Trends I'm Watching

A Possible Solution to the Iraq Chaos

Trend: A political compromise between Iran, Saudi Arabia, and the United States has potential for calming the Iraq situation.

In John Mauldin's InvestorsInsight: Thoughts From The Frontline, George Friedman of Stratfor addresses the recent three party discussions between the Americans, Iraqis, and Iranians. He says that both Iran and the US realize that neither party can achieve their objective and that no single party can control or stabilize Iraq without the explicit cooperation of all parties. Further, the risk that everything spins out of control is forcing negotiations among enemies. Excerpts below.

Link: InvestorsInsight : Thoughts From The Frontline

There are three major powers with intense interest in the future of Iraq: the United States, Iran and Saudi Arabia. The United States, having toppled Saddam Hussein, has completely mismanaged the war. Nevertheless, a unilateral withdrawal would create an unacceptable situation in which Iran, possibly competing with Turkey in the North, would become the dominant military power in the region and would be in a position to impose itself at least on southern Iraq -- and potentially all of it. Certainly there would be resistance, but Iran has a large military (even if it is poorly equipped), giving it a decided advantage in controlling a country such as Iraq.

In addition, Iran is not nearly as casualty-averse as the United States. Iran fought a war with Iraq in the 1980s that cost it about a million casualties. The longtime Iranian fear has been that the United States will somehow create a pro-American regime in Baghdad, rearm the Iraqis and thus pose for Iran round two of what was its national nightmare. It is no accident that the day before these meetings, U.S. sources speculated about the possible return of the Iraqi air force to the Iraqis. Washington was playing on Tehran's worst nightmare.

Saudi Arabia's worst nightmare would be watching Iran become the dominant power in Iraq or southern Iraq. It cannot defend itself against Iran, nor does it want to be defended by U.S. troops on Saudi soil. The Saudis want Iraq as a buffer zone between Iran and their oil fields. They opposed the original invasion, fearing just this outcome, but now that the invasion has taken place, they don't want Iran as the ultimate victor. The Saudis, therefore, are playing a complex game, both supporting Sunni co-religionists and criticizing the American presence as an occupation -- yet urgently wanting U.S. troops to remain.

The United States wants to withdraw, though it doesn't see a way out because an outright unilateral withdrawal would set the stage for Iranian domination. At the same time, the United States must have an endgame -- something the next U.S. president will have to deal with.

The Iranians no longer believe the United States is capable of creating a stable, anti-Iranian, pro-American government in Baghdad. Instead, they are terrified the United States will spoil their plans to consolidate influence within Iraq. So, while they are doing everything they can to destabilize the regime, they are negotiating with Washington. The report that three-quarters of U.S. casualties in recent weeks were caused by "rogue" Shiite militia sounds plausible. The United States has reached a level of understanding with some nonjihadist Sunni insurgent groups, many of them Baathist. The Iranians do not want to see this spread -- at least not unless the United States first deals with Tehran. The jihadists, calling themselves al Qaeda in Iraq, do not want this either, and so they have carried out a wave of assassinations of those Sunnis who have aligned with the United States, and they have killed four key aides to Ayatollah Ali al-Sistani, a key Shiite figure.

If this sounds complicated, it is. The United States is fighting Sunnis and Shia, making peace with some Sunnis and encouraging some Shia to split off -- all the time waging an offensive against most everyone. The Iranians support many, but not all, of the Shiite groups in Iraq. In fact, many of the Iraqi Shia have grown quite wary of the Iranians. And for their part, the Saudis are condemning the Americans while hoping they stay -- and supporting Sunnis who might or might not be fighting the Americans.

The situation not only is totally out of hand, but the chance that anyone will come out of it with what they really want is slim. The United States probably will not get a pro-American government and the Iranians probably will not get to impose their will on all or part of Iraq. The Saudis, meanwhile, are feeling themselves being sucked into the Sunni quagmire.

Six market waves

Trends: Alternative energy, Mine Resistant Ambush Protected (MRAP) vehicles, clean water, biotech, 'Chindia' middle class, and jetliners could be fertile ground for investing in the near future.

Tobin Smith describes six major waves that ChangeWave Investing has identified for investers looking for market gains. Excerpts below.

Link: Tobin Smith Journal

1. Alternative energy wave

2. Mine Resistant Ambush Protected (MRAP) vehicles wave

3. Clean water wave

4. Biotech wave

5. 'Chindia' middle class wave

6. Jetliner wave

These markets don't come all the time. It's certainly here for the next two to three years, but beyond that I couldn't tell you.

We are guided by our ChangeWave Alliance research as we continue to expand our horizons -- meaning we're on the lookout for the niche companies and sectors in which we can double our money every two to three years.

I've got to be a stock market cheerleader because you're going to hear all sorts of bad news this summer about subprime loans. You know we're going to get a pullback, but it's that pullback that gives you the next great buying opportunity.

The way you make market-doubling and market-tripling returns every year is to be ahead of the crowd.  You've got to be in the right places at the right time at the right price.

Geopolitical Events Accelerate Peak Oil

Trend: The oil in the ground will not have an easy and peaceful transport to the consumers who need it most in the future.

Jeff Vail at Energy Intelligence writes that “above-ground factors”, driven by the geological reality,  will accelerate the decline in global oil production beyond that predicted by models derived from logistics curves. Excerpts below.

Link: Jeff Vail: Energy Intelligence

...geopolitical side-effects of peaking global production will accelerate the rate of production decline, as well as increase the impact of that production decline by simultaneously increasing marginal demand pressures. The result: the right side of the global oil production curve will not look like the left…whatever logistics curve is fit to the left side of the curve (where historical production increased), actual declines in the future will be sharper than that curve would predict.

1. Return on Investment: Increased scarcity of energy, as well as increased prices, increase the return on investment for attacks that target energy infrastructure. up the price, which further increases the ROI for such attacks.

2. Mercantilism: To avoid the dawning “bidding cycles” between crude oil price increases and demand destruction, Nation-States are increasingly returning to a mercantilist paradigm on energy. This is the attitude of “there isn’t enough of it to go around, and we can’t afford to pay the market price, so we need to lock up our own supply.”

Russia, Iran, and Saudi Arabia

Trend: Russia is aligning with Iran to counter the US military and Saudi Arabia energy policies.

Stratfor President George Friedman discusses the long-term strategy that Russian President Vladimir Putin is setting in place in John Mauldin's Outside the Box at InvestorsInsight. Excerpts below.

Link: InvestorsInsight : John Mauldin's Outside the Box

The two main Islamic powers between the Levant and the Hindu Kush are Saudi Arabia and Iran. The Russians have things they want from each, but the Saudis and Iranians have dramatically different interests. Saudi Arabia -- an Arab and primarily Sunni kingdom -- is rich but militarily weak. The government's reliance on outside help for national defense generates intense opposition within the kingdom. Desert Storm, which established a basing arrangement for Western troops within Saudi Arabia, was one of the driving forces behind the creation of al Qaeda. Iran -- a predominantly Persian and Shiite power -- is not nearly as rich as Saudi Arabia but militarily much more powerful. Iran seeks to become the dominant power in the Persian Gulf -- out of both its need to defend itself against aggression, and for controlling and exploiting the oil wealth of the region.

Putting the split between Sunni and Shiite aside for the moment, there is tremendous geopolitical asymmetry between Saudi Arabia and Iran. Saudi Arabia wants to limit Iranian power, while keeping its own dependence on foreign powers at a minimum. That means that, though keeping energy prices high might make financial sense for the kingdom, the fact that high energy prices also strengthen the Iranians actually can be a more important consideration, depending on circumstances. There is some evidence that recent declines in oil prices are linked to decisions in Riyadh that are aimed at increasing production, reducing prices and hurting the Iranians.

This creates a problem for Russia. While Moscow has substantial room for maneuver, the fact is that lowered oil prices impact energy prices overall, and therefore hurt the Russians. The Saudis, moreover, need the Iranians blocked -- but without going so far as to permit foreign troops to be based in Saudi Arabia itself. In other words, they want to see the United States remain in Iraq, since the Americans serve as the perfect shield against the Iranians so long as they remain there. Putin's criticisms of the United States, as delivered in Munich, would have been applauded by Saudi Arabia prior to the 2003 invasion of Iraq. But in 2007, the results of that invasion are exactly what the Saudis feared -- a collapsed Iraq and a relatively powerful Iran. The Saudis now need the Americans to stay put in the region.

MIT’s smart flying drones

Trend: The market for unmanned aerial vehicles (UAVs), which can reduce casualties and costs in many martial environments, may see significant growth in the next few years.

Emerging Technology Trends at ZDNet.com describes unmanned aerial vehicles (UAVs) being developed at MIT. Excerpts below.

Link: » MIT’s smart flying drones | Emerging Technology Trends | ZDNet.com

MIT researchers have developed a multiple-UAV test platform which can be operated by anyone with a high-speed Internet connection. And these small and inexpensive helicopters could soon stay in the air for a week, automatically coming back to their base and landing to recharge their batteries.

Here are additional details provided by Lauren Clark, who wrote an article about MIT's intelligent aircraft for MIT News (September 26, 2006).

The test platform consists of five miniature "quadrotor" aircraft — helicopters with four whirling blades instead of one — each a little smaller than a seagull. It also includes an indoor positioning system, as well as several miniature autonomous ground vehicles that the UAVs can track from the air.

Each UAV [, costing only about $700,] is networked with a PC. The setup allows a single operator to command the entire system, flying multiple UAVs simultaneously. Moreover, it requires no piloting skills; software flies the vehicles from takeoff to landing.

If you think that the UAV business is small, you're wrong. According to the Boston Globe, it "will represent a $55 billion worldwide market over the next 10 years. Annual spending on flying drone systems could triple, to $8.3 billion in 2016 from $2.7 billion now."

Big Oil Says Forget about Peak Oil

Trend: Big Oil denies that Peak Oil is real; therefore, alternatives to fossils fuels are not needed.

Jim Jubak at MSN Money describes the efforts of Big Oil representatives to reassure oil consumers that there's plenty of oil for the forseeable future. According to their pronouncements, there's no reason to develop alternative energy technologies. Why would anyone doubt their motivations?

Even if Peak Oil is predicting the decline of oil too early, what about climate change and dependence on terrorist supporting states?

Has Big Oil dropped the price of oil recently to stifle the development of alternative energy technologies?

Below are some excerpts from Jubak's article.

Link: 3 stocks for a world running out of oil - MSN Money

...the National Petroleum Council, a federally chartered and privately funded oil-industry research group, ...graciously agreed to a request from the U.S. Department of Energy to "study" claims that world oil production has peaked. Lee Raymond, former chairman of ExxonMobil and current chairman of the National Petroleum Council, will chair the study, due in the summer of 2007, of "peak oil." Proponents of peak oil say that while the world isn't about to run out of oil tomorrow, global oil production has peaked, in 2005 possibly, or will soon peak, around 2010 possibly.

Talk about putting the fox in charge of the henhouse.

We can anticipate the study's conclusion from public comments made by ExxonMobil and Raymond. Mark Nolan, ExxonMobil's chief in Australia, told an oil-industry conference in September that "the end of oil is nowhere in sight." ExxonMobil officials are fond of citing the U.S. Geological Survey study that estimates that only 1 trillion barrels of a total 3 trillion barrels of conventional recoverable oil has been produced.

You don't have to be much of a conspiracy theorist to understand why companies sitting on the biggest oil reserves would want to convince us all that oil production hasn't peaked. If the slide to crisis isn't gradual, it could set off alarm bells and lead to a crash program to develop alternatives to oil -- not a happy development for oil companies. A base price of $55 a barrel this year, $60 next year and $65 the year after that is certainly preferable to a sudden peak to $200 a barrel that leads to the vast investment in wind and solar power and alternatives to gasoline-powered vehicles. Too much investment in alternatives could drive down global demand for oil while oil owners still have a big supply of oil in their inventories. Better to convince consumers there's plenty of oil so they'll keep buying even as the price gradually increases.

Listen to state-owned Saudi Aramco's Chief Executive Abdallah Jum'ah make exactly this point at a speech in Vienna in September:

The world has produced only 18% of the earth-producible potential of 5.7 trillion barrels of oil, he said, using a resource estimate 90% above the U.S. Geological Survey's estimate. "That fact alone should discredit the argument that peak oil is imminent, and put our minds at ease concerning future petroleum supplies." The remaining 4.7 trillion barrels of oil is enough to last more than 140 years, he added.

In other words relax, do nothing and just keep buying our oil with your dollars.

Peak-oil advocates such as Kenneth Deffeyes, an emeritus professor of geology at Princeton University and author of "Beyond Oil: The View from Hubbert's Peak," pretty effectively punch holes in those numbers, in my opinion. I don't know if Deffeyes hit the mark exactly when he pegged December 2005 as the peak year for global oil production, but I am convinced by his geologist's logic in predicting a long-run decline in oil production from conventional sources in the near past or the not-too-distant future. (I highly recommend "Beyond Oil" for its solid summary of the geology behind peak oil and its level-headed assessment of other energy sources.)

Oil and Politics

Trend: Alternatives to oil can undermine the empires currently funded by oil profits.

John Mauldin's Outside the Box on the InvestorsInsight web site presents an essay by Charles Gave of GaveKal focusing on the decline of oil as an energy source and the effects on global politics.

Link: InvestorsInsight : John Mauldin's Outside the Box

The fact that oil is mostly controlled by unreliable lunatics (Iran, Venezuela, Russia, Iraq...) should lead the non-lunatic parts of the World to invest - regardless of the costs involved - to achieve energy independence (this is what France did in the 1970s and 1980s with its nuclear program, though few countries decided to follow this path). This process will likely involve massive wastes of capital (but then, that is the price of independence). It will also push oil-producing nations towards political irrelevance. This movement will take place in three steps.

In the first step, the lunatics have a field day.

In the world today, there are massive possibilities to explore for oil, and there is certainly no shortage of oil discoveries to be made. However, almost everywhere there is a chance to find oil, the underground has been nationalized. As a result, the oil companies that have the technology can not drill, while the countries that have the oil do not have the technology, nor the will to look for it.

Most of the existing oil-producing countries have done the analysis that there is much more in it for them if they do not develop their capacities since, as a result, oil prices shoot upwards. Being usually totally uneducated (e.g.: Chavez), these leaders believe in the Malthusian legend that there will not be enough oil for everyone and that its price can thus only go higher. In their (very limited) minds they believe that their strategy has no downside. They will be disappointed in the not so distant future, when the market reasserts itself.

With oil at US$70/bl, Iran gets roughly US$70bn per annum in oil exports. Half of that money goes to domestic subsidies (food, oil, transportation, etc...). The rest goes to the mad mullahs' pet projects, such as developing nuclear weapons, sending weapons to Hezbollah, subsidizing terrorism... If and when the oil price goes down to US$35/bl, our mad mullahs will no longer have any money to buy rockets to lob into Israel's coastal towns. At US$20/bl, they will no longer have the money to feed their rapidly growing and young population; we could then have a revolution in Iran.

If the US administration is thus serious about regime change (and we hope that they are, for there is little to like in the current Iranian regime), then the way to achieve it is to trade in the Humvees, boost electric cars, put on a sweater in the winter, and build nuclear power plants. Unfortunately, our reader might say, this is hardly happening. Our conspiracy-theory inclined clients might also point out that such a course of action is unlikely to become national policy in the US as long as the president hails from Texas and the Veep from Halliburton... But the interesting fact here is that, while it might not be happening in the rich United States (where spending on energy as a percentage of disposable income remains tolerable, even after the past few years' increases), it could be starting to happen in other markets such as China, Thailand, South Korea, Japan, India...

In every past energy cycle, whenever capacity of production was reached, oil producing nations, rather than let our companies drill (or drill themselves) to increase production, instead tried to extract from their customers the maximum amount in the shortest time period possible. On top of it, oil-producing nations would usually try to capture unearned and undue political advantage. The local governments call that 'using the oil weapon'. The Arab nations did it in the 1970s. Venezuela, Iran and Russia are doing it today. And one can get away with using the 'oil weapon' for a while, but not for a long while.

...we continue to believe that the structural decline of oil will happen sometime in the coming quarters. After the 1970s/early 1980s boom and bust, it took twenty-five years for oil to recapture its previous highs.

Once the coming bust gets underway, oil may never recapture the highs it makes (made?) in the current cycle, if for no other reason that, twenty years ago, there was no credible alternative for short-haul transportation, heating, air conditioning, etc... (Remember Chernobyl, Three Mile Island...). Today, and even more tomorrow, credible alternatives will be in place.

Our 19th century world was dominated by coal. Our 20th century was dominated by oil. It is our firm belief that the 21st century will not be dominated by oil. It will be dominated by electricity; and oil will become a marginal energy. This simple truth might help explain why, since 2001, uranium has not had a single down month, and since 2003, uranium has never traded down for even a single day, regardless of what was happening to oil prices.

As oil becomes irrelevant, one should probably expect serious political turmoil, and revolutions, in Venezuela, Russia, Iran... Which, of course, would be a shame and could not happen to a nicer bunch of people.

Iran's Strategy in the Persian Gulf

Trend: Iran is expanding its power and gaining credibility with Muslims in the Middle East.

In John Mauldin's InvestorsInsight - Outside the Box, George Friedman, the President of Stratfor.com, has posted a reality based in-depth and logical analysis of the dilemma facing the U.S. on the situation in Iraq.

Link: InvestorsInsight : John Mauldin's Outside the Box

The Iranians had always wanted an Iraqi satellite state, as protection against another Iraq-Iran war. That was a basic national security concept for them. In order to have this, the Iranians needed an overwhelmingly Shiite-dominated government in Baghdad, and to have overwhelming control of the Shia. It seemed to us that there could be a Shiite-dominated government but not an overwhelmingly Shiite government. In other words, Iraq could be neutral toward, but not a satellite of, Iran. In our view, Iraq's leading Shia -- fearing a civil war and also being wary of domination by Iran -- would accept this settlement.

We may have been correct on the sentiment of leading Shia, but we were wrong about Iran's intentions. Tehran did not see a neutral Iraq as being either in Iran's interests or necessary. Clearly, the Iranians did not trust a neutral Iraq still under American occupation to remain neutral. Second -- and this is the most important -- they saw the Americans as militarily weak and incapable of either containing a civil war in Iraq or of taking significant military action against Iran. In other words, the Iranians didn't like the deal they had been offered, they felt that they could do better, and they felt that the time had come to strike.

A Two-Pronged Offensive

When we look back through Iranian eyes, we can now see what they saw: a golden opportunity to deal the United States a blow, redefine the geopolitics of the Persian Gulf and reposition the Shia in the Muslim world. Iran had, for example, been revivifying Hezbollah in Lebanon for several months. We had seen this as a routine response to the withdrawal of Syrian troops from Lebanon. It is now apparent, however, that it was part of a two-pronged offensive.

First, in Iraq, the Iranians encouraged a variety of factions to both resist the newly formed government and to strike out against the Sunnis. This created an uncontainable cycle of violence that rendered the Iraqi government impotent and the Americans irrelevant. The tempo of operations was now in the hands of those Shiite groups among which the Iranians had extensive influence -- and this included some of the leading Shiite parties, such as SCIRI.

Second, in Lebanon, Iran encouraged Hezbollah to launch an offensive. There is debate over whether the Israelis or Hezbollah ignited the conflict in Lebanon. Part of this is ideological gibberish, but part of it concerns intention. It is clear that Hezbollah was fully deployed for combat. Its positions were manned in the south, and its rockets were ready. The capture of two Israeli soldiers was intended to trigger Israeli airstrikes, which were as predictable as sunrise, and Hezbollah was ready to fire on Haifa. Once Haifa was hit, Israel floundered in trying to deploy troops (the Golani and Givati brigades were in the south, near Gaza). This would not have been the case if the Israelis had planned for war with Hezbollah. Now, this discussion has nothing to do with who to blame for what. It has everything to do with the fact that Hezbollah was ready to fight, triggered the fight, and came out ahead because it wasn't defeated.

The end result is that, suddenly, the Iranians held the whip hand in Iraq, had dealt Israel a psychological blow, had repositioned themselves in the Muslim world and had generally redefined the dynamics of the region. Moreover, they had moved to the threshold of redefining the geopolitics to the Persian Gulf.

This was by far their most important achievement.

The Hidden Cost of Imported Oil

Trend: The real cost of a gallon of gasoline is $10.86 in the United States when oil is $60 per barrel. In 2003, it was $5.20 per gallon.

Gas in oil-producing Venezuela sells for 14 cents a gallon, due to government subsidies by the Chavez administration. Many Americans think $3 a gallon gasoline is overpriced, but that is only about 30 percent of the real cost, according to the research of Milton Copulos.

Milton Copulos is president of the National Defense Council Foundation. He has researched energy issues extensively. Below are excepts from his presentation to the US Senate Foreign Relations Committee on March 30, 2006.

Link: Averting Disaster of Our Own Design

America is rushing headlong into disaster. What is worse, however, is that it is a disaster of our own design.

More than three decades have passed since the 1973 Arab Oil Embargo first alerted the nation to its growing oil import vulnerability. Yet, despite this warning, we are now importing more than twice as much oil in absolute terms than we did in 1973, and the proportion of our oil supplies accounted for by imports is nearly double what is was then. What makes this dependence even more dangerous than it was three decades ago is the fact that the global market has become a far more competitive place with the emerging economies of China, India and Eastern Europe creating burgeoning demand for increasingly scarce resources.

While it is broadly acknowledged that our undue dependence on imported oil would pose a threat to the nation’s economic and military security in the event of a supply disruption, less well understood is the enormous economic toll that dependence takes on a daily basis.

The principal reason why we are not fully aware of the true economic cost of our import dependence is that it largely takes the form of what economists call "externalities," that is, costs or benefits caused by production or consumption of a specific item, but not reflected in its pricing. It is important to understand that even though external costs or benefits may not be reflected in the price of an item, they nonetheless are real.

Today, crude oil prices are hovering around $60 per barrel and could easily increase significantly. Indeed, whereas in 2003 we spent around $99 billion to purchase foreign crude oil and refined petroleum products, in 2005 we spent more than $251 billion, and this year we will spend at least $320 billion.

But skyrocketing crude oil prices were not the only factor affecting oil-related externalities. Defense expenditures also changed.

In 2003, our armed forces allocated $49.1 billion annually to maintaining the capability to assure the flow of oil from the Persian Gulf.

I should note that expenditures for this purpose are not new. Indeed, last year marked the 60th anniversary of the historic meeting between Saudi monarch King Abdul Aziz and U.S. President Franklin Roosevelt where he first committed our nation to assuring the flow of Persian Gulf oil – a promise that has been reaffirmed by every succeeding President, without regard to party.

Because the price of crude oil is expected to remain the $60 range this year, expenditures for imports are expected to be at least $320 billion this year. That amounts to an increase of $70 billion in spending for foreign oil in just one year. That increase would raise the total import premium or "hidden cost" to $825.1 billion, or almost twice the President’s $419.3 billion defense budget request for fiscal year 2006. If all costs are amortized over the total volume of imports, that would be equivalent to adding $5.04 to the price of a gallon of gasoline. For Persian Gulf imports, the premium would be $8.35. This would bring the "real" price of a gallon of gasoline refined from Persian Gulf oil to $10.86. At these prices the "real" cost of filling up a family sedan is $217.20, and filling up a large SUV $325.80.

War and Peak Oil in the Middle East

Trend: The rising demand for energy underlies the escalating conflicts in oil-producing regions.

Below are excerpts from an article Middle East at a Crossroads by Richard Heinberg from EnergyBulletin.net | Peak Oil News Clearinghouse. We only pulled the peak oil material; the article also contains an eye-opening summary of Middle East political history.

Link: Middle East at a crossroads | EnergyBulletin.net | Peak Oil News Clearinghouse.

There is considerable danger that the smoke and fire from these three geographic flashpoints—Iraq, Iran, and Lebanon—could converge in a larger regional conflagration. In light of all this potential for apocalyptic mayhem, a discussion of the oil business may seem almost frivolous. But it is important to remember that, historically, the drawing of borders in the Middle East; the establishment of British, French, and later US-backed puppet governments in these faux nations; and the rise of a radical Islamic fundamentalist movement to challenge the Western-backed regimes, have all been fueled by the wealth produced by oil, and by the need for oil on the part of importing countries.

For decades there was a petroleum status quo of sorts in the Middle East: the capacity for production exceeded demand, and OPEC worked to restrain exports in order to keep prices from collapsing; meanwhile big producers like Saudi Arabia served as the world’s petroleum bankers, maintaining the solvency of the system. On only one occasion—the embargo of 1973-74—did the swing producers withhold needed oil flows for political reasons, or cause prices to reach levels unacceptable to consumers (the other major post-1970 oil shocks, due to wars or revolutions, were beyond OPEC’s control).

Now the status quo is crumbling—not so much for political reasons (though those are certainly imaginable, given the situations outlined above), but for reasons of geology.

Questions about the real size of Kuwait’s oil reserves have emerged in the Kuwaiti National Assembly, leading the opposition party to call for production cuts. Remarkably, Kuwait appears to be groping toward implementation of the Oil Depletion Protocol, without ever having heard of it. However, from the standpoint of nations that want to keep the oil flowing so the global industrial party can continue, this is bad news.

Even worse news, potentially, comes from Saudi Arabia, where oil flows have shrunk by some 400,000 barrels per day over the past few months, despite astronomic prices. No one knows for sure what is going on. The Saudis themselves say the production cuts are due to lack of demand, but this hardly seems plausible, unless the kingdom is only able to deliver unwanted heavy, sour crude to market—but even in that case, one would expect flows to increase, with a price discount factored in for resource quality.

At the same time, the Saudis are hiring just about every spare drilling rig in the world, resulting in a dramatically falling rig count in the Gulf of Mexico—a place that would otherwise be seeing an increasing count, given the fact that Mexico’s giant Cantarell field is in now in steep decline, with dire implications for the nation’s economy.

Matthew Simmons (Twilight in the Desert) has been insisting for the past few years that Saudi production is close to peak and that Ghawar, the world’s biggest field, may be in decline. Now many others are speculating that this is the real reason for the falling production figures.

What happens next? It depends on the real condition of Ghawar. Perhaps a heroic drilling campaign could result in a temporary bloom in production, lasting perhaps three years, followed by a swift, terminal collapse. On the other hand, it is possible that the field has been so thoroughly exploited already that we are seeing the irreversible, rapid decline. At the ASPO conference a well-connected industry insider who wishes not to be directly quoted told me that his own sources inside Saudi Arabia insist that production from Ghawar is now down to less than three million barrels per day, and that the Saudis are maintaining total production at only slowly dwindling levels by producing other fields at maximum rates. This, if true, would be a bombshell: most estimates give production from Ghawar at 5.5 Mb/d.

While these events in Kuwait and Saudi Arabia are not front-page news, they are in their way every bit as significant as the ongoing violence in Iraq and Lebanon, and the ritualistic war dance of the American and Iranian leaders. The Israel and Lebanon situation seems to be about religion, terrorism, and land; the US-Iran situation seems to be about nuclear proliferation. But if one looks beneath the surface, nearly everything of significance that happens in the Middle East is at least partly about oil.

It may be pure coincidence that, just as the world’s biggest oil producers are reaching a historic turning point signaling the end of the energy regime that has held since the end of US production dominance in 1970, a war has erupted between Israel and a militant organization supported by a nation the US plans to attack anyway in order to maintain dominance of world oil supplies going forward. History is full of such coincidences. But coincidence or not, it will be difficult to keep these unfolding realities from rebounding off one another, undermining attempts at a peaceful resolution.

via Investing the Middle Way