Friday, June 27, 2008

History in the Making -- The Biggest Commercial Deal Ever

Yesterday a regular reader asked the question, "Can Bush control the price of oil"? The answer is that the Bush "team" can. The Bush team has more power players than any other international team in history. Some of the significant players include Goldman Sachs, Russia, Saudi Arabia, Iraq, Israel, Japan, China, India and Europe. Some of the key players are members of the UN Security Council, some are members of the G8, some are predominately Sunni, some are predominantly Shiite, some are democracies, some are oil producers, some are oil consumers, some are enthusiastic and some are being pulled along for their own good. The Bush team has timed the introduction of new supplies of oil such that the team can afford to embargo all of the Iranian oil if necessary. So far, the timing has been carefully orchestrated such that new supplies are coming on line equal to the amount of Iranian sequestered supplies.

In the old days, European Leaders and the US got together for what were know as the G6 meetings. Later, this group became known as the G7 and then as the G8. The G8 includes the UK, France, Germany, Italy, the United States, Canada, Japan and Russia. It is important to note the inclusion of Germany, Japan and Italy with the allies and to note the inclusion of Russia with its cold war opponents. At what other time in history has there been the cooperation of so many major nations? Yesterday, this group petitioned Iran to carefully consider the latest proposals, made by the UN Security Council and Germany. The second request was for Iran to act more responsibly in regard to the terrorist activities in the Middle East. If Bush is able to pull this deal off, it will be written about history books throughout the ages.

Yesterday on Kudlow and Company, once again the market decline was blamed on the US dollar without a mention of the most recent "back-up" in the negotiations with Iran. According to Kudlow, the price of gold and oil went up and the price of the dollar went down because Ben Bernanke did not raise the Fed Funds Rate by a quarter point or at least talk strongly about stopping inflation. The news pundits must alway find reasons to speak. The reality is that the price of the dollar fell because of the "back-up" in the negotiations with Iran. Until there is a deal with Iran, two of the largest oil fields in the world will remain sequestered. The 30 million barrels of Iranian oil that is stored in super tankers is not going any where until there is additional progress in the negotiations.


China recently completed a large expansion in their oil storage facilities. As a result, oil imports to China have spiked in recent weeks. I noticed the spike on a chart and failed to write down the numbers but millions of barrels of oil are now stored in China, the same way that the USA now has 700 million barrels stored in our Strategic Petroleum Reserve. The US added about 14 million barrels to its SPR in recent weeks, even though Bush has agreed to stop adding barrels as of July. Iran has no more ships to fill at the same time that the US and China are full to the brim and at the same time that the new Saudi and other production is set to come on line. The table is set, it is time for dinner.

One of the big ironies is that "the big boys" are twisting the arms of India, Syria, Iran, Venezuela and others by keeping the price of oil high. Take the arm twisting going on in India as an example. The Prime Minister of India must soon run a campaign for reelection at at time when food and energy prices are soaring and at a time when his central bank has been forced to raise interest rates to 8.5% in an attempt to slow a soaring inflation rate. This Prime Minister signed off on a 123 Peaceful Use of Nuclear Power Agreement over a year ago. However, India's democracy is a Parliamentary System like England's and one party that supports the Prime Minister has threatened to withdraw if the 123 Agreement is accepted. The Prime Minister can drop the agreement and hold elections off until next year or he can implement the agreement and face elections before this year is out. He obviously wants to wait until Iran is ready to make a deal before he commits. He knows that a deal with Iran will bring oil and food prices down and help his chances for re-election. Bush and his team can give assurance that food and fuel prices will decline once a deal is made.

Over in Venezuela, where inflation is off the chart and milk is being rationed, Chavez is facing these and other severe problems. Low and behold, Russia has offered to come to the rescue. Russia has offered Venezuela a slot on the "team". I call it a slot because there is great prestige to be had by being among the first to acquire nuclear power. This situation is quite remarkable. A few months ago, a tentative deal was made with Syria to join the team. This really made Iran mad but it did not stop the march toward the final agreement with Syria. Would it not be incredible if Venezuela signed with Russia! It would be like a football player joining a team where he hated the offensive coach but joined to play defense. Venezuela hates the USA but it does not want to be the last man selected to play or to be left off the team.

The Biggest Commercial Deal Ever

The pending deal for the US and Russia to form a huge commercial partnership to provide nuclear fuel and technology to the rest of the world will be the largest commercial deal to date. Around 1867, the USA purchased Alaska for $7.2 million dollars. That was a lot of money in those days. We paid a little more than 1.9 cents per acre. The purchase was very controversial. It was called Seward's Folly, Seward's Ice Box and Andrew Johnson's Polar Bear Garden.

An even larger and more controversial deal was made about 65 years earlier, the Louisiana purchase. Opponents declared that the purchase was unconstitutional. They noted that there is no provision in the US constitution that grants the authority to purchase territory. The purchase price was $15 million dollars and, again, in 1802, 15 million dollars was a whole lot of money. On the other hand, $15 million in exchange for 828,000 square miles of land is a pretty good bargain, don't you think? Even if it was inhabited by Indians? The French got the money, the US got the land and the Indians got the shaft. Bonaparte's comment about the deal, "This accession of territory affirms forever the power of the United States...".

The 123 Agreement between Russia and the US involves no territory and there is not a price tag attached, but the history of the world will be changed in ways that we cannot fully appreciate yet. The age of abundant electricity is in gestation. The deal is controversial but every bit as attractive as the Louisiana purchase.

Today, the electricity cost of operating a computer is far greater than the capital cost to buy the computer. Great strides are being made to bring both cost down. For the first time, Petra-Flop computers are in operation. Things that were impossible yesterday are possible today and more things will be possible tomorrow. The coming of the powerful mobile computer is going to change the world. The pace of advance is swift but ready to hit another gear.

When Google first started hiring software engineers right and left, the new hires were told to design products without factoring in the cost of computing, data storage, electricity, calculation .... What Google understands is that the cost of computing is declining so rapidly that one can treat this cost as zero per transaction. Indeed, the cost per transaction is already out to many zeros to the right of the decimal point.

The reason Google has invested millions of dollars in energy projects is because a huge portion of that very small number approaching zero is the energy cost. The advent of abundant electricity will mean that the cost of trillions of transactions will approach zero. If there is no cost for a few million contestants to attend a teleconferenced chess championship, would players from North Carolina, Iran, Russia and England do battle? Would millions of novice players take the opportunity to kibitz?


The US Congress is investigating speculators who trade the futures markets. They give these traders far more credit and scorn than is due. What a speculator does is tries to guess the direction of future prices. The problem is that the shorter the time frame the more difficult to predict. To the extent that futures traders can guess the future correctly, they do us all the great service of moderating extremes or bubbles. Unfortunately, numerous academic studies have shown that predicting short term price fluctuations with any degree of consistency is impossible. The most successful investor of our time, Warren Buffet, has made this point many times. Those who think they can "catch that last 15%" of the market are fooling themselves, but, it is impossible to see longer term trends.

What trend can we all predict will continue?

In only a few years, we have seen communication capacity explode. Men, women and children are "in-touch" today like never before. From the communication point of view, it did not matter that my brother was at the beach when I called him yesterday. As I recall, it was around 1938 when the picture phone was introduced at the Chicago World Fair. The dream of instant and "complete" communication has been alive for centuries. The dream is quickly becoming reality. Today, the kid who challenges other kids half way around the world to a video game match, including a continuous conversation connection between the players, will be the kid who does business in a "virtual world" in the future.

Nuclear power will be one of the keys to making the future happen. The cost of nuclear electricity is about 4.5 cents per kilowatt and going down while the lowest cost hydro-carbon based power, including the cost of pollution, is at least double the price and going up.

Iran, Venezuela, Russia, Saudi Arabia and other oil producers recognize that nuclear power is the power of the future. These countries can choose to bleed oil for all they can before becoming second class world citizens or they can join the biggest commercial trade deal ever. Saudi Arabia and Russia have already joined. Indeed, seventy-one nations have joined. India, North Korea and Syria are all but ready to sign. Venezuela has a long way to go but it is no where near the strategic importance of Iran. Venezuela does not want to abandon its friendship with Iran but it also does not want to fall behind Brazil and Columbia.

The pressure on Iran is great. This relatively wealthy country (70,000,000 people with a $12,000 per capita income in 2005) has been reduced to economic pain. The country is experiencing everything from shortage of goods to hyper inflation. It is even suffering from terrorist attacks! Sunnis from neighboring states are giving Iran a taste of its own medicine. Of course, Iran blames the USA and Britain for the attacks but the nuclear treaties being signed require opposition to all terrorist activities.

Drawing the connection to Bush's support for corn based ethanol and the shortage of rice in Iran may seem like a stretch but it is a real connection. The high price of corn and the high price of oil are being used as the tools for George's Team to recruit players. If you appreciate the words spoken by Bush in the aftermath of 9-11, you appreciate that his administration has been focused on bringing about a new "world order", a world in which supporters of terror pay a stiff price.

There is a clear connection between the idealism of Woodrow Wilson and George W. Bush. Woodrow Wilson had a dream of world peace and he worked hard to try to accomplish it. His proposal, The League of Nations, was a gallant attempt to achieve world peace through the cooperation of all nations. The League was formed but the US Congress was not willing to join!

Woodrow had his share of detractors. He was the son of a preacher and we all know how easy it is for people to turn on a preacher or a preachers son. One of the reasons many people hate George Bush with passion is because he has not been afraid to openly allow his religion to influence his policies. George has been painted as a war monger but his religion promotes peace. His religion is against war but it includes 5 tests of what makes a "justified war". In the eyes of Bush, the war in Iraq has been a part of a justified war against terror. It does not matter if you agree with Bush or not, there is a strong probability that the war in Iraq is winding down and there is a strong probability that Iran is going to be forced to join the rest of the world in discouraging state supported terror.


There is no escaping the fact that wars are ultimately fought for economic reasons. Those who say the war in Iraq is a war over oil are correct. Those who say that it is only about oil are absolutely incorrect. The fact of the matter is that trillions and trillions and trillions of commerce, year after year after year will be determined by the outcome of the current negotiations. It is in the economic interest of Iran and everyone else for these deals to go through. Iran wants to negotiate as large a slice of pie as they can but they do not want to bargain so hard that they miss out. Time is getting very short. The pressure is on. Trillions of dollars and millions of lives are at stake. Americans should always remember that we would not be an independent nation without the aid of the French against the British. We should always remember that we would be speaking German today without the aid of the Russians against the Germans. Is it not wonderful that the Americans, the French, the British, the Germans and the Russians have all joined in cooperation to prevent another potential WWII and that we all agree that we should solve the current hostilities by placing economic sanctions on Iran. If we stand together, who will rise against us?