And Iran, Iran So Far Away

Great article in the FT about Iran and oil recently. Yahoo also ran it. It’s called Faith-based frenzy that unites Iran with the oil speculators, by John Dizard

The speculator part of the story is interesting…you can read it on your own. The Iran part is even better: According to the author, Iran will be screwed if the price of crude declines, so they need a massive geopolitical crisis to stay in business. That’s why they’re doing all this nuke stuff now. But they won’t be able to milk that game forever, the author says, and when the music stops the brinksmanship will, too.

My own guess is that it is factors like the nuclear brinksmanship, in addition to the possibility of Peak Oil and disruptions in places like Nigeria and perhaps the Gulf of Mexico that will keep the game going for a long time…Anyway, here’s a lengthy excerpt for your intense reading pleasure:
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....There is a shortage of refined product, because that takes big, complicated plants that take a long time to build and are difficult to operate. That's too much like work for people in the developed world. So the developed world (and its speculators) is effectively long crude and short refined product.

There will continue to be a shortage of refined product, in part due to price controls on product in fast-growing parts of the world. One of those places is Iran, which heavily subsidises refined products, which it has to import. According to Iran's numbers, they use 50 per cent more petrol per capita than Americans.

So Iran is long crude and short refined product. Just like the speculators, it needs a high and rising oil price. Without $70+ oil, Iran would face fiscal disaster. In the Iranian fiscal year just ended, government expenditure rose by 25 per cent, or27 per cent above what was budgeted. Only high oil receipts kept government finances from collapsing. Most of the increased spending went to operating expenses such as salaries and price subsidies, rather than capital expenditure. That will be hard to cut. The report of an IMF mission to Iran from last December said a "fiscal adjustment", or government spending cut, of 3 per cent of gross domestic product would be needed, along with tightened monetary policy.

To avoid that, Mahmoud Ahmadinejad, Iran's president, needs crude oil prices to keep rising. I don't know why people think he's insane. Creating a panic over the prospects for oil supply is his only way out. If Gulf crude oil were to decline to $40 a barrel, the long-term upward price trend would remain in place, expensive substitute supplies such as the Canadian tar sands would still be economic, and the rest of the Middle East would still prosper, though at a less frenzied pace.

Light Crude (NYMEX) prices

But those who bought the ETFs and the "sophisticated" investors who bought into crude-long hedge funds would lose a lot of money. When they started liquidating their futures positions and selling ETF shares, the product behind those holdings would also be sold, eventually, to refineries, which would accelerate the price decline. And the Ahmadinejad administration would be finished.

This won't take that long. Energy prices are cyclical. The underlying physical and economic laws haven't been repealed. We are talking about a year or two until this happens, based on past experience.

Nationalist frenzies in commodity exporting countries collapse with the decline of commodities prices. It always happens. This time will be no different. The professional commodities players will go back to making nickels and dimes off rolling their contracts into a backwardated market. The war freaks will slink back to their think-tanks.