 70 percent of the stock, with the rest restricted to investors in Saudi Arabia and the five other states of the Gulf Cooperation Council. Buying the division will give SABIC a foothold in polycarbonates, easily worked plastics used in applications ranging from riot shields to compact discs. GE’s proprietary Lexan plastic is used in roofs, lighting, walkways, windows and domes.

SABIC was established by Royal Decree in 1976 (1396/97 AH) - its task being to set up and operate hydrocarbon and mineral-based industries in the Kingdom of Saudi Arabia. The Public Investment Fund provides long-term loans to SABIC on highly concessional terms. The balance of SABIC’s capital requirements come from SABIC’s joint venture partners. In addition, SABIC can make use of normal commercial loans. With these sources of finance, SABIC is able to undertake industrial projects considerably in excess of its own authorized capital of 10,000 million Saudi Riyals.

Since beginning production, SABIC has held a 5% share of world petrochemical markets, and a larger market share in key products such as ethylene, ethylene glycol, methanol, MTBE and polyethylene. This will be significally increased with the acquisition of GE Plastics.

We forecast that annual production capacity will reach 51 million metric tons (mmt) in 2006 and 60 mmt in 2008.

Basic Chemicals, SABIC’s largest strategic business unit, accounts for around 40% of the company’s total production.

SABIC is the world’s fourth-largest producer of polyolefins. It is the world’s third-largest producer of polyethylene and the sixth-largest producer of polypropylene.

SABIC is also the world’s single largest producer and exporter of granular urea (needed for production corn ethanol) and one of the world’s top producers of olefins.

More than two-thirds of SABIC’s production is exported; more than half of these exports go to Asia.

Russia’s Nationalization of Foreign Oil Companies

In April, the world’s largest integrated oil and gas project called Sakhalin-2. had been wrested from Royal Dutch Shell. The Royal Dutch/Shell group of Europe and Japanese trading houses Mitsui & Co. and Mitsubishi Corp. ceded a majority stake in the joint project after Russia’s resources ministry ordered a partial suspension of the project due to environmental concerns. The suspension was believed by some to be a pretext for the Russian government’s efforts to secure Gazprom’s leadership of the project.

On April 29, Gazprom eyes exclusive purchase of Sakhalin-1 gas: MOSCOW (Kyodo) Gazprom is negotiating for exclusive rights to buy all of the natural gas to be produced by the Sakhalin-1 international oil and natural gas project, according to a senior official of the partially state-owned gas monopoly.

The suspension was believed by some to be a pretext for the Russian government’s efforts to secure Gazprom’s leadership of the project.

The move suggests the possibility that Russia will take full control of the exporting rights for the natural gas produced by the project, which Exxon Mobil Corp. has led since the mid-1990s and in which Japanese stakeholders, including the government, hold a combined stake of about 30 percent.

On May 21, according to the Financial Times Moscow warns TNK-BP over gas licence: Moscow ratcheted up pressure on BP’s Russian venture on Monday, warning that TNK-BP could see the license for its vast Kovykta gas field revoked within “a matter of days”.

Oleg Mitvol, head of Russia’s environmental watchdog, said his agency would open a probe on Wednesday into whether TNK-BP was meeting license terms to develop the east Siberian field – as a three-month deadline passed for production there to be boosted to 9 billion cubic meters in line with requirements. TNK-BP has said this target would be impossible to meet.

“If everything goes according to the law then [TNK-BP] should lose the license,” Mr. Mitvol said, adding that a special commission would meet in “the next few days” to decide whether to revoke it.

Mr. Mitvol’s comments came as talks intensified over state-controlled Gazprom taking a stake in the operation. Industry observers have seen the stand-off over Kovykta as part of a broader gambit to put pressure on TNK-BP’s Russian shareholders to sell their stake to a state-controlled company as Moscow seeks to tighten its grip over the energy sector.

Moscow eyes tighter grip on energy routes according to the Financial Times of May 14. Russia, Kazakhstan and Turkmenistan have called for a new pipeline to be built along the coast of the Caspian Sea to carry additional Central Asian natural gas exports north into Russia in a move that would tighten Moscow’s control over energy routes out of the region.

The Beltrans gaz deal, which was 13 years in the making, will increase Gazprom’s lock over gas networks to the west just one week after Russia, Turkmenistan and Kazakhstan agreed to expand shipments out of Central Asia via Russia in a blow to western governments’ efforts to build alternative pipelines bypassing Russia.

Russia continues to tighten the energy noose on Europe as reported by the Financial Times of May 22, Pipeline set to tighten Russian grip on energy.

The Russian government yesterday approved plans for an oil pipeline that could enable the country to bypass Belarus and tighten Moscow’s grip over much of Europe’s energy supplies.

The proposal by Transneft, Russia’s oil pipeline monopoly, to build a new 1m barrel per day spur across Russian territory to a key Russian oil terminal in the Baltic port of Primorsk will boost the terminal’s capacity as a hub for supplies to Europe to 2.5m b/d.

Conclusion

The Leftist/Marxist – Islamist Alliance is utilizing the weapons of economics, energy and immigration to rest control of the Western world. The Alliance through their operatives in the U.S. and the EU has furthered the progress of world domination and Islamization though appeasement, open borders, lack of fiscal disciple and greed among the populous, government leaders, financial advisors and banks seeking near term gains.

The U.S. and its allies need to understand who the enemy is and their goals, and put forward a plan for survival of the freedoms and liberty we enjoy. Commercial interests, and not security, are driving our actions as they did then prior to WW II.

This image will not be improved by elites counted among the Leftist/Marxist – Islamist Alliance who have not only abandoned, but are attacking their own people, selling out their historical legacy to their worst enemies, and muzzling those who object to this. It is going to be interesting for future historians to unveil how many senior Western leaders or bureaucrats, bankers and corporate leaders have been bought and paid by petrodollars.


David J. Jonsson is the author of Clash of Ideologies —The Making of the Christian and Islamic Worlds, Xulon Press 2005. His new book: Islamic Economics and the Final Jihad: The Muslim Brotherhood to the Leftist/Marxist - Islamist Alliance (Salem Communications (May 30, 2006). He received his undergraduate and graduate degrees in physics. He worked for major corporations in the United States and Japan and with multilateral agencies that brought him to more that fifteen countries with significant or majority populations who are Muslim. These exposures provided insight into the basic tenants of Islam as a political, economic and religious system. He became proficient in Islamic law (Shariah) through contract negotiation and personal encounter. David can be reached at: mailto:djonsson2000@yahoo.co.uk?cc=info@SalemTheSoldier.us

U.S. Policy Toward Iran and Russia - David J. Jonsson

US%20policy%20Toward%20Iran%20a.html

Can the "Axis of Oil" Topple the US Dollar? - Gary Dorsch

by Gary Dorsch

Were it not for its "reserve currency" status, slowly turning into a post-World War II relic, the US dollar would have already collapsed by now. A string of $4.4 trillion of US trade deficits since 1996, and a heavy reliance on foreign money to fund its external imbalance, has severely weakened America's global economic leadership over the past five years. The US dollar survives, due to America's political stability, its military might in the Persian Gulf, its large $12.5 trillion economy (28% of global GDP), and deep and liquid financial markets for bonds and stocks.

Last week, the US dollar fell to an all-time low against the Euro, a new milestone in a steep decline that began more than six years ago. The Euro hit a record high of $1.3682 on April 27th, up from $1.20 a year ago and as little as 83 cents in October 2000, when the rally against the dollar began. The British pound is hovering near $2 area, and the Australian dollar fetches 82.50 US-cents, both at 15-year highs.

Since the beginning of the year, 50 of the world's currencies have risen against the dollar while only eight have declined. Behind the falling US dollar is a changing global economy. China and the US are the locomotives in the global economy, accounting for 60% of all the global growth in the last five years. But now, the $12.5 trillion US economy is sputtering, due to a slumping housing sector, while the $2.5 trillion Chinese economy is overheating, expanding at a blistering 11.1% pace in Q'1

India's elephant, China's dragon, and other dynamic economies, such as Russia and South Korea are expected to contribute more than 50% to world economic growth in 2007, with China's contribution alone being 30% and India's 10%. In comparison, the US contribution to world growth is expected to fall to 12%, after its economic output halved to 1.3% in Q'1, the smallest gain in four years.

Every time US year-on-year GDP growth has dipped below 2% since 1960, a full-blown recession unfolded. In contrast, the Euro zone economy is expanding at a 2.6% clip, its best performance in six years, and the European Central Bank is aiming to lift its interest rate in June, thus making the US dollar less attractive next to the Euro. As such, many foreign central banks have been reducing their exposure from the US dollar to the Euro and British pound over the past year.

US Dollar Slides despite Improvement in Foreign Trade

Since the bursting of the dot-com investment boom on Wall Street in 2001, the US Dollar Index has been sliding on a slippery slope, weakened by rising US trade and budget deficits, and an increasingly unpopular war in Iraq, which is costing the US Treasury about $2 billion per week. The US Dollar Index has a weighting of 57.6% in Euros, 13.6% in Japanese yen, 12% in British pounds, 9% in Canadian dollars, 4.2% in Swedish kronas, and 3.6% in Swiss francs.

The weaker dollar is beginning to translate into an improved US trade balance for the first time in six years. The US trade deficit is February was $59.4 billion, compared with a record high of $69.6 billion in July 2006. In February, the US posted a surplus with Britain for the first time since 2001. For the first two months of 2007, the deficit with the European Union was less than $13 billion, down 28% from a year earlier. With Canada, the deficit fell to below $12 billion from more than $16 billion.

Still, the US deficit with China soared to a record high of $232.5 billion dollars in 2006, up from $201.5 billion the year before, to account for nearly one-third of the total. The annual US deficit with Japan also hit a new high at $88.4 billion, up 7.2% from 2005, thanks to Tokyo's weak yen policy. Beijing and Tokyo have achieved such spectacular results by manipulating their currencies against the US dollar.

Japanese Financial Warlords Buck the Trend

The giant US trade deficit of $763 billion in 2006 produced a huge outflow of dollars to other countries. The People's Bank of China, the Bank of Japan, and Arab Oil kingdoms have been the key linchpins in limiting the US dollar's losses by buying US Treasury debt. Foreign central banks boosted their holdings of US Treasury and agency debt by $14.2 billion in the week ended April 25th, to a record $1.93 trillion.

Although the US dollar is sliding to multi-year lows against most major currencies, the greenback is up 5% against the Japanese yen from a year ago. The Bank of Japan is the largest holder of US Treasures with $618 billion, and pursues a radical monetary policy, pegging its overnight loan rate at only half-percent, or 475 basis points below the US fed funds rate, in order to prop-up the US dollar.

"Most countries are diversifying their investments to non-US dollar assets. But in the case of Japan, we are still cautious about shifting from the dollar to other currencies," said Hiroshi Watanabe, Japan's powerful FX chief in Abu Dhabi, on April 19th "If we do that, it goes towards the depreciation of the dollar. So why should we trigger such a stupid action?" Watanabe asked.

The Bank of Japan is the world's largest "yen carry" trader. Last fiscal year, Tokyo paid 7.6 billion yen in interest expense, while earning 3 trillion yen in interest rate income on US Treasuries. "Thus, we don't have any plans to sell foreign currencies to redeem government bonds," said Japanese finance minister Koji Omi on March 23rd.

The US Treasury is thrilled with Japan's "cheap yen" policy, which encourages the flow of capital from Tokyo to US financial markets. Tokyo also reaps big rewards, as yen has fallen 14% in the past year against the Euro, 5% against the dollar and 9% against China's yuan. That's boosted Japan's trade surplus by 74% to a record 1.63 trillion yen ($14 billion) in March from a year earlier. China overtook the US as Japan's largest trade partner in the year ended March 31st.

Arab Oil Kingdoms Recycle Petrodollars into US$

Washington's allies in the Arab world, particularly in the Persian Gulf, are now worried about the influence of Shi'ite Iran in Iraq and elsewhere in the predominantly Sunni Muslim region. The US accuses Tehran of seeking to set up a covert nuclear weapons program, a fear shared by Saudi Arabia, the world's biggest oil exporter. Riyadh fears that US troops will leave Iraq prematurely, and enable Iran to consolidate its influence and leaving Sunni Arabs at the mercy of Shi'ite militias.

The Arab Oil kingdoms are supporting the US war effort in Iraq by recycling much of their petrodollar surpluses into US Treasuries. But nearly four years into the Iraq war, America's patience with the war is growing thin. Democrats voted for a $124 billion funding bill for Afghanistan and Iraq for the current fiscal year, but with strings attached, ordering US troops to begin withdrawing from Iraq by October 1st.

The Arab Oil kingdoms are willing to recycle petrodollars into US Treasuries, but also want to be compensated for a weaker dollar with higher oil prices. The OPEC-10 cartel has lowered its daily oil output by 1.8 million barrels since November 2005, and with the depletion of 500,000 bpd from Mexico's giant Cantarell oil field last year, OPEC is back in the driver's seat. OPEC has guided the benchmark North Sea Brent price upward to $68 /barrel, from as low as $51 /bl in January.

China Grows weary of weaker dollar, US Protectionist Threats

But while Tokyo's financial warlords and Arab Oil Kingdoms are firmly committed to the defense of the US dollar, how Beijing decides to use its $1.2 trillion of wealth would have much bigger ramifications for financial and commodities markets worldwide. China's FX reserves soared by $136 billion in Q'1, more than half the $247 billion gain for all of 2006, and are on course to reach $1.5 trillion next year.

China suffers losses on its massive $700 billion US bond portfolio, whenever it allows the dollar to move lower against the yuan. The dollar has fallen only 1.3% against the yuan so far this year, and dealers expect a devaluation of only 4% for 2007. Still, the dollar fell to a new post revaluation low of 7.7025 on April 30th, after the Chinese central bank raised bank reserve requirements 0.5% to 11% last Friday.

The slow pace of yuan appreciation could invite "veto-proof" US Congressional protectionist legislation against Chinese exports in the second half of this year. Until now, Congressional efforts to get China to move toward a more flexible exchange rate with threats of tariffs have been frustrated by the leverage exerted by the Chinese through their huge ownership of US Treasury debt.

But if the US Congress slaps tariffs on Chinese imports into the US this year, it might cause Beijing to switch its allegiance to the "Axis of Oil," a loosely aligned alliance of top oil producers, who are slowly chipping away at the US dollar's allure, and aim to thwart American economic and foreign policy at every turn.

"Axis of Oil" Chipping away at US Dollar's Base of Support

The "Axis of Oil" led by Russia, Iran, and Venezuela, is slowly chipping away at the US dollar's status as the world's "reserve currency." Russia, the world's second largest oil exporter demands rubles in exchange for its Urals crude oil, and Iran, the world's fourth largest oil exporter is earning most of its revenues in the Euro. Venezuela's central bank began shifting its FX reserves to Euros in 2005.

The "Axis of Oil" seeks to draw China into its sphere, exploiting China's huge thirst for oil. Iran became China's top oil supplier in January, providing 2.14 million tons of crude, up 13% over the same month last year, and tripling that of December's supply of 740,000 tons. China aims to establish 625 million barrels of strategic petroleum reserves to be able to cover 90 days of net oil imports by 2015.

China's state-run Zhuhai Zhenrong, the biggest buyer of Iranian crude worldwide, began paying for its oil in Euros late last year. Japanese refiners who buy 500,000 bpd of Iranian crude, or a fifth of Iran's 2.4 million-bpd shipments, continue to pay in dollars but are willing to shift to yen if asked.

A major share of global trade in commodities belongs to crude oil, which is widely transacted in US dollars. That forces oil importers and central banks to buy US dollars, regardless of the direction of US interest rates. Last month, world-wide oil consumption rose to 85.5 million bpd. By 2030, crude oil demand is expected to reach 118 million bpd, so the dollar-crude oil link is vital to maintain the dollar's "reserve currency" status, and allowing America to live beyond its means.

Right now, the only serious threat to the US dollar's international dominance is the Euro. The gross domestic product of the Euro zone is roughly the same as that of the US, and its population is 60% bigger. Europe is the Middle East's biggest trading partner, is a major oil importer, has a comparable share of global trade as the US, but its external accounts are much better balanced. The Euro zone ran a current account deficit of only 3.2 billion euros ($4.2 billion) over the past 12-months.

But the "Axis of Oil" could topple the US dollar, if it demands payment for oil sales in Euros. In November 2000, Saddam Hussein insisted that Iraq's oil be paid for in Euros. When the value of the Euro rose, Iraq's oil revenues increased accordingly. The economic threat this represented to the US dollar might have been one of the reasons why the Bush administration was so anxious to topple Saddam.

Russian Bear Leads the Assault on the US Dollar

But a greater threat to the US dollar's hegemony is the "Axis of Oil." Russia is the #1 producer of natural gas and the #2 producer of crude oil and much of its vast energy assets are still under exploration. Each up-tick in the oil price pumps billions of additional dollars into the Kremlin's coffers. One year ago, on May 10th, Russian kingpin Vladimir Putin declared that Russian Urals blend crude oil would be traded for Russian rubles, instead of US dollars, and made the ruble fully convertible.

One month later, on June 8th, 2006, the Russian central bank said it had cut the share of US dollars in its reserves by 5% to 50% and boosted the Euro's share to 40%, with the rest in sterling and yen. Due to soaring oil revenues and an appreciating Euro, Russia's foreign exchange reserves have mushroomed to $361 billion today, the third largest in the world, behind China and Japan.

Russia's FX reserves now exceed its outstanding foreign debt of $103 billion, a vast improvement since 1998, when Moscow defaulted on $40 billion of debt repayments. Russia's FX reserves ballooned with a widening foreign trade surplus, which rose to $164.4 billion in 2006, up 15.1% from 2005. Two thirds of Russia's oil and natural gas exports were shipped to the European Union.

Russia's $800 billion economy expanded at a sizzling 8.4% rate in the first quarter, and industrial production was 16% higher from a year ago, outpaced only by China and India. The Kremlin is securing its control over Russia's natural resources, yet has done little to scare foreign investors away, at least in the energy sphere.

Russia attracted $26 billion in foreign direct investment last year, even after the Kremlin pressured Royal Dutch Shell to relinquish its controlling stake in the Sakhalin II oil-and-gas field, and installed Gazprom as the controlling partner. The Kremlin built Rosneft into the world leader among publicly traded oil companies with 16-billion barrels of oil reserves and 24.7 trillion cubic feet of natural gas, and a reserve life of 30-years for oil and 51-years for gas. Russia's other top oil producer Lukoil has oil and gas reserves of 20.4 billion barrels of oil equivalent.

Russia also earns 15% of its export revenues from metals and is home to the world's largest nickel producer, Norilsk Nickel, and Rusal, the world's largest aluminum company. Russia is the world's fourth-largest steel maker with foreign sales of $22.5 billion and non-ferrous metal exports of $16.5 billion last year. Russia's gold mines produced 164.2 tons of the yellow metal last year.

The Russian central bank prints massive amounts of rubles each year, in exchange for Euros and US dollars that are flooding into the country. The central bank said its M2 money supply grew by 52.7% in the 12-months thru April 1st. Yet the US dollar is sliding to seven year lows against the Russian ruble. The Russian central bank said the annual increase in Russian M2 is equal to around 27% of gross domestic product, which creates excessive liquidity and inflates financial assets. The Russian Trading System Index (RTS) has been further inflated by "yen carry" traders, who borrow yen in Tokyo at less than 1% to buy Russian stocks.

Russian kingpin Putin on Collision Course with US, Turns to China

Russia is the largest economy in the world that is not yet a member of the World Trade organization, and had apparently overcome all major roadblocks in bilateral WTO talks with the US last year. But once Putin made it clear that Russia would continue building Iran's nuclear reactor, the US began hindering its admission to the global trade body. On April 9th, US Trade Representatives Susan Schwab said Moscow was making only "slow progress for entry into the world trade body."

"We would like to see Russia a full fledged member of the WTO and hope that Russia will undertake the commitments and responsibilities, the obligations that come with being a WTO member," she said. Schwab also said Congress was not prepared to revoke the 1974 Jackson-Vanik amendment, crucial for Moscow to enter the WTO.

But in a swipe at Russia's steadfast support for the Iranian regime, Washington says its 10 interceptor missile sites in Poland and radar in the Czech Republic are meant to defend against long-range missile threats from Iran.

Washington also accuses Moscow of rolling back democracy and reviving its imperialist past, and Moscow charges Washington with meddling in its domestic affairs.

America's efforts to isolate Iran diplomatically and economically have been frustrated by Putin's insuring that any UN Security Council resolutions against Tehran's mullahs are watered down as much as possible.

On April 23rd, US Defense chief Robert Gates met with Putin to address criticism of Washington's plans to place missile defense systems in Poland and the Czech Republic, a dispute that is driving relations between the countries to a Cold War low. Putin argues the sites are too close to Russia's borders and the US could eventually equip the sites with offensive weapons aimed at Russia.

Moscow has also provided Iran with anti-aircraft missile systems and S-300 missiles that could make any possible US military strike on Iranian nuclear sites more dangerous. Then on April 26th, Russian kingpin Putin suspended Russia's obligations under the Conventional Forces in Europe Treaty, a move he linked to US plans for a missile defense shield in Europe.

Two days later, on April 28th, Russia's pipeline monopoly Transneft said it has built a third of its planned pipeline to China and is on track to complete the 1650 mile pipeline by the end of 2008. The pipeline, Russia's first oil route to Asia, will eventually pump 600,000 barrels per day of crude oil to China.

China is a major buyer of Russia's oil and natural gas and lobbied hard for top priority access over Japan to the oil pipeline carrying Siberian crude to Asian markets.

China is also helping Russia develop its natural resources, particularly in Siberia. Trading between the two emerging giants is growing rapidly.

In February 2005, Russian Finance chief Kudrin revealed that Chinese banks provided $6 billion in financing for Rosneft's acquisition of Yuganskneftegaz, secured by long-term oil delivery contracts between Rosneft and the Chinese National Petroleum Company. The CNPC is also involved in several joint ventures with Gazprom to develop energy reserves in Iran.

Last year, bilateral Sino-Russian trade was $33 billion, up from $20 billion in 2005, and is expected to reach $70 billion by 2010. China is Russia's fourth largest trading partner while Russia is China's eighth largest trading partner. They are the most important members of the Shanghai Cooperation Council, one of the most powerful economic centers of the world.

Iran Solidifies Alliance with China

Beijing must walk along a delicate tightrope, balancing its hugely profitable trade surplus of $232 billion with the United States, against its increasing dependence on crude oil imports from Iran. An oil exporter until 1993, China now produces only for domestic use. Its proven oil reserves at home could be depleted in 12 years, so Beijing is aggressively trying to secure supplies in hot spots the globe.

China's Sinopec 0386.hk will visit Iran next week to discuss outstanding financial issues on a possible $100 billion deal to develop the giant Yadavaran oilfield said Gholamhossein Nozari, director of the National Iranian Oil Company. Yadavaran is expected to produce 300,000 bpd, about the same amount Iran now exports to China. Royal Dutch Shell is also interested in participating in Yadavaran.

Beijing also wants to reinforce its relations with Iran to tap the Caspian Sea energy region, and lessen its dependence on maritime oil imports from the Arab kingdoms in the Persian Gulf, thus securing an uninterrupted flow of oil. China proposes to help Iran modernize its petroleum industry and the wider Iranian economy with industrial technology, capital, engineering services and nuclear technology.

The Sino-Iranian economic relationship extends beyond exploitation of Iran's oil reserves. Beijing sells anti-ship missiles like the Silkworm and surface-to-surface cruise missiles to Tehran, and has assisted in the development of Iran's long-range ballistic Shihab-3 and Shihab-4 missiles. But Beijing wants to deepen the presence of its firms in the Iranian market, which could be a good outlet for Chinese exports.

Blessed with the second largest oil reserves in the world, Iran's oil production has averaged about 3.9 million for the past three years. However, as a result of surging domestic demand, growing 10% per year and depleting oil fields, Iranian oil and gas revenues are expected to fall from $54 billion in 2006 to $49 billion this year. In ten years, Iran's 2.4 million bpd of oil exports could dry up, unless new oil fields are developed with the help of Chinese, Russian, or European oil companies.

But the US State Department is strongly urging its trading partners not to invest in Iran. The US Congress is pushing a broad spectrum of legislation against Iran this year, with "veto proof" bipartisan support. The most recent proposal is sponsored by Senator Chris Dodd and Rep Tom Lantos, which brings China and Russia into the fray, threatening economic sanctions on any country that aids Iran's oil industry.

But Tehran is well aware of its commercial links with other nations, and buys one third of its imports from the European Union, led by Germany, France, and Italy. This all means that Iran is actually in a far stronger position than its size. Consider the year of debating, cajoling, threatening, and blackmailing that went into two UN Security Council resolutions aimed at Iran's nuclear program. In the end, China and Russia stripped the guts outs of the resolutions.

Meanwhile, tension with Iran over its nuclear weapons drive is keeping oil prices high, which in turn, pumps up the flow of cash to the Kremlin and Venezuela. For good measure, Iran sits on the neck of the Strait of Hormuz, through which 17-million barrels of oil flows each day. Once Iran's mullahs obtain nuclear weapons, the cost of crude oil and shipping rates could sky rocket, and force central banks to inflate their money supplies at an even faster clip, to offset the economic pain.

On March 26th, Ebrahim Sheibany, Iran's central banker said the Iranian economy can withstand the watered down UN sanctions, and the regime has enough foreign currency reserves to handle any major shocks. "In US dollars, it is at 20% because we need to keep that" he said. Sheibany indicated that Iran is asking overseas buyers of its oil, including China, to pay in Euros rather than US dollars, a tactic that is being closely watched by foreign-exchange markets.

"That's our policy and right now we are doing that. I think that this is bad for America and the importers. As I say, I believe that they are shooting their own foot because they have international currency and they should take care of that. If not, we are shifting to other currencies," Sheibany said.

Venezuela's Hugo Chavez a key player in the "Axis of Oil"

Adding Venezuela's mercurial Hugo Chavez to the "Axis of Oil", makes matters much tougher for Washington. Venezuela is the fourth-largest supplier of oil to the United States, accounting for more than 10% of American oil imports, and ships 1.3 million barrels of crude oil north every day. Chavez has promised to cut off oil shipments to the US, if Iran is attacked by the US military. Chavez has already reduced oil shipments to the US by 200,000 bpd from a year ago.

On July 30th, 2006, on a two day visit to Tehran, Chavez pledged that his country would "stay by Iran at any time and under any condition. We are with you and with Iran forever. As long as we remain united we will be able to defeat US imperialism, but if we are divided they will push us aside," Chavez said. He invited Iranian oil companies to invest in Venezuela.

Iran's president, Mahmoud Ahmedinejad, replied, "I feel I have met a brother and trench mate after meeting Chavez. We do not have any limitation in cooperation. Iran and Venezuela are next to each other and supporters of each other. Chavez is a source of a progressive and revolutionary current in South America and his stance in restricting imperialism is tangible."

Chavez noted that, "Russia helped break a US-imposed blockade by agreeing to sell fighter planes and helicopters worth billions of dollars to Venezuela."

On May 1st, Chavez declared that Venezuela will strip the world's biggest oil companies of operational control over the Orinoco Belt crude projects that can convert about 600,000 bpd of heavy, tar like crude into valuable synthetic oil. Oil Minister Rafael Ramirez has said that Venezuela will only consider agreements on the booked value of the projects rather than their much larger current net worth.

Venezuela says there are around 235 billion barrels of crude reserves in the vast Orinoco Belt, and if correct, would give Chavez the planet's largest oil supply. Venezuela currently has 80 billion barrels of proven reserves. Petroleos de Venezuela PDVSA is working with oil companies from China, India, Iran and Brazil to certify the Orinoco reserves, while Chavez seeks to reduce his reliance on the United States.

The implications are potentially stark for the United States, which imports 62% of its oil supply. Chavez says PDVSA is ready to become the sole energy supplier to Cuba, Bolivia, Nicaragua and Haiti, and would finance up to 50% of the total oil bill. Chavez is also giving away at least 100,000 bpd to Cuba, which the Castro brothers sell on the open market at their own profit, draining Venezuela's finances further.

Chavez is absorbing higher shipping costs to reach China, expanding oil exports to the Asian juggernaut by tenfold, to about 160,000 bpd since 2004. The Baltic Exchange's Dry Freight Index, a composite of global seaborne trade routes for commodities, hit a record high on April 27th, driven by surging demand for raw materials to Asia. The cost index of merchant ships, tripled to 6,230 points over the past 14-months, surpassing the all-time high of 6,208 in Dec 2004.

Venezuelan Finance Minister Nelson Merentes said Caracas used some petrodollars to pay off $4.7 billion of foreign debt in 2006, lowering the national debt by 15% to $26.3 billion. Merentes aims for Venezuela's debt to be lower than 25% of Gross Domestic Product by the end of 2008. Revenue at PDVSA came to $101 billion in 2006, but the net profit was only $4.8 billion. Chavez spent an estimated $9 billion to keep gasoline prices under 20 cents a gallon, and spent billions more to cement political alliances with Bolivia, Cuba, and Nicaragua.

Because of heavy spending on social programs and subsidized oil sales to Central America, Venezuela's FX reserves haven't grown anywhere near to the extent of Moscow's hoard. S&P still has a "junk status" rating of BB- on Venezuela's bonds, and has put Caracas on notice about a possible downgrade, due to the ouster of Exxon Mobil, ConocoPhilips, Chevron Corp, Total, Statoil, and British Petroleum from the Orinco Belt. That might not scare Chavez however, who can attract investment capital from Sinopec, Lukoil, and probably Petroleos de Brazil for future development of the giant Orinco oil reserves.

The G-7 Response to an "Axis of Oil" Shift from the US Dollar

During the last several decades, control of global oil reserves has steadily passed from private companies to national oil companies like Rosneft and Petróleos de Venezuela. Roughly 77% of the world's 1.15 trillion barrels of proven reserves is in the hands of the national companies, and 14 of the top-20 oil companies are state-controlled. Together, the "Axis of Oil" pumps one-fifth of global oil output.

Maintaining the US dollar monopoly on the sale of oil is critical to the Fed's ability to print money, without sending the greenback into a tailspin. However, if the "Axis of Oil" and /or the Chinese dragon decide to shift more of their trade surpluses towards the Euro or gold, it could seriously undermine the US dollar, increasing the cost of US imports, and corral the US economy into the "Stagflation" trap.

Such a scenario is more likely in the event of a US military strike on Iran. But the Group of Seven central banks have worked together for a long time, dealing with many market crises, usually by coordinated inflation of their money supplies, to keep currencies in stable target zones. Still, a shift by the "Axis of Oil" and especially China, away from the US dollar could override the G-7's manipulative antics.

On May 1st, Fed chief Ben Bernanke warned Congress against imposing tariffs on Chinese imports into the US, which could spark Beijing's flight from the dollar. "If trade both destroys and creates jobs, what is its overall effect on employment? The answer is, essentially, none," Bernanke said in Butte, Montana. The Fed's ability to print unlimited amounts of US dollars and inflate assets, might hang in the balance.

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HUI/Gold Ratio Trends - Hamilton

by Adam Hamilton

As we continue our fascinating journeys of discovery as students of the markets, we do a lot of charting work at Zeal. Recently a chart that I hadn't given much thought to for the better part of 8 months caught my attention again. It was a HUI/Gold Ratio chart, also known as HGR in this essay.

The HUI/Gold Ratio is as simple as it sounds, it is calculated by merely dividing the daily close of the HUI unhedged gold-stock index by the daily close in the price of gold. When this resulting ratio is graphed over time, it vividly illustrates the ever-shifting relative strength of the gold stocks versus gold. As their bulls mature, one is stronger and then the other, back and forth. They are engaging in a great secular tug-o-war.

At times the gold stocks are thriving, rising much faster than their golden underlying primary driver, so the HGR rises. At other times much like what we've witnessed so far this year, the gold stocks are languishing in consolidation mode so gold has the chance to rise faster than them and thus drive the HGR lower. Over time this evolving dynamic carves some interesting chart patterns.

In the early years of this bull, a friend of mine came up with an elegant trading system for actively trading the gold stocks based on the HGR's technicals. Like most trading systems, it was very successful for years but then its efficacy started to fade. Prior to 2005 its buy and sell signals were rare and useful, but later that year the wild HUI made them start to thrash. With buys and sells happening constantly, this system's utility waned. I discussed the limitations of this particular HGR trading system last year.

After that experience, my focus drifted away from the HGR. But last month as I was updating some of the charts in the subscriber chart section of our website, the secular trend of the HGR caught my eye. It looked like a long-term trend channel had emerged in this indicator and that it was nearing the place where gold stocks started to really outperform gold in the past, or a major HUI buy signal.

So is the venerable HUI/Gold Ratio once again suggesting that a major gold-stock upleg is drawing nigh, that gold stocks are due to outperform the metal they mine? Yes, it sure is. And considering how horribly dismal the HUI sentiment has been so far this year, a ray of hope shining in from the HGR is certainly most welcome.

Here is a smaller essay-sized version of the chart that caught my attention. Note the well-defined secular uptrend channel rendered below, which shows that the HUI has been rising faster than gold on balance for many years now. Also note that the HGR is once again near the lower support of this trend channel today. Each time in the past this happened, soon after the HGR soared as a mighty HUI upleg launched.

The HGR is the blue series in these charts, with accompanying key moving averages. It is superimposed over the raw HUI itself, shown in red. Not surprisingly, when the underlying HUI shoots higher in a mighty upleg, it rises much faster than the gold price and hence drives the HGR heavenwards. And the beginnings of such hugely profitable major HUI uplegs in recent years have occurred at HGR support.

The HGR secular support line shown here is well-defined. The HGR bounced off it decisively in mid-2002, early 2003, and mid-2005. In each case the HUI surged sharply after its HGR support approach. And today the HGR is once again converging to this same support line that has been so bullish for the HUI so far in its bull market to date.

And interestingly a top resistance line perfectly parallel to the lower support is also readily evident in this chart. At the end of major uplegs, the HUI would get ahead of itself and correct, falling faster than gold which leads to gold's relative outperformance which drives the HGR down. While there was a massive above-resistance surge in late 2003, this parallel resistance line held strong in mid-2002, late-2004, and early 2006.

So the complex and often tactically chaotic interrelationship between the gold stocks and the metal that drives them can be distilled down into a simple technical uptrend! The strength and potency of any trend channel is directly proportional to the number of years that it has remained in place. With this uptrend starting way back in 2002 and showing no signs of failing yet, odds are it is pretty important to consider.

Its simple message today is buy gold stocks because they are probably on the verge of a major upleg. When the HUI performance has been bad for so long that the HGR is driven down to support, a period of gold-stock outperformance is once again due. We are very near such a critical bullish inflection point today.

This is very exciting, but as a lifelong student of the markets I am usually more interested in why particular trading signals work rather than just trading blindly on their mere existence. So the logic underlying this HGR secular uptrend, and the alternating cycles of gold then gold-stock outperformance, is very intriguing to me. Having pondered this question for some weeks now, this pattern makes sense.

All financial markets are driven by never-ending sentiment waves. These waves are the collective sum of traders' emotions regarding a particular sector. Their crests are driven by greed, euphoric times when new highs are being carved and traders think prices will never stop rising. Then inevitably the troughs driven by fear follow, dark times in the bowels of major corrections when traders think prices will never quit falling. All tactical price action is ultimately the result of aggregate popular greed and fear.

Gold stocks and gold certainly aren't immune to these sentiment waves. In fact, given the incredible gold-lust that burns deep within virtually all the hearts of men, gold's reactions to collective greed and fear are often magnified. There is an old market aphorism stating "there is no rush like a gold rush", and history certainly validates it.

Although there are separate sentiment waves echoing through both gold and gold stocks, for a couple reasons gold's usually steer both sets. First, the gold price is much more fundamentally-driven than the stocks. Gold's annual mined supply is very finite, and nothing can rapidly speed its growth due to the difficult and time-consuming nature of this industry. So gold's price should be closer to fundamentals than stock prices most of the time, and far less noisy.

Stocks, ultimately, are just paper. While they do represent fractional ownership in real gold mines, existing companies can issue new shares at will and new companies can form at any time and float stock. Both of these events add to existing gold-stock supply. While gold supply growth is ironclad finite, theoretically there are no limits on gold-stock supply growth. This means gold-stock prices are not as fundamentally absolute as gold's and hence more susceptible to tactical sentiment-driven anomalies.

Second, gold is the ultimate driver of gold-stock prices. Gold miners mine gold, so higher gold prices lead to higher profits. The stock markets eventually reward higher profits by bidding up stock prices to reflect them. And there is a psychological element here too. Gold-stock traders are most likely to buy gold stocks when gold is rising. So climbing gold is the primary catalyst for bullish gold-stock action, leading gold to influence gold stocks and not the other way around.

Although gold is being driven relentlessly higher on balance by fundamentals, its path is not arrow-straight. Sentiment waves force gold to oscillate around its long-term uptrend, temporarily going above trend when traders get greedy and excited and temporarily going below when they get scared and worried. These sentiment flows and ebbs in gold largely drive the sympathetic yet amplified gold-stock sentiment waves.

When gold strength gets gold-stock traders excited, their capital floods into the relatively tiny gold-stock sector. Stock prices soar as they try to absorb the capital inflow. Eventually, as in all uplegs in all sectors, greed grows too great and all the traders who want to buy have bought. Then the inevitable correction arrives. The resulting trough of the sentiment wave brings selling and ultimately fear, and gold-stock prices are hammered.

I think these sentiment waves are what we are seeing in the chart above, the logical cause for a tight secular HUI/Gold Ratio uptrend channel carved over years. When the greed part of a wave arrives both HUI and gold rise but the stocks rise much faster since they have such a tiny collective market capitalization compared to the trillions of dollars worth of gold out there. This dynamic drives the HGR higher to its upper resistance line. These events are marked "surge" in this chart.

Then when the sentiment waves crest, gold and the HUI tend to peak within close temporal proximity of each other. Four of these peaking events, marking the ends of major HUI uplegs, are numbered above. Note that they generally occur at or above upper HGR resistance. Soon after when the trough of the sentiment waves follows, it manifests itself in parallel corrections in gold and the HUI.

But just as the HUI leverages gold's gains to the upside when greed is waxing extreme, it also leverages gold's losses to the downside. During the ebbing of the sentiment wave when the HGR is retreating, it is often not because gold is rising faster than the HUI but because gold is falling less fast than the HUI. This too represents gold outperformance relative to the HUI. These episodes are labeled "drift" above, and they drag the HGR back down to its support. We see this HGR surge, top, drift, bottom pattern over and over again.

Thus there seems to be a logical sentiment cause for the HUI and gold interaction that created the stunning uptrend in this chart. Since these waves hit with some regularity and tend to have similar amplitudes and durations, they are able to gradually flesh out a linear ascent. It is really fascinating to step back from the markets and try to understand sentiment and its effects from a strategic level!

Even with a probable cause outlined, the conclusion is the same. The HUI/Gold Ratio is near secular support because the fear trough of a sentiment wave is passing. Gold has outperformed the HUI for a year now, as evidenced by the falling HGR, but since the HGR is near support this episode is probably drawing to an end. In order for this cycle to continue and the HUI to outperform gold and drive the HGR up to resistance again, we are going to have to see another massive HUI upleg.

Although the regularly alternating episodes of HUI-then-gold relative outperformance driven by sentiment are the most intriguing part of this whole thread of research to me, the tactical HGR is also quite interesting. If we zoom into just the very right edge of the chart above, since gold's and the HUI's latest interim tops of last May, this latest drift is forming a tightening wedge. It is rendered here.

While this tactical wedge is not as well-defined as the secular uptrend, it is still quite apparent when drawn with best-fit lines. Interestingly it is symmetrical too, with its upper resistance representing the same slope, but inverted, of its lower support. This sideways action is technically a drift, a period of gold outperformance, but with the HGR trending flat neither the stocks nor the metal have pulled decisively ahead for a year.

This wedge pattern is getting ratcheted tighter and tighter the longer that gold and the HUI struggle for the outperformer crown. At the current wedge rate of convergence, it takes about two months for a 0.01 HGR increment to be cut out of the wedge. With the wedge point now trapped between roughly 0.51 to 0.54, this means that this wedge must mathematically break this summer and it will likely fail even sooner.

The big question is which way will the HGR go once its tactical wedge fails? Will the HUI outperform driving the ratio higher or will gold outperform driving it lower? Based on the bull-to-date precedent discussed above, I think the odds far favor the HUI outperforming gold so the HGR breaks out to the upside. Here's why.

Gold remains in a strong secular bull market for fundamental reasons. I discussed the very latest gold fundamental data in the new May issue of our monthly newsletter just published this week if you are interested. It is incredibly bullish! Gold's global mined supply is falling while its demand is rising, a sure recipe for higher prices. And if gold is still in a secular bull, then gold stocks will ultimately follow it higher.

As the history of the HUI/Gold Ratio clearly shows, periods of HUI outperformance alternate with periods of gold outperformance. Over this past year we've been in a drift phase, where gold was outperforming the HUI on balance. Thus we are due to reenter the other state where the HUI outperforms. This can only happen if a major new gold-stock upleg is on the verge of launching. So cycle probabilities favor the HGR breaking out to the upside.

This leaves one more exciting question. If a major HUI upleg is coming and it ultimately drives the HGR up to resistance again, how high could the HUI go? Well, based on the first chart the next HGR resistance intercept should be between 0.65 and 0.70. So let's use 0.68 as an estimate. And of course the level of the HUI at this secular resistance line depends on where gold itself tops.

If gold was merely to top at $700 when the greed-laden crest of the next sentiment wave passes, then a 0.68 HGR yields a potential HUI top of 475. This is 40% higher from here! Imagine how a portfolio comprised of elite high-potential gold stocks would perform if the HUI merely rises to 475. I suspect the ultimate upleg gains would be pretty awesome.

But odds are gold is not just going to stop at $700 in this upleg. The massive gold upleg that topped last May, gold's first Stage Two investment-driven upleg, soared about 70%. Back in Stage One, gold uplegs tended to run around 20% each. Using a conservative back-weighted average, let's assume gold will run 40% higher in this upleg. From its lows of this past October, a 40% gain would carry gold to $785.

At $785 and a 0.68 HGR resistance level, the HUI itself would have to soar to 535 or so! This is 55% higher from here. As always these exact target numbers aren't all that important, just the understanding that if the HUI/Gold Ratio sticks to bull-to-date precedent the next major interim high in the HUI should be far higher than today's levels. If such an upleg indeed materializes, traders riding it will win enormous profits.

At Zeal we have been preparing for this expected upleg since the October lows. We have deployed a bunch of gold-stock positions already, and are buying more on weakness. Some have been stopped out on the HUI's various pullbacks since then, but the survivors are thriving. This week even in the depths of the latest HUI pullback, we had unrealized gold stock gains running as high as 65% on individual stock trades.

If you are looking for cutting-edge research and analysis on not only timing major gold-stock uplegs but on finding the highest-potential gold stocks to buy to ride these uplegs, our acclaimed monthly Zeal Intelligence newsletter is for you. In it, as we have done in every HUI upleg since 2000, we research and recommend elite gold stocks when the technical timing to buy looks opportune. The profits so far have been great and should only grow as this bull matures. Please subscribe today and join us!

The bottom line is the HUI/Gold Ratio is approaching its long-term support. In this bull to date, each time this has happened the HUI has soared heavenwards soon after in a mighty new upleg. With gold's fundamentals still awesome, and gold driving this gold-stock bull, the odds favor the HUI soon outperforming gold again and surging higher to drive up the HGR as it has done in the past.

The HGR drift of the past year has been a trying one psychologically, but it has built the perfect foundation for a new upleg to launch. Not only is HUI sentiment still pretty pessimistic today, the contrarian time to buy, but it has built a new higher technical base from which to launch its assault on new highs. On top of all this it is technically due to start outperforming gold again in a cycle sense.

Adam Hamilton, CPA
Zeal LLC.com

Do you enjoy these essays? Please help support Zeal Research by subscribing to Zeal Intelligence today! &www.zealllc.com/subscribe.htm

If you have questions I would be more than happy to address them through my private consulting business. Please visit www.zealllc.com/financial.htm for more information.

Thoughts, comments, flames, letter-bombs? Fire away at & zelotes@zealllc.com Due to my staggering and perpetually increasing e-mail load, I regret that I am not able to respond to comments personally. I WILL read all messages though, and really appreciate your feedback!

Mr. Hamilton, a private investor and contrarian analyst, publishes Zeal Intelligence, an in-depth monthly strategic and tactical analysis of markets, geopolitics, economics, finance, and investing delivered from an explicitly pro-free market and laissez faire perspective. Please visit www.ZealLLC.com for more information, www.zealllc.com/samples.htm for a free sample, and www.zealllc.com/subscribe.htm to subscribe.

Copyright © 2000-2007 Zeal Research

Offshore Technology Conference Update - Byron King

by Byron King

The Offshore Technology Conference (OTC) 2007 proceeds apace. Are you in the business? What do you need? What do you want to know? It is all here. Pick an item or service.

What Do You Need?

Corrosion and abrasion control? 76 exhibitors. Wellbore equipment? 36 exhibitors. Laboratory equipment? 14 exhibitors. Offshore platforms? 68 exhibitors. Decommissioning services? 33 exhibitors. Mooring and positioning systems? 60 exhibitors. Pumps and compressors? Another 60 exhibitors. Artificial lift? 25 exhibitors. And it goes on. Just the OTC program alone is the size of a small-town telephone directory. Welcome to the world of the offshore, and to the OTC.

From Where Does It All Come?

In other articles, I have asked the question, how far upstream do you think? When you fill the gas tank of your car, do you ever wonder about the fuel-holding systems under the parking lot of the gas station? Do you think about the tanker truck that hauled the fuel from a terminal to the gas station? Do you think about the terminal tanks? How about the interstate pipeline or barge that carried the fuel from the distant refinery to the nearby terminal? Or the pipelines that brought the oil to the refinery? Right about at this point is where the purpose of the OTC begins.

What Is the OTC?

The OTC includes the geophysical services that help the geologists pick a spot in the middle of the ocean, so they can tell management where to spend a billion dollars or more. The OTC includes the drill ships, the jack-up rigs, and the semi-submersibles that will drill the wells. The OTC includes the drill bits, the pipe systems, and casing plans. The OTC includes the down-hole equipment that penetrates six or seven miles into the crust of the Earth. The OTC includes the massive equipment that powers and runs the rigs, the cables, the wires, the electric transmission, the safety systems, and pollution control devices. The OTC includes the transport vessels that haul stuff out to the rig, and other vessels that haul the oil ashore, or the subsea systems that pipe it there. The OTC includes the communications equipment, the training for the workers, the logistics that puts it all together, the insurance, the inspections and quality assurance, the banking, and even the good-old government regulation. The OTC is a reflection of a complex, world-spanning industry.

Rocket Science, Without the Rockets

So the OTC highlights the offshore oil industry, but with an emphasis on things about which you do not usually ponder unless you have been there. Take all of the complexity of drilling for oil and gas onshore. Take all of the geological risk, the political risk, the high costs and financial risk, the environmental risk. Take it all and then put it out in the ocean, up to hundreds of miles from shore, in water (almost always cold water, by the way) up to two miles deep, and constant corrosion and occasional hurricanes, typhoons, or icebergs coming your way. And the dictates of the modern global economy are that whatever you do, you have to do it quickly, efficiently, and safely. It is rocket science, but without the rockets.

History and Trends

The offshore industry has been around for about 60 years or so, ever since people started siting drilling rigs out over the shallow waters of the coastlines of several continents. Quite a bit of what goes on offshore is an evolutionary development of technology, with people identifying challenges and meeting them progressively.

In today’s world, as you can imagine, there are many dedicated programs to provide a boost to that evolutionary process, if not to “force” the process along. These range from government-funded research to university-level programs, and many private industrial and consultative efforts, with all sorts of combinations of the foregoing. It is all about moving farther out from shore, to more prospective areas, to deeper waters, to more extreme climates. It is all about looking for oil and gas, finding it, and bringing it to landfall.

Alternative Energy Sources From Offshore

Well, it was all about looking for oil and gas and bringing it home. This year’s OTC program actually devotes quite a bit of time and effort to offshore wind power development, as well as to capturing energy supply from tidal and wave action. It makes sense. The same people who have been designing structures and bending metal for the offshore hydrocarbon extraction industry for the past six decades are the ones whom you would expect to have the technical expertise to bend metal for energy capture systems in wind and wave.

Matthew Simmons: Energy From the Ocean

Energy derived from the ocean will be a key source of future energy supplies for the United States, said Matthew Simmons, the chairman of Simmons & Co. Intl. and author of the highly regarded book Twilight in the Desert. According to Simmons, who presented his talk to an eager and enthusiastic crowd of OTC attendees, the U.S. industry and government need to begin “now” to conduct aggressive levels of research to develop oceanic energy resources.

“This is the issue we should have paid attention to for the last 15 years,” said Simmons. Simmons noted that offshore oil production has already begun to decline, using as examples the depletion profiles of areas in the Middle East, Mexico, and the North Sea. In January 2007, noted Simmons, global offshore oil production was down 1 million barrels per day (b/d) from May 2005.

Meanwhile, according to Simmons, the offshore rig fleet is becoming “long in the tooth” as rigs age without adequate levels of new construction. Due to skyrocketing construction costs and shortages of yard space and personnel, offshore vessels and rigs are not being replaced as quickly as they should be to maintain the future pace of offshore drilling. Many vessels will also “become obsolete” in the next five-10 years, Simmons said, explaining that contractors have done an “excellent job of refurbishing rigs,” but “rust never stops.”

One key point that Simmons made in his talk was that “To slow the decline in oil and gas production, we must drill faster.” But he warned, “We may be faced with a declining rig fleet.”

Thus, according to Simmons, energy capture from the ocean offers a number of opportunities to develop future energy supplies. These include waves, currents, tides, aqua biofuels, ocean geothermal, and vent and seep energy. In a comment that had many in the room nodding their heads, as if complimenting a great idea, Simmons said, “Algae is the single most interesting biofuel. There is plant life in the oceans far below where light ever strikes.”

Simons also noted that gas hydrates are another potential energy source that remains untapped. “We have never tried to capture them, so we don't know if it would be successful, but at least we have not tried and failed.”

And on that hopeful note, I will end this update from the OTC.

Until we meet again…
Byron W. King

For Whiskey and Gunpowder

Byron King is a practicing attorney in Pittsburgh, Pennsylvania, with real clients and real law books on his shelves. After graduating from Harvard University more years ago than he cares to discuss, Byron worked as a geologist in the exploration and production division of a major international oil company. He has followed developments in the oil and gas industry for almost three decades. However, in the process of seeking more excitement than a man can safely obtain from flaring over-pressurized gas whipping out of a 21,000 foot well, Byron also served for many years in both the active and reserve components of the United States Navy.

While in the sea service, Byron logged more flight time in tactical jet aircraft than George W. Bush, as well as 127 more carrier landings than the current commander in chief. Among other assignments, Byron has served as a field historian with the Navy.

Byron looks at current events, economics, and politics through the lens of history. He brings to the table a unique perspective that incorporates many millions of years of the Earth’s geologic history, and blends its significance into the more recent, man-made kind of tale.

Beware of Windfall Profits Taxes - Amoss

by Dan Amoss

It's impossible to make the case that there's a perfectly free market in oil or any other globally traded commodity. Production limitations, depletion, military conflicts, nationalization risks, taxes, and environmental regulations -- they all muddy the waters of a market that many would like to be clear and efficient.

The international oil trade does not operate in a vacuum. Despite what energy resources may or may not lie underneath the ground, "aboveground factors" matter very much and tend to matter more as prices rise. Just because we can use computer models to estimate that so many billion barrels of oil are in some reservoir in some remote part of the world doesn't mean that this potential supply will affect prices five or even 10 years from now, if at all.

As my colleague Byron King pointed out in "Bakhtiari's Event of the Century," concerns about oil scarcity are not likely to be taken very seriously until the world faces a crisis -- a crisis that could impose serious change on financial markets. I agree with Byron that the issue of future scarcity will be addressed only "if informed people and the industrial and political policymakers of the world actually take Peak Oil as a serious matter and set policy accordingly."

Unfortunately, right now, long-term perspective hardly exists in industrial and political policies. A pair of economists recently tested the logical assumption that most free market operators extract oil as fast as they can, rather than maximize the productive life of a reservoir. Why? From the perspective of those funding massive projects, a barrel of oil produced this year is far more valuable than a barrel produced 15 years into the future.

Technology Cannot Completely Mitigate Oil Scarcity

The history of large oil projects shows that technology -- while vital to extending the boundaries of exploration -- has rarely been able to reverse a depleting field once it's passed peak production. In a paper entitled "Technology and Petroleum Exhaustion: Evidence From Two Mega-Oilfields," John Gowdy and Roxana Julia, two economists from Rensselaer Polytechnic Institute, tested the assumption that technology can ramp up oil production on demand. Here's the abstract:

"In this paper, we use results from the Hotelling model of nonrenewable resources to examine the mainstream view among economists that improvements in recovery technology can offset declines in petroleum reserves. We present empirical evidence from two well-documented mega oil fields: the Forties in the North Sea and the Yates in West Texas. Patterns of depletion in these two fields suggest that technology temporarily increases the rates of production at the expense of more pronounced rates of depletion in later years -- in line with Hotelling's predictions. Insofar as our results are generalizable, they call into question the view of most economists that technology can mitigate absolute resource scarcity. This raises concerns about the capacity of current mega-fields to meet future oil demand."

The "Hotelling model" refers to a rule outlined by 20th-century economist Harold Hotelling. Hotelling was noted for his work on the economics of nonrenewable natural resources. He argued that prices for scarce natural resources rarely include an accurate premium for scarcity. But as we're seeing, the scarcity premium, or "fear premium," is growing and is likely to increase as more evidence of scarcity arrives.

Generations ago, Hotelling was ahead of his time in arguing for a scarcity premium. It simply can't develop when aboveground supplies are consistently ample. But this has changed over the past few years. Rather than being seen as a mere commodity price, the price of oil should be viewed as a combination of production costs, profit, taxes, and scarcity premium. Economics textbooks tell us that, over the long run, a commodity will sell at its marginal cost of production, but evidence is growing that the different grades of crude oil are making oil less and less of a "commodity" in the economic sense.

Available Oil Becoming Heavier, More Sour

The widely held assumption that technology can immediately address a shortage of crude oil fails to address the quality of the crude we have to work with. World refining capacity is not optimized to deal with the reserves that remain. David Wood & Associates clearly shows in the following diagram that light, sweet crude is growing increasingly scarce. This diagram, published in the April issue of Petroleum Review, is a great snapshot of the oil production that refiners have to work with. The size of each of these bubbles is proportional to 2005 production volumes:

Source: www.dwasolutions.com

Wood concludes from his studies that "The average global crude oil currently produced has an API gravity close to 32 degrees and a sulfur content in excess of 1 weight percent (wt %). Only some 20% of global oil production supply can be classified as light and sweet, with the remaining 80% or so classified as medium/heavy and sour [emphasis added]."

But perhaps more importantly, "Medium-gravity, sour crudes dominate the oil production from the Middle East and Russia, and heavier crudes are dominating remaining oil reserves." This chart, from the July 2006 issue of Strategic Investment, shows that over time, crude has become heavier and more sour. The axes on this chart are the opposite of David Wood's chart, but the red dots show a clear historical trend of declining average crude quality:

This trend is reflected in growing spreads between the prices of West Texas Intermediate blend, which is a type of light, sweet crude, and imported crude oil blends, which tend to be heavier and more sour. If you want to participate in the investment boom, pay close attention to new refinery construction projects and the refiners that are consistently forward-looking.

Economist Ed Yardeni included the following chart in his firm's latest energy publication:

Source: www.yardeni.com

How are foreign producers reacting to the fact that most of their reserves are of lower quality and will be expensive and difficult to produce and refine? They'll take their time to ramp production to meet Western demand -- and charge higher prices. This involves reasserting control over their remaining resources. Yardeni made a great point in a recent morning briefing:

"We still believe that the cheapest oil in the world is in the U.S. stock market. The sector's profit margin was 10.4% during Q4 2006, exceeding the S&P 500's 8.5%. P/Es have been held down by investors' perceptions that oil prices and forward earnings aren't likely to rise much from here. We agree, but they aren't likely to fall much, either, from their lofty heights. So the industry should have lots of cash flow and M&A activity over the next couple of years. The most challenged industry, yet the one most likely to have plenty of cash for acquisitions, may very well be integrated oil and gas, with the sector's biggest market cap share at 63%. National oil companies are increasingly demanding that the international majors basically accept a service fee for managing their production without much, if any, upside [emphasis added]. This might be one reason why analysts' long-term expected earnings growth for the sector has dropped from a record high of 12.3% three months ago to 10.0% in March."

Service fees? This goes a long way in explaining why executives at big oil companies like to keep public attention focused on their mega-projects, rather than talk openly about the chance that leaders of oil-rich, underdeveloped countries may choose to follow the Hugo Chavez/Vladimir Putin playbook.

Geopolitics Remains a Wild Card

ASPO-USA's latest Peak Oil Review describes the situation on the ground in Nigeria in the wake of last weekend's presidential elections. This country must give several big oil executives sleepless nights, considering the billions they've invested in major projects within reach of violent, kidnapping gangs:

"Among the more interesting incidents surrounding the election was a failed attempt to blow up the national election commission's headquarters with a gasoline truck, plus a massive assault by insurgents on the Bayelsa State Government House in the capital Yenagoa. Nine boatloads of insurgents emerged from the creeks, overcame the police and military forces in the town and burned the governor's mansion and a police station. The governor, who is also expected to be declared the new vice president of Nigeria, was forced to flee the city for his life.

"The raid illustrates the growing power of insurgents to strike at will and overcome corrupt and ineffective police and military forces. Some weeks back, the insurgents announced a stand down during the run-up to the election but vowed to be back unless the election led to significant changes -- which it clearly did not.

"Nigerian oil production dropped by another 100,000 b/d during March to 2.15 million b/d. Although the Nigerian government has been saying recently that Shell will soon resume 300,000 b/d of shut-in production [at Forcados], Shell has yet to confirm this claim. Foreign oil workers in Nigeria now are largely confined to fortified compounds and travel to job sites by armored vehicle or helicopter [emphasis added]. A number of companies have pulled out of the country.

"There was nothing in the recent elections to suggest that the situation will improve soon. The insurgents have said they will step up attacks following the election and usually make good on their promises. Prospects for reduced Nigerian oil production seem likely."

This is a situation in which those fighting for a larger share will keep fighting until they get it. Pressure on the Nigerian government to share the oil wealth will keep mounting. Oil companies operating in the region should beware windfall profits taxes, or even forced changes to production-sharing agreements. Algeria recently set a very alluring precedent for those countries looking to balance the interests of both their citizens and the oil companies.

It's Mayday for a Few Big Oil Companies

Last week's Wall Street Journal had a piece describing this trend:

"Even some nations that are new to the oil game are demanding stiff terms. Some of the biggest finds in recent years have been in Angola, which has popularized an oil-production contract built on progressive taxation. As oil prices rise, boosting an oil company's rate of return, Angola's share of the proceeds also goes up."

This "progessive taxation" idea will probably catch on elsewhere -- a good reason for energy investors to own a few oil service stocks. Regardless of how the resource wealth is shared, more oil field exploration and development must be done. It looks like the Venezulan government has decided to move forward with major development projects practically on its own, but it may enlist the services of companies like Schlumberger or Baker Hughes when it runs into trouble down the road.

Next Tuesday, May 1, marks the end of private control of the vast heavy-oil deposits in Venezuela's Orinoco basin. This is obviously negative for long-term oil supply, as Chavez has already demonstrated that PDVSA cannot even maintain its conventional oil production. How anyone can expect much out of the Orinoco Basin -- as long as Chavez is running things -- is beyond logic. The Journal continues:

"To grab more of that profit for itself, the Venezuela government broke existing contracts. Income taxes on heavy-oil projects over the past couple years rose to 50% and royalty rates doubled, to 33%, having previously been raised from the original 1%. The government also legislated that the state oil company, Petroleos de Venezuela SA, be given a 60% stake in existing fields by May -- and thus a majority of future profits."

Fadel Gheit, an energy analyst from Oppenheimer & Co., concludes the article with an image any baseball fan will recognize: "'This is like drafting a kid to the major league and he's making $100,000 a year. All of a sudden, he is hitting 50 home runs. Guess what, he wants to renegotiate his contract, and under the circumstances, one can understand the way Chavez feels.'"

Despite how distasteful it is to view the world from the perspective of a socialist dictator dismantling his country, Gheit makes a good point. It may not be great for oil consumers, or follow the rules of the free market, but a few more emerging oil-producing countries may look to "renegotiate their contracts." What big oil could lose in volume over the coming decade, it must make up in price -- if regulators allow such a thing. So energy investors should hedge positions in big oil stocks with positions in leading oil service stocks.

Good investing,
Dan Amoss, CFA

for Whiskey and Gunpowder

Dan Amoss CFA is managing editor of Strategic Investment, the highly respected US newsletter. Previously Dan worked at Investment Counselors of Maryland - investment advisors tor one of America's top small-cap value mutual funds over the past 15 years.