2006: The Year of the Balance Beam

As tempting as it may be to usher in the new year with a round of punditry and prophecy, I'll try to avoid speculating about what will happen in 2006, and instead just outline some possible events. There are a great deal of spectacular and monumental events that could happen in 2006, but in my opinion none of them are very probable. The thing is, dramatically improbable events happen all the time, simply because there are so many potential events that the occurrence of at least one is virtually assured, despite the improbability of each event individually. This is the troubling part about 2006: the sheer number of improbable but potentially catastrophic events that have raised their heads above water seems to me to suggest the great probability that at least one of them comes to pass. This situation is aggravated by the different gambits being put in play by many of the world powers, which with varying degrees of desperation and mutual incompatibility seem set to only exacerbate the situation. For that reason, I'm predicting that 2006 will be the year of the balance beam: imagine a few dozen bespectacled, middle-aged men sporting the full spectrum of gray attire trying to pass in opposite directions without pulling one another into the abyss. I forgot to mention that they're all connected with bungee cords. It could happen...

1. Bird Flu: Most likely won't happen this year, but it's certainly not impossible. But when it does come--and that seems almost certain at some point in the next 10-15 years--it will send shockwaves through every corner of the global system. A gradual onset over the course of several years would probably be best, but the sad reality of the current global health system is that we are most capable of preventing exactly the kind of gradual onset that could prevent an eventual, catastrophic outbreak.

2. Terrorism: Most likely there won't be an attack this year on the scale of 9/11, or even on the scale of Madrid or London. Most likely (notice the theme...). Al-Qa'ida, as a conceptual entity, is regrouping in Saudi Arabia, and will not likely crack that nut in the immediate future. The odds of a large-scale attack on the domestic United States are equally small--despite the evidence that several groups would like to proclaim their continued viability by such an attack, a smaller scale attack in Milan or Copenhagen is the most likely.

3. Iraq: Expect a settling period. The Iraqis have just concluded what was, by most measures, a "successful" election. But over the course of the new year the realization will gradually dawn that there is no correlation between a successful election and those elected politicians actually solving the country's problems. And they have many problems--most of which remain just as intractable as always. The insurgency has already shifted tactics following the elections to highlight just this problem--by shifting their focus back to the electrical system (and other infrastructure targets) they will undermine the ability of the democratic government to get anything done--aside from begin the creation of a de-facto system of channeling the majority of oil revenues to the Kurdish and Shi'a regions. Over the course of the year this will reverse the positive sentiment following the election and favor fragmentation. As this will likely proceed with few spectacular inflection points, however, it will be perceived as progress in the US--which will facilitate the decrease in US troop levels in Iraq. The "Iraqi-ization" of the counterinsurgency is a similar case of setting themselves up for failure--but it will be effective in furthering US policy interests. Talil Air Base will remain a safe point of departure for US planes, and the ability of the British to withdraw some troops from the South and the Norwegians to increase their oil partnerships in the North will prevent those countries from sliding ever closer to the Euro (which is an inevitable result of the peaking of North Sea oil production--the petrodollar standard only benefits oil producers that have significant US debt reserve holdings).

4. Iran: With the US military drawing down to perhaps less than 50,000 troops (more likely 80,000) by the end of 2006, along with the drawdown of some forces from Europe and South Korea, the US military will surprise many pundits with a reconstituted expeditionary capability. Equally important will be the forces that are not withdrawn from Iraq but are freed up for internal re-deployment (preventing the notification that is a de-facto result of re-deployment overseas from the US). All of which leads directly to a discussion of Iran and Syria. An almost unending stream of commentators have theorized that the US will attack Iran in March of 2006. Not at all likely--that's too early--but by the end of the year it will be certainly within the realm of possibility. Which demands a brief analysis of what kind of an attack that might be. A ground invasion is simply impractical--the terrain, size and population of Iran are vastly different from that of Iraq. Of course, the hubris of the current US administration is such that it can't entirely be ruled out--it just isn't very likely. More likely would be some kind of airstrikes aimed at Iran's nuclear facilities--by either the US or Israel. While there seems to be the kind of political will necessary to carry out such an attack in Israel, it isn't very likely to succeed. The Iranians just bought enough top-of-the-line Russian SA-15 surface-to-air missile systems to provide excellent point defense of their nuclear facilities--even some defense against cruise missiles and GPS-guided bombs. They'll take delivery beginning this Spring. Despite the rusty nature of Iran's Shah-era air force (Vietnam-era US fighters like the F-4 and older Soviet models), they also have been long rumored to have the Russian-built SA-10 system, which makes US Air Force planners wince. More significantly, however, is the political fall-out of a potential attack. It's my opinion that Israeli long-term interests would not be served by an airstrike, even if it successfully derailed the Iranian nuclear program for several years, as it would build resolve to finally get a bomb AND use it. US "interests" (by which I mean the current administration's), however, might be better served by such airstrikes, as it could create an environment of instability regarding Iran that would pressure early-adopters to shy away from Iran's euro-denominated oil bourse that opens this March. Which, of course, leads us to a discussion of oil...

5. Oil: What will oil do in 2006? It could hit $100/barrel, but that isn't very likely. More likely it will oscillate about $60/barrel, gradually working its way up to a stable $70 by year's end. It's necessary here to offer a disclaimer: an honest psychological self-evaluation suggests that I may be overly bullish on the price of oil as I have a substantial personal investment in (long-term) oil prices. That said, it will probably take more than one year before the reality of the depletion:discovery ratio really dawns on the broader financial powers, so prices will probably remain relatively flat this year. Unless, of course, Summer '06 exceeds Summer '05 in the Gulf-Coast hurricane category. How high a price can the current economy sustain before significant demand destruction kicks in? Well, prices in the late 70's and early 80's maintained a $70+/barrel level (in 2004 dollars) for quite a while without significantly decreasing demand (which eventually did happen, but more due to a recession that can't be solely linked to oil prices--it's a sticky point, I'll admit). In addition, by all measures we produce more GDP per barrel of oil burned today than we did back then (though not at double the level as some suggest--that is largely owing to the monetization of services in the modern economy). I think that prices of at least $100/barrel can be sustained with no appreciable impact on demand, but depletion rates over 5-6% could push prices far above that even with demand destruction. But there are really three factors that are pushing the price of oil upwards, only one of which is the "Peak Oil" phenomenon. The second is inflation. Oil prices will increase based on fundamentals, and they will also track inflation because it is not some fiat-commodity, but a commodity that has real value. So a 10% increase on fundamentals and 10% inflation will be additive. The third driver of oil price increase is the strength of the dollar. If the dollar drops 10% relative to the euro, then the price of dollar-denominated oil contracts will go up 10% because arbitrage between the US and Europe will keep the real price of oil roughly equal between the two. And if the Iranian oil bourse is a success, on thing that it will certainly do is depress the value of the dollar. It's also worth making a brief statement on oil exploration. Most commentators are suggesting that oil companies have increased the future price of oil assumption (the indicator that tells them which exploration ventures are acceptable from a financial risk perspective) from roughly $20/barrel to roughly $30/barrel. This is, conveniently, in line with the official line spouted by the oil majors and the Saudis. Privately, they mostly suggest that they aren't really convinced that oil will return to $30/barrel, but that it's a safe, low-risk assumption for their ventures. This price assumption is very important, because many market-economists who tout the salvation potential of oil-shale, tar-sands, gas-to-liquids and other higher costs oil options say that there is plenty of oil (hence no "peak oil"), but that we just need a slightly higher price assumption to see these supplies rapidly come on line--say $40 to $60/barrel. Well, these oil companies all employ numerous finance-MBAs, and any finance-geek worth their salt could tell you that with the December 2011 crude oil future currently trading at over $57/barrel, exploration ventures can utilize put-options to hedge against any price drop below current levels. Even with the cost of financing the options over time (which is significantly offset by inflations impact on oil prices), oil companies would have to be financially illiterate to not be using de-facto price assumptions in the $45 to $50/barrel range. My calculations suggest that the correct future price assumption from a financial risk standpoint is roughly $10/barrel below the price of the December futures contract 5 years out--in this case, CLZ11 (which closed today at $57.48, suggesting a price assumption of $45/barrel).

Well, I'll draw the line there on my 2006 overview. While I don't think that it will be a year that goes down in history any more than 2005, I certainly don't think that it will be boring.

A Peak Behind the Curtain

Exactly one month ago, the US Federal Reserve issued a simple press release that they will cease reporting M3 as of March 23, 2006. Three whole sentences (read it...). It received zero coverage by the mainstream media. A Fed spokesman said that ''M3 does not appear to convey any additional information about economic activity that is not already embodied in M2."

If M2 and M3 make you think of British motorways or BMWs, read this primer on money supply. I think that this is CRITICAL, because it is the structural backbone to modern geopolitics.

In short, M0 is the value of all US currency that exists in actual bank notes and coins. M1 is M0+checking accounts. M2 is M1+money market accounts and CD's under $100k. M3 is M2+all larger holdings in the dollar (Eurodollar reserves, larger instruments and most non-European nations' reserve holdings). The key point here is that which will be lost when the Fed stops reporting M3, but continues to report M2 and M1: we will lose transparency on the value of reserve holdings in dollars by other nations and major financial institutions.

And, of course, the timing of the discontinuation of M3 data just happens to coincide with the opening of Iran's euro-denominated oil bourse. Funny how that hasn't exactly been reported at all by ABC, CBS, NBC, CNN, Fox or the other "Main Stream Media" sources.

So what will happen when Iran opens its bourse? They won't just sell Iranian oil (although that alone is a sizeable chunk of world production, roughly 4 million barrels per day, or about 5% of global production). Instead, they will create an entirely alternate derivative market to the exclusively dollar-denominated sale of oil derivatives at the International Petroleum Exchange (London) and the New York Mercantile Exchange. The way this works is that NYMEX crude futures are for "West Texas Intermediate" crude, theoretically "deliverable to Cushing, Oklahoma." It will come as no surprise that all the oil is not actually delivered to Cushing, and that oil consumers from around the world still use these NYMEX futures to purchase and hedge on oil. By way of arbitrage, people who need crude oil don't have to actually ship it through Cushing--it doesn't even have to be West Texas Intermediate crude, for example, Nigerian "Bonny Light" or Algerian "Saharan" crudes can all be bought and sold using derivative and arbitrage mechanisms on the NYMEX. So an Brazilian refinery can purchase crude via NYMEX and may actually take delivery from a tanker direct from Nigeria. This is critical because it is exactly the same mechanism by which the new Iranian oil bourse will be a direct competitor to both the IPE and NYMEX. You can count on Venezuela's PDVSA using the Iranian bourse, for example. And naturally, it would only make sense for Euro-zone customers to purchase via Iran using their own currency. This may take some time to build momentum, but it will be a truly monumental shift in the global geopolitics.

The result of this is that countries will no longer need to use the US Dollar as their reserve currency. As reserve currency levels drop, the fundamental impact will be a drop in demand for the US dollar. This will result in a decrease in the value of the dollar, but much more importantly it will mean that there is also a decrease in people wanting to purchase US government debt--the debt that we use to carry huge and consistent budget deficits. Of course, it will still be possible to get other nations to purchase our debt instruments and finance our deficit, but the market will shift the price equilibrium for this debt upward--that is, the interest rate that we are paying on the national debt will increase significantly.

Suddenly the mysterious Fed is much less mysterious: the M3 statistic that they will stop reporting this Spring is exactly the one that would be used to identify just such a shift in the use of the US Dollar as a reserve currency. Was that the motivation for the Fed's move? It's the only one that I am aware of, but it's no more than conjecture.

Just how fast and how strong this shift from the petrodollar to the petroeuro will snowball is difficult to predict. There are plenty of people who think that it will be alternatively minor, catastrophic, or lead to the US nuking Iran in a few months. My goal here (for once) isn't to speculate, but just to shed some light on this murky topic.

Syriana

A round of applause for George Clooney's new movie, Syriana. It's gritty. It's complex--just like the actual issue that it deals with, so thankfully for once it wasn't excessively dumbed down to meet the Hollywood standard concept of what an audience can understand. It is just about as real as what is actually happening. It isn't a slick example of post-production effects or CGI. In fact, the cinematography has an almost doccumentary feel. Of course, if you're looking for the kind of happy ending that Hollywood provided in such recent movies as "The Constant Gardener" and "Lords of War," then you're out of luck. But surely that was to be expected.

I was amused to see how accurately the CIA Predator-UCAV experience was represented. I was peripherally involved in such fun and games in 2001 when it was just called "Project 417." Even today people involved with the Air Force's Predator fleet usually just say "the 'other' customer," so it is a testament to how well researched this film is, down to the smallest details.

While the plot skirted the issue of Peak Oil, I can't fault them for their focus: this wasn't intended to be a warning about Peak Oil--it is a warning about energy geopolitics. The major element that should have been covered, however, was the petro-dollar issue. That's the invisible elephant in the room here. Oh well, maybe next Summer we'll finally get a blockbuster about fiat money and the petro-dollar system. I won't be holding my breath...

Waiting for Godot (Peak Oil)??

Time again to raise the issue of Peak Oil: an honest psychological self-evaluation shows that I most certainly take pleasure in a certain degree of pessimism. That said, when confronted with the s.p.e.ct.r.e of Peak Oil, I'm MUCH more afraid of one of the possible solutions to peak oil: fusion. There is a very real (though my grossly underinformed guess is that it is very small) chance that once of the variety of fusion energy programs actually bears fruit. The European/Japanese bid currently underway in the south of France may even bear fruit while it's still possible to implement a global fusion-powered hydrogen economy. While this kind of Star-Trek utopia is attractive to many, I'm concerned about how centralized and "ownable" fusion technology will be. Is there any reason to believe that the fusion-energy-world system will be any less hierarchal, intensifying and uneven than the current Petro-energy-world system? Is it a coincidence that a recent article in Joint Forces Quarterly (by John M. Amidon, LtCol, USAF) was titled "America's Strategic Imperative: A "Manhattan Project" for Energy"??? A country that controls Fusion power in a post-peak-petroleum world will wield far more power than the US did with it's exclusive atomic armory after WWII.

So I will admit that I am more than a little eager to see the peak of oil come and go. Because when it does, if nothing else, it will prevent the development of a fusion, a modern "Pharo Maker" as i've written about before in "Energy, Society & Hierarchy."

Coincidentally, take a look at the cover graphic on Amidon's JFQ article. Despite what the caption syas, the cover graphic is one of the offshore Gas & Oil terminals in the al-Faw complex. It was one of the least-publicized operations of the Iraq War, but the very first land operation was a seizure of two of these platforms, as well as three other key oil infrastructure installations in al-Faw by a Seal Team 3 and the Royal Marines' 40th Commando Brigade. My role in it was relatively small: I planned the electronic warfare component, consisting of jamming support from EC-130H Compass Call and E/A-6B Prowlers to ensure that the SEAL assault on the offshore platforms would not tip off the Iraqi land forces in Al Faw of the coming invasion, even though they hit the platforms about 2o minutes before the Royal Marines hit the beach. What did strike me as interesting about the operation was how aggressively it was marketed as an effort to prevent an environmental disaster, because by capturing the oil infrastructure before the Iraqis could sabotage it would, of course, avert a major oil spill in the Gulf. So, naturally, given the Bush administration's strong environmental credentials, it was worth the lives of the dozens of US/UK forces killed in the "unexpectedly fierce" resistance in Um Qasr (because we used up our one time shot at a surprise operation in al-Faw) in order to prevent an oil spill. Sure thing boss, whatever you say...

And on a topic that is much more related than it may at first seem, take a look at this article by Jorge Hirsch:

Nuking Iran Without the Dachshund

Thoughts on Comments

Blogs can be powerful, largely because of the ability for outside readers to comment on the articles posted therein. Here's my argument for a Code of Comments:

Any one who wants to can comment on my blog. You're welcome to be "anonymous" if you like. It seems that blogger.com will give you some minor issues if you aren't registered, but you don't have to register or leave a name or anything of the sort. I think that all blogs should work that way.

If you do choose to use the name "anonymous," expect that I and many others really will immediately question what you are hiding, what agenda do you not want revealed, etc. Go ahead and be anoymous, but it's a strike against you.

Sign your post with your real name. My URL is my real name. If you can't sign with your real name, what are you hiding? Don't sign with "M. Simon" or something equally ambiguous. Let us know who you are, so we can research you, your past writings and comments, your motivations, etc. In some ways it's like the "rigorous vetting process" that a political candidate goes through. If you can't associate your ideas with who you are, I'm not putting much trust in their authenticity...

If you have a web site or blog, link to it. Save us the time, show us right where we can find the repository of your writings and opinions...

If we all did this, it would certainly help with the efficiency of the blogosphere as an information processing network.

Just a few thoughts. Comment on...