Monday, January 02, 2006

2006: Escalation of the Resource Wars
by Stirling Newberry
Mon Jan 02, 2006 at 06:40:39 AM PDT
(Promoted from the diaries by DarkSyde)

The march of Iran to deterrent state status are prompting "use it or lose it" pressures for preventative - that is aggressive - strikes against Iran and its atomic weapons program, as Iran declares that it has a right to enrich Uranium on its own soil. The Ukraine-Russia gas stand off escalates as Russia accuses Ukraine of stealing Natural gas. In Iraq insurgent threats keep a major refinery shut down in Iraq.

On this, the first working day of the New Year, we are already getting a good stiff taste of the running theme of 2006. If 2004 and 2005 saw resource inflation, 2006 is the year when resource rich countries begin using those resources as weapons, and resource poor countries begin taking aggressive steps to secure resources. The current world market approach to energy is going to break down, as more and more nations are forced to jostle for position.

Somewhere in the next two years it will dawn on the American public that we live in the pre-war, not post-war, era, and that Iraq was a foreshock.

For reasons outlined before, an attack against Iran is unlikely at this time - the danger zone begins in July and runs through late October - because that is the point where a spike of popularity and power will be necessary for Bush, if it seems he is going to lose the Congress. The next danger zone is next year, as he needs to reframe the debate should he lose congress. However, before there are large airstrikes, there must be an escalating campaign of crowding Iranian airspace, in hopes that a pilot will give the US an excuse for further action.

But the larger picture needs to be looked at.

First, resources are fundamentally different from manufacturing, in that manufacturing is wide spread, but resiliant. Resources are concentrated, but brittle. This makes a difference both during escalating tensions, and for the possibility of all out war. The resiliant nature of manufacturing means that pin prick military actions are generally worthless. Bomb one plant, and the equipment will be moved to another. Extraction is the reverse - it is rife with fragile infrastructure that is very worth destroying - oil refineries, petrol storage facilities, oil and gas pipelines and nuclear reactors for enriching Uranium - are all fragile and expensive, and generate economic benefit far out of proportion to their size.

Thus during escalation, manufacturing is not targetted, but resource concentrations might be. Look at China's handling of Taiwan. The Chinese could easily begin attacking Taiwan - but pinprick attacks would not significantly undermine Taiwan's economy or deny it crucial components. It also means that the chance for all out war is higher over resources than manufacturing. This is because a general war will destroy manufacturing, but it will leave the raw resources in tact. Manufacturing is about buildings and people -war destroys both. Resources are about land, and war, while it wounds the land, seldom kills it.

These two factors exacerbate each other - faster escalation, and greater temptation to war mean, more wars. Whether over water, oil, arable land, coal, gold, diamonds or any other economic rent - resources bring greater geo-political uncertainty.

In the current world economic environment, most commodities are traded on world markets. The difference between buying from two different suppliers for almost any commodity is a difference in the time and cost of shipping, and little else. Standardized contracts, large futures markets, sophisticated financial systems, logistical and information networks make it possible to hedge and balance resource prices. This highly liquid and highly fluid system allows shocks to be buffered. For example, when Katrina knocked out oil and gas production equal to the current output of Iraq, it was possible to use the Strategic petroleum and gas reserves to spread the pain, and prevent a sharper spike in prices.

In a world where nations use the resource card to push political agendas, particularly the resource scarcity card, nations begin seeking exclusive contracts and stable supplies. The Chinese have been working to acquire exclusive oil contracts. This is only worthwhile if the cost of an exclusive contract - higher than a hedged free market supply - is insurance against the cost of supply disruption. If it is cheaper to buy the exclusive deal, than get the insurance that there will be no disruption, then it is worth inking the deal. As the supplies of oil and gas that are free for exploitation dwindle, the pressure for more and more countries to follow this road grows.

2006 will see the increase in flare ups over this process. As countries lock in supplies, they, by definition, lock others out.

In 2005 this effect caused diplomatic jostling, but few open crisis points opened. Now however, as industries accept that energy prices, and commodity prices, are going to remain high for the foreseeable future, there is going to be a drive to secure commodities before the inevitable rise in prices. This is so because energy can be used to substitute for most commodities, as energy prices go up, the substitution moves the other way - don't buy lower quality ore and use more energy to refine it, buy higher quality ores. As prices rise, more and more businesses will find, on the margins, that it is better to switch than fight. Those who realize this first will want to lock in supplies for the forseeable future before others do. Futures prices for commodities are rising to be in line with spot prices across the board.

The continuation of an inflationary policy in the United States - the Federal Reserve has said that it is not going to be aggressive about inflation fighting and is willing to accept 5% real consumer inflation and higher than comfort zone inflation ex-housing, energy and food - means that more and more nations are going to realize they are in direct competition with the US for prosperity, and governments that are less accomodative should not only continue to come to power - but that those that have not made the break are going to be under increasing pressure. While Europe is moving towards a more economically accomodative stance towards the US politically, practically everywhere else is not. And the European Bushite accomodationists are going to find that they are not treated any better than Blair has been. Gratitude is monopolar in Bush's Washington.

What we will see then is more and more of the benefits of trade with the US will flow to a smaller and smaller number of places. This will mean that in nations that trade resources with the US, there will be more pressure to spread that wealth through the country. This will lead to populist regimes where there are functioning, or semi-functioning, democracies, and increasingly aggressive rebellion - such as the FARC in Columbia - where there is not.

Fears about the US dollar - or about oil trading in Euros, are however, overblown. Instead, instability will help the dollar, as "flight to safety" will drive risk averse parked money here to the US. It doesn't matter what oil is traded in - the pound crumbled in the 1920's even though it was the unit of account for major commodities - but instead where the money is parked afterwards. Trading in euros will give Iran and other nations a hedge against another move on the dollar, but this is not significant. What is more significant is that there is a sharp willingness on the part of major dollar holders to move to Euro based stocks and bonds. The trigger point will be a European recovery. If europe can recover from its current economic slump, and raise rates, this will be a capital magnet. There are those that worry that this is destined to happen soon. However, the likelihood is that it will not happen until late in 2006 or early 2007, which means that the pressure on the greenback is still two years away.

The real tinderbox is not mechanisms, but control over the oil itself, and US attempts to keep nations that are oil holders vulnerable to US military pressure. Iran is getting attention now, but it is not a state which is on the verge of violence. The middle east may be a tinderbox, but the core of this tinderbox is, of course Iraq. Had Saddam been in power, we would currently be dealing with a containment problem - higher energy prices make it harder to keep a dictator locked out of prosperity. As it is we have created a failed state, with a series of parties jocking for creating an oligarchic state with their party at the apex. This means that Iraqis are going to be going broke during an oil boom, as parties cut off oil development, in the hopes of getting enough tinder dry enough to kindle the fire of open chaos.

But Iraq is merely going to be the most visible flash point, the one which we hear of, but are carefully not shown. Around the world there are going to be increasingly violent and widespread agitations, as many countries will be forced to raise energy prices - almost universally subsidized so that people can have access to mechanization and the freedom it btrings - and thus being forcing people on the margins out of affluence. These people will not take it lying down.

This is going to be basically invisible to the US public, which will be pressing to make matters worse. There is an entire generation that wants to retire - that means a very high pressure to keep housing prices high for just a bit longer, so they can hit 30 years and retire. It means increasing pressures for protectionism, so they can keep their high paying position for a bit longer, hit thirty and keep their pension. There is going to be increasing pressure to close the borders, as the disorganized working class - used to the fat years of the housing boom - suddenly finds that jobs are getting harder to come buy for the pickup truck set.

The US is also going to experience a short term upward movement in stocks, as the huge volume of money looking for a home comes to rest here. The more uncertainty out there, the more people flee to the safety of the US. However, because the underlying consumer demand is not there to provide profits at higher stock prices - this upward surge will both have a very hard ceiling and a relatively short life. While few are predicting a crash for '06 - it is not beyond reason for the Dow to turn in another losing year, and have inflation adjusted gains in stocks be zero.

This will add to the pressure to allow cashing out from houses, and it this, in turn, will add to the pressure to keep rates lower than they should be, which will accelerate the inflationary building boom of capital in China where it won't cause inflation here directly - and therefore accelerate the resource tensions. This year is the year where conflict over resources breaks out into the public mind, because it is the year when flash point stand offs become common place.

In short, there is going to be pressure in the US to find a way to pass the costs on to others. Which means that the year is going to close out even more turbulently than it began, and will seem more uncertain at its close.