Source: Casey ResearchMarin Katusa - Chief Energy Investment Strategist
Casey Research
Report: India and Iran are hammering out a deal to trade oil for gold
Rumors are swirling that India and Iran are at the negotiating table
right now, hammering out a deal to trade oil for gold. Why does that
matter, you ask? Only because it strikes at the heart of both the value
of the US dollar and today's high-tension standoff with Iran.
The official line from the United States and the
European Union is that Tehran must be punished for continuing its
efforts to develop a nuclear weapon. The punishment: sanctions on Iran's
oil exports, which are meant to isolate Iran and depress the value of
its currency to such a point that the country crumbles.
But that line doesn't make sense, and the sanctions
will not achieve their goals. Iran is far from isolated and its friends –
like India – will stand by the oil-producing nation until the US either
backs down or acknowledges the real matter at hand. That matter is the
American dollar and its role as the global reserve currency.
The short version of the story is that a 1970s deal
cemented the US dollar as the only currency to buy and sell crude oil,
and from that monopoly on the all-important oil trade the US dollar
slowly but surely became the reserve currency for global trades in most
commodities and goods. Massive demand for US dollars ensued, pushing the
dollar's value up, up, and away. In addition, countries stored their
excess US dollars savings in US Treasuries, giving the US government a
vast pool of credit from which to draw.
We know where that situation led – to a US government
suffocating in debt while its citizens face stubbornly high
unemployment (due in part to the high value of the dollar); a failed
real estate market; record personal-debt burdens; a bloated banking
system; and a teetering economy. That is not the picture of a world
superpower worthy of the privileges gained from having its currency back
global trade. Other countries are starting to see that and are slowly
but surely moving away from US dollars in their transactions, starting
with oil.
If the US dollar loses its position as the global
reserve currency, the consequences for America are dire. A major portion
of the dollar's valuation stems from its lock on the oil industry – if
that monopoly fades, so too will the value of the dollar. Such a major
transition in global fiat currency relationships will bode well for some
currencies and not so well for others, and the outcomes will be
challenging to predict. But there is one outcome that we foresee with
certainty: Gold will rise. Uncertainty around paper money always bodes
well for gold, and these are uncertain days indeed.
The Petrodollar System
To explain this situation properly, we have to start
in 1973. That's when President Nixon asked King Faisal of Saudi Arabia
to accept only US dollars as payment for oil and to invest any excess
profits in US Treasury bonds, notes, and bills. In exchange, Nixon
pledged to protect Saudi Arabian oil fields from the Soviet Union and
other interested nations, such as Iran and Iraq. It was the start of
something great for the US, even if the outcome was as artificial as the
US real-estate bubble and yet constitutes the foundation for the
valuation of the US dollar.
By 1975 all of the members of OPEC agreed to sell
their oil only in US dollars. Every oil-importing nation in the world
started saving their surplus in US dollars so as to be able to buy oil;
with such high demand for dollars the currency strengthened. On top of
that, many oil-exporting nations like Saudi Arabia spent their US dollar
surpluses on Treasury securities, providing a new, deep pool of lenders
to support US government spending.
The "petrodollar" system was a brilliant political
and economic move. It forced the world's oil money to flow through the
US Federal Reserve, creating ever-growing international demand for both
US dollars and US debt, while essentially letting the US pretty much own
the world's oil for free, since oil's value is denominated in a
currency that America controls and prints. The petrodollar system spread
beyond oil: the majority of international trade is done in US dollars.
That means that from Russia to China, Brazil to South Korea, every
country aims to maximize the US-dollar surplus garnered from its export
trade to buy oil.
The US has reaped many rewards. As oil usage
increased in the 1980s, demand for the US dollar rose with it, lifting
the US economy to new heights. But even without economic success at home
the US dollar would have soared, because the petrodollar system created
consistent international demand for US dollars, which in turn gained in
value. A strong US dollar allowed Americans to buy imported goods at a
massive discount – the petrodollar system essentially creating a subsidy
for US consumers at the expense of the rest of the world. Here,
finally, the US hit on a downside: The availability of cheap imports hit
the US manufacturing industry hard, and the disappearance of
manufacturing jobs remains one of the biggest challenges in resurrecting
the US economy today.
There is another downside, a potential threat now
lurking in the shadows. The value of the US dollar is determined in
large part by the fact that oil is sold in US dollars. If that trade
shifts to a different currency, countries around the world won't need
all their US money. The resulting sell-off of US dollars would weaken
the currency dramatically.
So here's an interesting thought experiment.
Everybody says the US goes to war to protect its oil supplies, but
doesn't it really go to war to ensure the continuation of the
petrodollar system?
The Iraq war provides a good example. Until November
2000, no OPEC country had dared to violate the US dollar-pricing rule,
and while the US dollar remained the strongest currency in the world
there was also little reason to challenge the system. But in late 2000,
France and a few other EU members convinced Saddam Hussein to defy the
petrodollar process and sell Iraq's oil for food in euros, not dollars.
In the time between then and the March 2003 American invasion of Iraq,
several other nations hinted at their interest in non-US dollar oil
trading, including Russia, Iran, Indonesia, and even Venezuela. In April
2002, Iranian OPEC representative Javad Yarjani was invited to Spain by
the EU to deliver a detailed analysis of how OPEC might at some point
sell its oil to the EU for euros, not dollars.
This movement, founded in Iraq, was starting to
threaten the dominance of the US dollar as the global reserve currency
and petro currency. In March 2003, the US invaded Iraq, ending the
oil-for-food program and its euro payment program.
There are many other historic examples of the US
stepping in to halt a movement away from the petrodollar system, often
in covert ways. In February 2011 Dominique Strauss-Kahn, managing
director of the International Monetary Fund (IMF), called for a new
world currency to challenge the dominance of the US dollar. Three months
later a maid at the Sofitel New York Hotel alleged that Strauss-Kahn
sexually assaulted her. Strauss-Kahn was forced out of his role at the
IMF within weeks; he has since been cleared of any wrongdoing.
War and insidious interventions of this sort may be
costly, but the costs of not protecting the petrodollar system would be
far higher. If euros, yen, renminbi, rubles, or for that matter straight
gold, were generally accepted for oil, the US dollar would quickly
become irrelevant, rendering the currency almost worthless. As the rest
of the world realizes that there are other options besides the US dollar
for global transactions, the US is facing a very significant – and very
messy – transition in the global oil machine.
The Iranian Dilemma
Iran may be isolated from the United States and
Western Europe, but Tehran still has some pretty staunch allies. Iran
and Venezuela are advancing $4 billion worth of joint projects,
including a bank. India has pledged to continue buying Iranian oil
because Tehran has been a great business partner for New Delhi, which
struggles to make its payments. Greece opposed the EU sanctions because
Iran was one of very few suppliers that had been letting the bankrupt
Greeks buy oil on credit. South Korea and Japan are pleading for
exemptions from the coming embargoes because they rely on Iranian oil.
Economic ties between Russia and Iran are getting stronger every year.
Then there's China. Iran's energy resources are a
matter of national security for China, as Iran already supplies no less
than 15% of China's oil and natural gas. That makes Iran more important
to China than Saudi Arabia is to the United States. Don't expect China
to heed the US and EU sanctions much – China will find a way around the
sanctions in order to protect two-way trade between the nations, which
currently stands at $30 billion and is expected to hit $50 billion in
2015. In fact, China will probably gain from the US and EU sanctions on
Iran, as it will be able to buy oil and gas from Iran at depressed
prices.
So Iran will continue to have friends, and those
friends will continue to buy its oil. More importantly, you can bet they
won't be paying for that oil with US dollars. Rumors are swirling that
India and Iran are at the negotiating table right now, hammering out a
deal to trade oil for gold, supported by a few rupees and some yen. Iran
is already dumping the dollar in its trade with Russia in favor of
rials and rubles. India is already using the yuan with China; China and
Russia have been trading in rubles and yuan for more than a year; Japan
and China are moving towards transactions in yen and yuan.
And all those energy trades between Iran and China?
That will be settled in gold, yuan, and rial. With the Europeans out of
the mix, in short order none of Iran's 2.4 million barrels of oil a day
will be traded in petrodollars.
With all this knowledge in hand, it starts to seem
pretty reasonable that the real reason tensions are mounting in the
Persian Gulf is because the United States is desperate to torpedo this
movement away from petrodollars. The shift is being spearheaded by Iran
and backed by India, China, and Russia. That is undoubtedly enough to
make Washington anxious enough to seek out an excuse to topple the
regime in Iran.
Speaking of that search for an excuse, this is
interesting. A team of International Atomic Energy Agency (IAEA)
inspectors just visited Iran. The IAEA is supervising all things nuclear
in Iran, and it was an IAEA report in November warning that the country
was progressing in its ability to make weapons that sparked this latest
round of international condemnation against the supposedly near-nuclear
state. But after their latest visit, the IAEA's inspectors reported no
signs of bomb making. Oh, and if keeping the world safe from rogue
states with nuclear capabilities were the sole motive, why have North
Korea and Pakistan been given a pass?
There is another consideration to keep in mind, one
that is very important when it comes to making some investment decisions
based on this situation: Russia, India, and China – three members of
the rising economic powerhouse group known as the BRICs (which also
includes Brazil) – are allied with Iran and are major gold producers. If
petrodollars go out of vogue and trading in other currencies gets too
complicated, they will tap their gold storehouses to keep the crude
flowing. Gold always has and always will be the fallback currency and,
as mentioned before, when currency relationships start to change and
valuations become hard to predict, trading in gold is a tried and true
failsafe.
2012 might end up being most famous as the year in
which the world defected from the US dollar as the global currency of
choice. Imagine the rest of the world doing the math and, little by
little, beginning to do business in their own currencies and investing
ever less of their surpluses in US Treasuries. It constitutes nothing
less than a slow but sure decimation of the dollar.
That may not be a bad thing for the United States.
The country's gargantuan debts can never be repaid as long as the dollar
maintains anything close to its current valuation. Given the state of
the country, all that's really left supporting the value in the dollar
is its global reserve currency status. If that goes and the dollar
slides, maybe the US will be able to repay its debts and start fresh.
That new start would come without the privileges and ingrained subsidies
to which Americans are so accustomed, but it's amazing that the
petrodollar system has lasted this long. It was only a matter of time
before something would break it down.
Finally, the big question: How can one profit from
this evolving situation? Playing with currencies is always very risky
and, with the global game set to shift to significantly, it would
require a lot of analysis and a fair bit of luck. The much more reliable
way to play the game is through gold. Gold is the only currency backed
by a physical commodity; and it is always where investors hide from a
currency storm.
The basic conclusion is that a slow demise of the
petrodollar system is bullish for gold and very bearish for the US
dollar. As for any more specific suggestions on how to profit, check out
our newsletters.
[Smart investors realize oil, like gold, is destined to rise dramatically and that investing in the right energy companies now will be like getting into the yellow metal 10 years ago.]
Additional Links and Reads
EU Embargoes Iranian Oil (Wall Street Journal)
European Union foreign ministers approved an embargo
on Iran after getting past an internal debate on the burdens an embargo
places on some EU members. Citing "serious and deepening concerns," the
EU agreed to impose a full embargo on Iranian oil exports, including
existing contracts, starting July 1. It also sanctioned Iran's central
bank and Iranian petrochemical exports to the EU.
Iran Threatens to Hit US Targets over Strait of Hormuz as Europe Joins Oil-Import Ban (National Post)
Iran is not pleased that the EU has joined with the
US in embargoing Iranian oil and responded to the news with aggressive
threats. One Iranian politician renewed his country's threat to blockade
the Strait of Hormuz; another warned that his country would strike US
targets worldwide if Washington used force to break a Hormuz blockade;
and a third threatened to cut off crude shipments to the EU immediately.
India's richest families like to invest in power
producers because sustained increases in electricity demand are a pretty
sure bet in India. However, soaring coal prices have forced a slew of
Indian power companies to mothball plans for new plants. The plants
would have produced 42 gigawatts – equal to 68% of the government's
targeted power-capacity increase for the five-year period ending in
March – but with thermal coal prices from major suppliers Australia and
Indonesia having climbed 27% and 24% respectively in two years,
producers are seeing their profits dwindle. The problem is only made
worse by India's regulation of power prices.
Bid to Halt South Sudan Oil Shutdown (Financial Times)
Despite aggressive moves from both sides, South Sudan
and Sudan have agreed to extend their negotiations in an attempt to
break a year-long deadlock over oil production and pipelines. The two
countries, which split last July, have yet to reach an agreement on how
to split oil revenues. Together the nations produce 460,000 barrels a
day; while three-quarters of production is in South Sudan, the only way
to transport the oil to a port is via a pipeline running through Sudan.
Khartoum wants to charge South Sudan a substantial fee per barrel to use
its pipeline, but the southern Juba government says it is only willing
to pay a small fee because it is owed millions in compensation from the
north after decades of civil war. Now the south has initiated a
production shutdown after accusing Khartoum of stealing $815 million
worth of oil.
North America to Become LNG Exporter by 2030 (Financial Post)
In its annual energy outlook, BP projected that
natural gas will be the fastest-growing fossil fuel globally to 2030,
with supplies growing at 2.1% annually. Within the industry, growth will
be greatest in the liquefied natural gas sector, where supplies will
rise at 4.5% per annum. China will eat up a lot of that gas: Chinese gas
use is expected to climb 7.6% annually to reach 46 billion cubic feet
per day in 2030. With unconventional natural gas production increasing
rapidly, BP also predicted that North America will be exporting 5
billion cubic feet of LNG per day by 2030.
Shell Canada announced plans to spend $1 billion
exploring Nova Scotia's offshore oil and gas deposits over the next six
years. Stuart Pinks, CEO of the Canada-Nova Scotia Petroleum Board, said
the announcement shows "some significant confidence in the potential of
the offshore of Nova Scotia." The board will continue to seek bidders
for other blocks in the area, helped by a newly published offshore
energy atlas that government geologists spent three years and $15
million developing.
