On the first anniversary of the financial crash, I have been thinking of the role oil played. Most pundits cite re-setting mortgage rates as the precipitate cause, but I believe the sudden spike in energy prices earlier that summer — and the resulting inflation in food and other prices — acted as the tipping point for many American families already living beyond their means.

Oil played a similar destructive role in the stagflation of the1970s. Then there were price spikes and shortages, lines waiting for gas. But the financial world was different. People were not used to living so far beyond their means — if you didn’t have the cash, you had to cut back. Far fewer women worked so when family finances became strained in the 1970s, women went out and got a job. Stagflation pushed women into the workplace as much as the women’s movement. The two person family economy has been how the American family has coped since then.

Both then and now, Americans predicated their lives on the assumption of permanent cheap energy. In this century, it was the huge house in the exurbs. His and her SUVs.

In the 1970s, food and gas couldn’t be paid for with a credit card. Everyone does now. We were told — why save? Hand your money over to a financial advisor, work that 401(k). Invest in real estate: it’s America — indulge —you’ll earn more in a couple years to afford it. But how could that work out for everyone?

Unlike the 1970s, wages have not kept pace with the real cost of living. Partly because of their confrontational tactics in the 1970s, unions became targets. As quickly as possible, jobs were shipped to cheaper more accommodating foreign shores. A college education is no longer the ticket to a glamorous life, just enough to get you a middle class one. Upward mobility is the American dream, but for two decades it has become increasingly a dream.

So when last year’s oil spike came, we were already too close to the edge in our lives. Except, unlike the 1970s, we had fewer escape hatches. Everyone in the family was already working for less and less. The house in the exurbs couldn’t be sold or moved closer in. We were already near our over-extended credit limit. As speculators, looking for the next big thing, assured us that demand would force oil to $200 a barrel, the tsunami that had been harmlessly rolling on, unseen, in the deep sea finally snagged on the shore.

My recollection is that the average American could sense something very bad coming in June, even though the pundits and financial stars were still telling us Bear Stearns was a fluke. It was the beginning of the crash, where we finally realized our debt had totally swamped our savings and this time, we had no buffer.

I know China’s economic philosophy is different than America’s but was it ever so glaring as a week ago, when it was reported that China “loaned” China National Petroleum Corp. $30 billion for yet more overseas projects?

Can you imagine Uncle Sam doing this for Exxon? (Okay, maybe GM, but the terms were a lot less sweet.)

But I’m not quite at the Thomas Friedman stage. He recently bemoaned the amount of compromise the US political system requires versus the autocratic Chinese one, which can take the longer view without political resistance. To me, there are still fewer democratic freedoms in China, less political inclusion, minimal public protection, and probably more corruption. And obviously, there are plenty of other autocratic countries that abuse their power far worse than China. And obviously, Exxon really hasn’t done so badly under the US system.

China is also investing heavily in its green energy projects. It has spent this recession moving heaven and earth to insure its commodity security.

Will China’s approach “win” against America’s?

It’s hard to say, its situation is so different. China doesn’t seem as geologically lucky with oil and natural gas deposits as the US. It has modernized at an amazing clip of course, but it has just now started to bump into ideas that must slow it down for the better: consumer safeguards, corruption control, environmental protection, unhappy outer provinces. Industrialized World economies have to deal with Industrialized World standards and norms.

Anyway, as we saw with Japan in the 1980s, sometimes a little competition, a different approach, can push us harder in the right direction than we would otherwise go.

I like it when things line up. Syzygy, they call it.

What do Mongolia, Iraq, and Venezuela have in common? (Hint: it’s not oil.)

It’s that they have all recently bumped into the sharp edge of resource reality.

There is something about the discovery of  valuable resources that make people and countries take leave of their senses and figure that now they are set for life; they just have to squeeze every penny from the energy or mining companies, sit back and let the money roll in. But this is not the economy for that, not with commodities being hammered the way they have been (and it would have been worse without China), and with national treasuries as depleted as they have become. The cash cow has become lean. Compromises are in order.

In late August, the Wall Street Journal reported

“Mongolia’s Parliament agreed to cancel a windfall-profits tax on copper and gold and took other steps aimed at hastening development of its more than US$3 billion Oyu Tolgoi project, one of the world’s largest undeveloped mineral assets.
The mine, which is being developed by Anglo-Australian mining giant Rio Tinto and Canada-based Ivanhoe Mines Ltd., is viewed as a blueprint for billions of dollars of investments in Mongolia. The country has some of the world’s largest untapped reserves of coal, copper and other commodities… Talks on an investment agreement have dragged on since 2003 and hit a serious snag in 2006, when Mongolia introduced its windfall tax in a bid to capture more profits from its resources. The provision imposed a 68% tax on copper sold above US$2,600 a metric ton and gold priced above US$500 a troy ounce on the London Metal Exchange.”

Not coincidentally, at almost the exact same moment, the Journal was also announcing,

“Iraq is seeking lower upfront payments in its second oil bidding round, hoping to recapture the interest of international energy companies that largely shunned the country’s first attempt to open its oil fields to investment in June.
The country is now seeking signing bonuses of $1.2 billion in total for contracts to develop the 15 fields on offer, Iraqi oil officials and executives from companies involved in talks on the deals said. Iraq’s attempt to auction off contracts for eight fields in June got hung up in large part on its demand for $2.6 billion in so-called soft loans that oil companies were supposed to pay when signing deals.

In addition to the lower up-front payments, Iraq this time will allow international oil companies to operate the fields. Terms of the first bidding round had stipulated that Iraqi oil officials would be involved in running the fields.”

It isn’t only greed (considering how rich extraction companies used to get off contracts that disproportionately favored them, countries are right to be suspicious and demanding) that is undermining the incomes of resource countries. It’s policy, and their own investment.

That’s where Venezuela comes in. Investors are hesitating in Venezuela. The Economist recently wrote on the oil sands there.

“It does not help that PDVSA wants a 60% share and operational control in each block while not putting up any money. On top of that the government will take a 33% royalty and a windfall tax.”
Energy specialist Michelle Billig is quoted saying it’s more than the recession that has caused investors to hesitate there; it’s political risk.

Hugo Chavez is famous for using the country’s oil resources not only to fill the coffers but to express his political pleasure or displeasure. This might be more feasible if Venezuela had a history of funneling funds back into maintaining and developing its oil industry itself, but it doesn’t. That expense is left for its investors. And that’s why although Chavez barks and occasionally bites the hands that feed (and try to pet), he has to back-pedal when to lure the money back.

It is  right that countries that have nationalized their natural resources (for better or worse) seek every penny they have coming to them — they owe it to their people. But they also owe them a fully developed economy that provides jobs in multiple sectors. Many developing countries, particularly those ruled by political despots, have a long sad history of taking what is offered them and keeping it for themselves. But it’s a negotiated relationship with the extraction companies. This is not the moment of commodity power. Footdragging is no substitute for  financial sophistication.

What so many countries ignore is the more they rely on these commodities, the more they see them as the solution to their financial problems and a pot of gold, the more the resource curse inevitably claims their economies.  After close to a century and countless promises that the oil would end poverty there, Venezuela’s people are still poor.

In my family, there is the story of how, when one of my aunts sold her house, her sisters, helping her empty the place, found 27 boxes of Fab detergent squirreled away in the kitchen cupboard. In case she should ever run out, and besides it was on sale, you see. Something like this may be about to happen to China.

This week’s Forbes has once again posed the questions sporadically floated for some time: what happens when the Chinese realize they have over-bought commodities? Did the Chinese inadvertently create a mini-bubble in commodities?

In the depths of the financial crash, when the global economy seemed to be unable to find bottom and the prices of oil, gas and metals were in freefall, China, as we know, went on quite a shopping spree.

Everyone was willing to sell and China gave loans in exchange for future guarantees on oil and gas from Russian companies, Brazil’s Petrobras, and many others. They went shopping in Africa, Latin America and Australia, snapping up commodities at great prices (and not always as low as they could have gone, either).  Overextended mining giants like Rio Tinto sought out China for huge cash infusions to keep them afloat — though that deal, of course, obviously ended in disaster with Rio Tinto pulling back as prices improved and China retaliating with charges of spying.

Most investors are not betting on metal futures. Oil and gas prices seem unnaturally high, given the lower demands. Metals like copper have piled up in Chinese warehouses. Forbes reports China has imported nearly 300 million tons of iron ore this year, and nearly a half million tons of copper more than it needs.

Even with all the building going on in Shanghai for next year’s World Expo, even with their own stimulus package, even with the Chinese banks supporting it, it seems impossible that China will actually need all this stuff in the foreseeable future, especially with world demand still slow and its own exports down.

Chinese buying has slowed. Will the oil, gas and metals prices hang in there till there is a real economic recovery, or again crash to reflect actual demand?

Today the Senate Energy and Natural Resources Committee voted for an amendment, as part of a comprehensive energy bill, which would give the Secretary of the Interior Department flexibility in suspending mandatory royalty payments to companies for the production of oil and gas. The incentives, originally part of the 2005 Energy Bill, allow oil companies to produce certain amount oil and gas royalty-free from specific offshore areas, including deepwater. They were designed to encourage businesses to invest in expensive technologies to develop areas that might not otherwise be profitable.

The new amendment, which will be voted on as part of a comprehensive energy bill later this year, affords the Secretary discretion in suspending the incentives. Today’s change follows a string of other modifications proposed by both the Hill and the Administration that would increase oil companies’ payments to the government, such as the Administration’s budget plan to reduce tax exemptions.

Proponents of the royalty change believe the incentives cost the government potential foregone revenue. They believe the high price of oil and gas acts as a greater inducement to drill than the royalty-free production allotment. I estimated that the government revenue loss from these mandatory royalty payments to be easily over a billion dollars a year (Note: I used to oversee the budgeting of oil and gas revenue for the federal government.)

Others such as Senator Lisa Murkowski (R-AL), who voted against the provision, believe that the mandatory incentives encourage firms to take greater risks to develop US oil and gas supplies.

Incentives remain a useful tool to encourage risk and investment in marginal producing or new areas, but their value declines as oil prices increase. Recently their use has become more of a political game and lost is the serious analysis to determine when government incentives are necessary. President George W. Bush said in 2005:

I will tell you with $55 oil we don’t need incentives to oil and gas companies to explore. There are plenty of incentives.

Nigerian militants from the Movement for the Emancipation of the Niger Delta (MEND) claimed to attack several pipelines of oil companies including Chevron yesterday, shitting in 100,000 barrels of crude a day. The attacks come in response as Nigerian forces over the past two weeks began a major operation against the rebel group. MEND claims to be fighting in part to ensure the impoverished delta region receives a greater portion of proceeds from oil and gas pumped from local lands. The attack comes a week after MEND announced a blockade of shipping channels, although it appears to have lacked the forces to enforce such an order.

The recent attack against Chevron has done little to rile the oil markets, unlike last year when an attack in the region prompted oil prices to jump over 2% in one day. Nigeria, the fifth largest supplier of oil to the US with reserves of 36 billion barrels of oil and 187 tcf of gas, now only produces about 1.6 million barrels a day, roughly half of its capacity according to Petroleum Minister of State Odein Ajumogobia. This drop in output reflects the recent up tick in violence, although the country has had difficulty in reaching its output potential due to regional instability. Over the past several years an estimated 20% of Nigeria’s oil production had been shut in.

The attacks highlight concern over future supplies …..click here to read more

OPEC reported a rise in output despite a pledge from the organization’s member to reduce production to meet quotas agreed to in December.

Five members (Saudi Arabia, Kuwait, Iran, Nigeria and Angola) increased production over the past month by a total of 180,000 bbls/day, although Saudi Arabia remains within its quota of roughly 8 mln bbls/day. The increase in output is the group’s first since last July. The cartel now produces just over 28 mln/bbls per day, almost 900,000 bbls over its quota.

OPEC members meet on May 28th and look set to maintain output as prices hit $60 a barrel - up over 80% from lows in February of $32/bbl - despite OPEC President Abdallah El-Badri’s stated goal that oil should reach $70/bbl and the expectations of weaker demand. OPEC announced it expects oil demand to drop to roughly 84 mln bbls/day as demand in industrialized countries shrinks due to economic conditions and as oil supplies increased.

Angolan Oil Minister Chakib Khelil hopes that OPEC members would reduce output to their quotas. Adherence to those levels would be an effective cut in production and have other benefits. The move would allow OPEC to control prices without resorting to an announced cut which would face political backlash for worsening the global recession by raising oil prices. Adhering to quotas also helps OPEC meet the goal of creating discipline within the organization as discussed here on March 16. Greater coordination when prices are low would “contribute to market stability” as the organization announced in March - or more directly, it increases the power of OPEC in determining price levels due to its ability to coordinate supply. If members cannot coordinate, prices will likely fall.

On Friday, T Boone Pickens entitled an article “Swimming in Natural Gas” playing off a similar quote from the Wall Street Journal. (It is also sounds similar to, er, my coulumn I wrote last month that the world is swimming in oil as stocks had increased driving down the price of oil.)

In his piece, he lays out part of the case for investing more heavily in natural gas. He believes the US now has the capability to tap trillions of cubic feet of natural gas, which could help reduce US reliance on imported energy and, therefore, bolster national security.

Natural gas is an important part of the United State’s future energy portfolio and could help offset our need for imported oil. But energy self-sufficiency by itself does not make us invulnerable to the demand of the international energy market. It is hard to imagine how the US would be secure in a world where we could meet our energy needs when many other nations could not — especially with the large role US companies play in the global energy market. Nations starved of energy would engage in a race for global resources that would likely lead to regional, if not global conflict. Security is more than ensuring the US can meet its needs; it’s also enabling a robust global energy market.

Florida’s Republican-controlled House of Representatives supported a measure yesterday to allow drilling in state waters. It is a major change in policy as supporting such legislation even just a few years ago would have almost been political suicide as so many citizens in the state feared for the cleanliness of the their beaches. The likelihood that the bill will pass this session, as the Senate has not considered similar legislation, remains remote. But with Florida facing fiscal shortfalls and the opportunity of a windfall estimated at $31 billion over 20 years from offshore revenue, politicians are facing a new reality.

Florida has been the linchpin to maintaining the moratorium on federal offshore drilling in the Atlantic, Pacific and certain areas of the Gulf of Mexico due to the size of its poltical clout, its coastline and the abundance of oil and gas off its shore. While Jeb Bush was governor, his brother supported his anti-drilling stance and ensured no new oil and gas activity would begin in federal waters off the coast of Florida (Federal waters on the outer continental shelf begin roughly ten miles from the coast, while the states control the sea floor until that point). In fact, the federal government bought back leases in federal waters in 2002 to placate Florida’s political leadership.

Now, the winds now appear to be shifting in Florida, and odds are they will eventually blow across the rest of the federal outer continental shelf.

The reality is that expanded offshore drilling will not be decided on after an exhaustive environmental or energy policy debate, but whether or not the government needs the proceeds from drilling and how it plans to spend them.

In one of the most candid assessments of the direction of US energy/environmental policy, Anadarko chief James Hackett blasts the current focus on carbon dioxide reduction. (Financial Times - registration required).

The histrionic and maniacal focus on carbon dioxide is intellectually repugnant to me.

He added that it is “taking the economy into a tailspin.”

Hackett’s comments highlight the battle that the Obama administration and a Democratic-led Congress will face in outlining a new energy framework

The difficulty in changing energy policy - unlike say an equally large concern of health care policy – is the overlapping interests of the economy, the environment and national security.  As to underscore the alliance between economy and energy, Hackett is not only the head of an oil company he is the Chairman of the Dallas Federal Reserve Bank.

To make policy formulation even more complicated, players with divergent views often sit in the same camp. For example, some, including New York Times columnist Thomas Friedman and Senator Richard Lugar, will argue that to improve national security we must tax oil to discourage its use and encourage the development of other energy sources. Others, like Hackett, would argue that such actions make the US less secure by reducing incentives for exploring domestic energy sources and thus making us more reliant on imports. 

The Anadarko chief is coming out swinging. And he has support from other powerful players in the industry.
He also appears to be taking a bullet from the cartridge of the National Rifle Association’s succesful strategy, that any infringement on current regulations will undermine society. Hackett isn’t going to turn into Charlton “from my cold dead hands” Heston as he has a company to run. But his comment that current US policy trends will make the US “the world’s cleanest third world country” is catchy.