Monday, April 21, 2008

The Oil Paradox

"The last thing we need is another supply disruption. The outage certainly adds to the bullish sentiment." -John Kilduff, VP of risk management at MF Global on the news that attacks by Nigerian militants on two pipelines had disrupted supply and sent oil to 117.48/barrel.

Oil is in short, the most certain and lucrative investment in the entire global market. On a fundamental level, if the price of oil begins to decline in any real sense, one of two things has happened. The attractive option is that the energy, transportation, industrial, and food sectors have begun to realign their infrastructure with a sustainable model at a faster rate than the supply of oil dwindles as chaos in oil-rich areas spreads. And I'm the Queen of England.

The second, and much more realistic option, is that all of these sectors begin to undergo some type of cataclysmic collapse resulting from costs of production (read: cost of oil) rising beyond the ability of markets to cope without resorting to bold-faced, out-and-out war over the stuff. And, of course, war in the 21st century consumes a great deal of oil.

The most obvious problem in the oil equation arises from the sentiment so apparent in Mr. Kilduff's remark. The world's economy can't withstand shocks in oil supply (which are increasingly likely as supply becomes more tenuous), while simultaneously those very shocks ensure the wealth of speculators and producers. It is not in the short-term interests of those invested in oil to stabilize its supply or its price. To do so would jeopardize their ability to continue posting the profits now expected by their investors, but to not do so risks the long-term solvency of their companies and the entire global commodity system.

The law of demand will set the price of oil for only so long. At a certain point, as oil drives upward the prices of all other commodities, the size of the consumer base able to afford the new cost of living will become smaller by orders of magnitude. As this occurs, as the masses can no longer be entertained with products and services which are priced beyond their reach (and possibly even beyond the reach of their ability to buy on credit), their degree of political instability will rise accordingly. As Americans we have difficulty envisioning how this will impact us. The greatest difficulty arises in the nature of OPEC member nations as unstable, underdeveloped regions. It is difficult to imagine the Caspian Sea region, lying so close to some of the most chaotic areas of the former Soviet Union, as stable in a society even further divided by class. It is even more difficult to imagine Iraq, Iran, the Sudan, or Venezuela becoming more functional under these conditions. Thus, as oil becomes more expensive, regional political tensions rise, and the resultant instability creates a more restricted supply of oil.

In America this means initially the rise of a populist leader or some form of extremely oppressive "unitary executive," and probably both. This, frankly, might not be the worst thing for the people of the United States. Huey Long built most of Louisiana's roads and bridges, a great university, and provided health care to the poor. FDR was the only president to stay in office beyond two terms, and he attempted to virtually take over both other branches of government (albeit unsuccessfully). Of course, Hitler was a populist, too, in many respects. Franco, Mussolini, and Lord Protector Oliver Cromwell were all masterfully efficient leaders who knew how to keep order in troubled times, and economic crisis and political upheaval brought them all to power.

This will be oil's legacy. Oil will make the next round of speculator millionaires. Oil will drive the production of sustainable energy research. Oil will bring the next Hitler to power. Oil will drive cooperation to end violent conflicts. Oil will spawn convoluted wars with no clear sides. Oil may end the world. Oil may force the world to save itself. Probably, in some sense, oil will do both, and sooner than we think.

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