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A Reversal of Fortune

Written by Brian Hicks
Posted March 8, 2005

Dear Wealth Daily reader:

Baltimore has turned schizophrenic.

On the way home yesterday, I opened the moon-roof, rolled down the windows, and played some tunes by the Man in Black.

The temperature outside? A balmy 72 degrees.

Yesterday, women wore shorter skirts, workers ate lunch outside, and the general depressed mood in the city retreated.

For about an hour last night, I didn't have a care in the world.

What a difference 12 hours (and a Canadian cold front) makes.

As I look out the windows from the Wealth Daily office, it's snowing and the temperature outside is 32 degrees, and dropping quickly. It's expected to hit 18 degrees by tonight.

This is the biggest turnaround a U.S. state has experienced since the Florida Marlins won the World Series in 1997-only to finish dead last the next year.

Cold weather is back in Baltimore. And so are higher oil and gas prices.

As I write this, June '05 crude oil futures are trading for $55.55, up more than a $1 in today's trading. June '05 unleaded gasoline is trading for $1.58, an all- time record high. Take a look at the chart.

Speaking of which, on my way to work every morning I pass no less than a half a dozen gas stations. And like clockwork for the past week, every morning I see an attendant changing the price of gas.

Today, regular unleaded is selling for $2.03, up 21.5% from $1.67 a month ago.

And, like Wealth Daily has been saying all along, it's only going higher.

According to an article in today's Christian Science Monitor, How High Could Cost of Gas Go? , "Americans are now paying just under $2 a gallon at the pump, the highest price they've ever paid at this time of year. And energy analysts predict that the price will keep rising right through the spring, closing in on $2.15 a gallon even before the summer driving season.

OPEC's acting secretary-general, Adnan Shihab-Eldin, is quoted in some press reports as predicting oil will trade between $50 to $60 a barrel for the next two years before rising to $80 a barrel."

And then we have this rather alarming report:

In two years' time, the price of oil could reach $200 a barrel. Farfetched? Maybe. Although estimates of oil and gas reserves vary widely, geologists Anders Sivertsson, Kjell Aleklett and Colin Campbell, of Uppsala University in Sweden, are the latest in a growing group of experts who believe that oil supplies will peak by 2010, if not before, and gas soon after.

"With most producers operating flat out to meet runaway demand increases this year, the world's immediately available spare production capacity has virtually disappeared," the report read.

Production quotas are unable to keep pace with world demand of 82-million barrels a day, which is increasing as China's and India's economies grow.

The era of cheap oil is at an end, experts and the industry are warning. A diverse range of oil industry insiders - like Ali Bakhtiari, head of strategic planning at Iran's National Oil Company; Dr Colin Campbell; a former executive vice-president of Total-Fina; and Matthew Simmons, an energy investment banker and energy adviser to the Bush administration - are united in their belief that global oil production is about to peak, which will signal the permanent end of cheap oil.

And they warn that this is the reason for the current rise in oil prices. Simmons believes oil is "far too cheap" and should be about $182 a barrel. The only way to control demand is to price oil realistically, allowing for time to find fuels to fill the gap between an oil economy and a renewable fuel economy.

Large new oil fields are ever more difficult to find and Campbell says endless growth is not possible. The adherents of the "peak oil theory" warn that the decline of world oil output will force oil prices higher for good, and that the knock-on effects could be catastrophic.

Bakhtiari believes there will be a sudden explosion in prices soon and the people who will be least affected will be the impoverished, who have no access to energy, and the super-rich. The middle classes will be hurt the most, he warns.

Campbell's research into oil reserves suggests that many official oil data are either flawed estimates or at worst downright lies. Scandals like the 23% of "lost" reserves at Royal Dutch/Shell last year have boosted interest in his work. False reserves threaten the security of energy supply, just as much as bombs under pipelines.

It seems clear the world is close to that tipping point where demand exceeds supply. Elementary economics warns that when this happens prices increase.

Political events, of course, also have an effect on oil prices. But it is unlikely that the US plans to invade Iraq were calculated around oil prices at $50 a barrel. The strategists were probably hoping for $20 a barrel. In the event that oil supplies from Iraq, Iran and Saudi Arabia become unpredictable, is $200 a barrel unrealistic if the world's largest producers are upset by war, invasions and political agendas?

A Pentagon study on the security implications of global warming, titled Imagining the Unthinkable, predicts that in the not too distant future, wars will be fought primarily over resources.

How many of us will be able afford the R1000 or more it will take to fill our cars' petrol tanks? How will the price of food be affected when the costs of bringing it to market rise dramatically? How much of our economic model will survive, given that much of it presupposes cheap oil? Can we continue to assume that we can procure raw materials for manufacturing from anywhere in the world? Can we assume that we can sell goods anywhere?

And what of those businesses that are dependent on cheap oil for their survival? The airline industry is under severe strain with oil at present levels, and some companies could go out of business.

And what of all the oil by-products, plastics, tar and chemicals? For some of these, there are no alternatives on the market yet.

If oil prices soar, it is likely that globalization will founder and world economies will become much more local. What we consume will need to be produced locally; where we work and where our children are schooled, too, will need to be close to home. We might end up in a world that rapidly contracts.

This may sound pretty far-fetched, but the data on oil supply seems to be telling us that we need to start making alternative energy plans." (Source: Business Day, Simon Ratcliff)

Now, if you think the global economy is going to slow down due to high energy prices anytime soon, think again.

On December 11, 2001, China was accepted in the World Trade Organization (WTO). When that happened, it unleashed a furious economy hell-bent on dominating the world.

The article below explains why China's economy will continue to roar, and why oil and gas must go higher to meet China's insatiable energy demands.

China, India to remain top FDI destinations

WASHINGTON - Emerging markets, notably in Asia, are expected to receive US$276 billion in private capital this year, according to the Washington-based Institute of International Finance (IIF). This follows last year's $279 billion - the highest level since 1997, according to IIF in its annual report on capital flows, published recently.

China and India will continue to be the major recipients of direct foreign investment (FDI), while China will attract a continuing inflow of portfolio investments in its equities market. However, last year's interest in Indian and Korean equities has waned, and these two countries are expected to drop down the list of priorities this year. New FDI commitments reached $253 billion last year - up from $115 billion in 2003. The large pipeline of new commitments and heightened global corporate enthusiasm for China suggest that new inflows of FDI should rise from $59 billion last year to $65 billion in 2005.

Efforts by Chinese authorities to slow down the economy have done little to deter investors. Indeed, expectations for a revaluation of the currency seem to be prompting foreign investors to accelerate funding for their investment facilities. As a consequence, China is projected to account for more than 85% of the $75 billion in direct investment expected to flow into the region this year. The IIF says growth in China is likely to slow marginally from last year's 9% as policies remain focused on preventing the economy from overheating.

India will be the second-largest recipient of direct investment in the region, with net inflows this year of $4.5 billion. Real gross domestic product (GDP) in India is projected to pick up slightly from last year's pace to reach 6.5% in 2005, supported by a round of public fixed investment. In the rest of Asia, real GDP growth is likely to be in the range of 4.5-6%.

South Korea, however, is likely to be the only country in the region to experience net outflows this year, amounting to $1 billion. This would be the third time in the last four years that the Koreans have experienced net outflows of direct investment. One reason is rising investment abroad by Korean companies as Korea moves from an emerging market to a mature economy, says the report. In Korea, with consumption and investment expected to remain subdued, real GDP growth next year is likely to decelerate to 3.5% from 4.5% in 2004.

Just as in FDI, the Asia Pacific region was the top destination for portfolio equity investment in 2004. This year, flows are expected to fall back slightly to about $30 billion from $31 billion in 2004. The fall will be felt by stock markets in India and South Korea. But China remains on the radar screen in part because of the upcoming initial public offerings of the Bank of China and Construction Bank. This is in spite of lingering concerns about corporate governance. The IIF suggests that China could receive new inflows of portfolio equity, likely to increase this year to $15 billion from $12 billion.

Net commercial bank lending to the Asia Pacific is expected to decline to less than $12 billion this year from more than $33 billion in 2004. China will account for a large portion of the decline in net lending, reflecting administrative measures taken by authorities to impose quotas on foreign banks' overseas borrowing. In Korea, rising international interest rates and sluggish investment are likely to reduce net commercial bank lending to less than $2 billion in 2005 - down from nearly $6 billion last year. India is the only country in the region expected to see an increase in net lending this year, as investment demand and external trade activity remain strong.

According to some experts, the large expansion in economic activity across the world has generated unanticipated inflationary pressures, especially in primary products and steel. This may force tighter monetary policies and higher interest rates in advanced economies, leading to reallocation of international portfolios and volatility in the pattern of capital flows to emerging markets. But most hold that emerging markets are not likely to experience any major meltdown in 2005 though trouble may be brewing in the long run for some that haven't carried out the necessary structural adjustments and reduced debt.

*****

In yesterday's Wealth Daily, I said I would tell you about the "law of unintended consequences, and how it started a democratic revolution in the Middle East."

I'm going to save that article for tomorrow as it speaks to my upcoming analysis of the current geopolitical situation emerging in the world.

Until tomorrow,

Brian Hicks
Wealth Daily

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