$68 Oil, Gold and Iraq Jude Wanniski August 25, 2005

There is no shortage of speculation on why the price of oil continues to inch up -- topping $68 bbl this week for the first time. How high it will go? Matthew Simmons, the neo-Malthusian oil expert, says it will hit $200 bbl, in today`s dollars, in 2010, and has bet John Tierney of the New York Times $10,000 that it will happen. We would take the same bet, especially as Simmons agreed to an inflation adjustment, which would mean the gold price would not be a factor. Where under normal conditions of long-term dollar stability gold would buy 14 bbl of oil, Simmons sees demand for oil outpacing supply that in just five years an ounce would only buy 2.2 barrels. 

In our analytical framework, if the dollar gold price remained constant at today`s $444 for the next five years – which could easily be done if the Federal Reserve switched from a federal funds target to a gold target at that price – the price of oil would drop to $31 bbl or thereabouts. That`s because the gold target eliminates the geopolitical risks associated with oil and also permits the capital markets to avoid the risks associated with the floating dollar. Without question, long-term capital would again push inventory cushions to 10-to-15% of daily consumption from today`s absence of any real inventory cushion at all. When the strike by oil workers in Ecuador can increase the world oil price to $68, or today`s news that a tropical storm in the Gulf won`t hit oil rigs cuts the world oil price below $68, we can be sure oil prices will be at a significant premium to gold.

Which brings us to Iraq, which after Saudi Arabia`s 261 billion bbl and Iran`s 125 b/bbl has the third highest proven reserves of liquid oil at 115 b/bbl and as far as we know has not drilled a new exploratory well in 15 years. Vice President Cheney, formerly of Halliburton, in 2003 predicted that Iraq would soon be producing 3 million barrels a day, the great majority for export to earn the funds to pay for the occupation and reconstruction. In the first four months of 2005 for which statistics are available, Iraq had been exporting a mere 925,000 bbl per month out of a total average production of less than 1,800,000 bbl per month.

This is when the Bush administration and the world oil markets still believed that the unfolding political process would result in a dramatic decline in violence in Iraq. The idea was that with elections, a new constitution, and a new government reflecting the aspirations of all Iraqis, the Iraqi people would assert their vested interest in protecting the nation`s oil resources. If so, we might soon expect Iraq to not only be exporting more than 2 million bbl per day, but also be developing new oil fields to expand reserves. 

Instead, the political process has clearly broken down, with the insurgency against the interim government growing worse every day. The latest deadline for a new constitution seems to have been suspended indefinitely. This reflects the fact that there can be no deal as long as two of the three factions involved in writing the constitution insist on a decentralized, sectarian, federalist state and the third insists on a centralized, secular nation-state. What does this mean for the world oil price?

As far as we know, there is still a flow of oil from northern Iraq, but here is a report I received Tuesday from a reliable Iraqi contact I have in London, a surgeon who lived in exile in opposition to the Hussein regime, but who opposed the U.S. war:

You may wish to know the following news, which I have just received from Iraq:

* Oil export from the south of Iraq has stopped completely because of the total lack of electricity.

* Demonstrations erupted in three major cities, Najaf, Diwaniyyah, Samawah as the first phase of civil disobedience. Further demonstrations are planned next Friday in other major cities.

* Muqtada Al-Sadr has just asked his followers in all the country to demonstrate peacefully next Friday after his warning two weeks ago to the puppet government to improve basic services to the Iraqi people. Today he issued an ultimatum to the government together with a call to his supporters and all Iraqis to demonstrate next Friday after prayer.

* More demonstrations have erupted in several other small cities against the planned constitution and federalism.

* It seems that Iraq is heading to a major civil disobedience and/or civil war between the supporters of the puppets installed in Iraq and the rest of political parties, movements, including the armed resistance. This phase of uprising was anticipated simply because of those appointed in the government have nothing to do but to strip the wealth of Iraq for their own benefit, which include stealing, bribery, and adding to it the spread of bribery in every government`s offices.

What we are seeing is potentially a total shutdown of Iraqi exports by the growing success of the insurgency, which had been blowing up pipelines that could be quickly repaired and are now blowing up power stations that shut down oil flows indefinitely. How President Bush can continue to insist that things are improving can only be explained by the failure of his foreign-policy team to see that the path Baghdad has been on moves the country further away from U.S. national interests. The federalist path would produce a Shiite government in control of the oil fields of Southern Iraq, controlled not from Baghdad but from Tehran. What should we have expected when the "interim government," with U.S. approval, selected an Iranian Shiite cleric, Humam Hamoudi, as head of the constitution drafting committee. 

As my source in London put it in another missive: "Ahmed Chalabi is the man behind all the trouble!!! He is the one behind the call for cutting the south, as he called it through federalism, which will eventually be handed to Iran. He was the one behind signing the recent agreement with Iran to build an oil pipeline between Basrah and an Iranian oil export port. Imagine, Iran exports oil to Iraq. Do you believe this?"

Chalabi, the deputy prime minister of the interim government, is of course the fellow who provided most of the "intelligence" to the Bush administration that led to the decision for war. The man has been part of the neo-con network in the U.S. for decades -- from his college days at the University of Chicago with Paul Wolfowitz, our new World Bank president. Chalabi, like the others in the Baghdad government, supported Iran during the eight-year Iran/Iraq war. He is now supposedly out of favor in the Oval Office, but his influence still dominates the Vice President`s Office, via the neo-con network. 

There may still be another effort to get a "partial constitution" through the National Assembly, to buy time for Washington to pull a rabbit out of a hat. But we must expect that the insurgents – representing the anti-Iranian nationalists, not the Sunnis or the Ba'athists -- will pay no attention to it. They will step up the costs until there is a decision from the administration to leave Iraq on a timetable that is sooner, not later. Until this happens, the world oil markets have to assume there will be no relief from Iraq`s considerable reserves. This leaves us with the monetary/gold option. We wonder if Alan Greenspan will mention gold tomorrow in his Denver swan song.