Fed getting tougher? OPEC losing control?

The Fed didn’t just raise interest rates yesterday. It also sent a signal to the market that it may be ready to get tougher.

How do we know?

The Fed subtly and quietly removed the word “measured” from its official statement about future rate increases, opening the door to raising them in bigger chunks than just a quarter-point.

Reason: Gold is screaming “inflation.” So is silver, copper, steel, aluminum, oil and virtually every natural resource on the planet. Even the Fed’s own inflation indicators are busting out of the Fed’s “comfort zone.”

We’ve been warning about this for a long time. Now it’s getting closer.

And it’s about time. But it could be too little, too late. As Sean explains below, commodity prices — especially oil — are veering out of control.

OPEC Losing Control
of Oil Prices? You Bet!
by Sean Brodrick

In a farewell comment to America, what if Alan Greenspan came on TV and said something like …

“I have no control over interest rates. Market forces will determine them. Same goes for the dollar. Good luck!”

Would investors welcome it as a refreshing breath of truth? Or would it send the market reeling?

Probably both!

So my question is: When Saudi Arabia, the “central bank of oil,” makes a very similar kind of statement about oil prices, why is it ignored?

Granted there’s a lot going on in the Middle East these days: Iran is pursuing its nuclear option … Iraq is going from bad to worse … terrorists were just elected as the new government of Palestine. So maybe the market just missed the statement by Saudi Arabia’s oil minister, Ali Naimi:

“I have no control over [oil] prices.”

This may be no surprise to readers. But to a world that counts on Saudi Arabia to use its spare capacity to moderate the price of oil when it gets too high … it should come as a shock.

Saudi Arabia produces about 9.6 million barrels per day (bpd) of crude oil. If it pumps flat-out, it might be able to tap another million. With all the oil from other sources, that adds up to 84 million bpd worldwide.

So why the alarm? Because global demand ran about 83.3 million bpd in 2005 — up 1.3% from the previous year — and should rise more than 1.8 million barrels per day in 2006. In other words, even if the Saudis pump the extra million, it’s still not enough.

Still, some people are pooh-poohing the impending shortages. Their view is that you should listen to the IEA, which expects OPEC production capacity to rise by a million bpd this year, while non-OPEC supplies rise by 1.3 million.

Are they right? Too soon to say for sure. But the clincher for me is that the IEA’s estimates of non-OPEC production have a history of being extremely optimistic.

• In 2005, the IEA expected non-OPEC production to grow. Instead it stagnated.
• And in places like the North Sea, production is falling off a cliff.
• Even OPEC’s output is lagging. Kuwait’s largest oilfield — the Burgan — hit peak production last year.

So it’s mostly downhill from here, and things may be worse than most of the world realizes: According to Petroleum Intelligence Weekly …

Kuwait’s oil reserves may be only 48 billion barrels … or less than half the officially-estimated 99 billion barrels. With Kuwait accounting for a whopping 11.7% of all global reserves, that’s an explosive revelation.

Plus …

Iran’s oil production is in trouble, too. All nine of Iran’s major fields, which produce 90% of its oil, are past their peak.

At the same time, domestic oil consumption is growing.

As a result, Iran’s oil exports — which were 4 million bpd during the reign of the Shah — have slumped to just 2.5 million bpd today.

Iran can’t even keep up with its own OPEC production quota!

Another former OPEC exporter, Indonesia, has seen its production fall so sharply that it’s now an oil importer.

And other OPEC members are seeing their major oil fields, discovered 40 or 50 years ago, come under increasing strain to keep up.

With oil production decaying or crumbling nearly everywhere, Saudi oil becomes more pivotal than ever. Well, America can always count on its good friends, the Saudis, right?

In a word: NO.

Saudi Arabia Is Rushing to Make New Deals with China
And India — a Bad Omen for America’s Energy Future!

Saudi Arabia’s oil planners see the handwriting on the wall. They see China and India racing around the globe, locking up future production, leaving Uncle Sam in the dust as they do it.

Indeed, that statement by Saudi Arabia’s oil minister Ali Naimi — that he couldn’t control oil prices — was made in New Delhi, while he was visiting India to forge a new energy deal, the “Delhi Declaration.”

The deal, signed by Saudi King Abdullah and Indian Prime Minister Manmohan Singh, tightened the two countries’ energy relationship to the point that Saudi Arabia can supply a huge chunk of India’s needs — not just now … but into the future as well.

Saudi Arabia already supplies a fourth of India’s oil. And India, which imports 70% of its oil, needs more and more all the time.

Its citizens are buying cars at an even faster rate than the Chinese. Whereas growth in Chinese car sales is expected to increase more than 10% this year, sales of passenger vehicles in India rose more than 18%, year-on-year, through July.

India’s oil consumption has doubled over the past 20 years to 2.5 million bpd, and is accelerating. It’s expected to grow 5% this year alone!

The Saudi King told reporters this was the first declaration he signed with any country. Well, that may be true, but the first international stop he made as the new King wasn’t in India — it was in China.

At a formal welcome, China’s president, Hu Jintao, proudly told King Abdullah:

“Your Excellency is the first Saudi king to visit China. This is also your Excellency’s first visit to another country since coming to the throne. And China is the first stop of your Excellency’s tour. These three ‘firsts’ demonstrate the importance you attach to Sino-Saudi relations.”

True. It’s not happenstance that the first stops for the new Saudi king were China and India. King Abdullah’s dislike for America is well known, and his actions speak louder than words: He’s putting Uncle Sam on notice.

In China, he finds an eager customer. A decade ago, China’s domestic oil production was able to meet its consumption. Now, as China’s 1.3 billion people make the transition from bicycles to scooters to automobiles, they import over 3 million barrels per day.

And according to the U.S. Energy Information Agency, China’s oil imports are projected to more than triple — to 11 million bpd — in the next 20 years.

But we won’t have to wait that long to see China’s demand for crude oil surge. They’re already gearing up to refine more crude for gasoline and other fuels. And this year alone, China’s primary refining capacity will increase by 650,000 bpd, according to Reuters.

Guess who’s helping China build some of those refineries? Saudi Arabia! Along with building new refineries at home, Saudi Aramco has teamed up with ExxonMobil and the Chinese state-controlled oil group Sinopec in a $3.6-billion refinery project in China’s southern Fujian province.

The refinery is being built specifically to process Saudi Arabian crude. And Saudi Aramco is also in talks with Sinopec for a minority share in its 200,000-bpd refinery project in China’s eastern Shandong province.

Bottom line:

Saudi Arabia, the world’s only oil producer with any extra capacity, is busy finding and developing new customers in two countries with the fastest growing energy demand in the world.

Some people are trying to persuade you that you shouldn’t make too much of the Saudi overtures to China and India. But I take my clue from the old Arabian proverb:

Once the camel’s nose is in the tent,
the rest is sure to follow.

Meanwhile, our own oil demand — and dependence on foreign imports — is also growing by leaps and bounds. Take a look at the chart above to view the IEA forecasts of North American oil demand through 2006.

You could argue that America needs to go on an oil diet (that is, start conserving energy).

Indeed, the United States represents just 5% of the world’s population but already consumes a fourth of the world’s oil.

Meanwhile, even as our demand has been rising, our domestic production has been falling — steadily for over 30 years!

Some key facts:

• 90% of all our transportation is powered by oil.
• 95% of everything you buy requires oil in its manufacture or its long-distance transport.
• The U.S. has only 2% of the world’s oil reserves.
• The average fuel efficiency of U.S. vehicles is falling. And our electricity use is rising.

In other words, we’re becoming more dependent on oil, not less.

Like it or not, we’re going to have to get more and more of our oil from the countries that still have significant reserves … like those in the Persian Gulf.

The Middle East: A Game of
Matches in a Gasoline Pit

That brings us back to the Middle East, which is turning its face from the U.S. to China and India, even as age-old grievances spiral out of control.

Any hopes we might have for less expensive energy seem mired in a desert morass of rising fundamentalism, imperial hubris gone bad, and wannabe nuclear tyrants.

The camel’s nose is in the tent. We can only hope that our leaders are up to the challenge of pushing the camel back out … or finding a better tent. As one oil minister said recently, at the rate that global oil demand is rising, the world needs to find a new Saudi Arabia every few years.

Where Is America Going to Get
Its Next New Energy Supplies?

Whenever I have this conversation — and I have it a lot — someone always mentions Canada’s oil sands. While there may be a lot of oil locked in those sands, don’t kid yourself — it’s no pot of black gold at the end of the rainbow. This is a topic that I’ll save for next week. For now, I’ll just say that the oil in Canada’s tar sands is expensive to produce and has other problems as well.

Don’t count on South America, either. Venezuela, for example, is busy making new deals with China. So are Ecuador and Bolivia.

Africa? Again, we’re being beaten to the punch by China and India.

Maybe it’s just coincidence that every step in China’s quest for new oil and gas resources is another kick at America’s underbelly of energy dependence. My view:

China is already thinking about the end game in the new global chess match for energy, while Uncle Sam has yet to make its opening moves.

If you want to wager that our leaders in Washington can guide us to a future of energy independence, that’s up to you. It’s your money. Good luck with it!

But if I were you, I’d be moving quickly to protect your portfolio — and potentially reap a barrel of profits as oil and gas gush higher. For starters, here are two mutual funds I like a lot …

#1. Fidelity Select Natural Gas Portfolio (FSNGX).

This fund invests in stocks that produce and distribute natural gas, as well as companies that provide equipment and services to natural gas drillers, including Burlington Resources, Valero Energy, Chesapeake, Halliburton and more.

FSNGX racked up a 45.7% return in 2005, and 38% average returns over the past three years. And it did it with a low expense ratio of 0.96% (compared to the group average of 1.49%).

#2: The Enerplus Resources Fund (ERF)

This is a Canadian royalty trust with nearly 3,000 natural gas wells and 2,000 oil wells. What’s more, Enerplus pays a hefty dividend — between 8% and 9%. And this fund is heading higher in a hurry.

#3: Select Energy Stocks.

Individual stocks will outperform mutual funds. How do I know this? We see it all the time — not just in energy but in gold and other sectors.

For example, in my just-published report, The Gold Rush of 2006, I name two gold-oriented mutual funds.

One of these is up 10%; the other, up 12%. Not too shabby for two weeks’ work … and several times better than the 5% rise in gold bullion over the same time frame.

But the funds’ performance is exceeded still further by the surges in some of the individual stocks I recommended in that same report — 14%, 16% and more. And that’s before the parabolic moves I expect gold stocks to make.

We see precisely the same pattern in the energy sector: You can make good money in the mutual funds. You can make better money in the red-hot small-caps. And if you want the biggest bang for you buck of all, consider LEAPS options on surging oil companies.

Best wishes,

Sean

Correction: Last week, while I was in the air returning from Vancouver, something got botched up in the editing process of my Money and Markets of Wednesday, January 25. The report said I see the commodity boom “ending” three years from now. What it should have said is this:

You could get a commodity boom CORRECTION around three years from now. But it’s way too soon to start talking about an end to the boom.

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About MONEY AND MARKETS

MONEY AND MARKETS (MAM) is published by Weiss Research, Inc. and written by Martin D. Weiss along with Larry Edelson, Tony Sagami and other contributors. To avoid conflicts of interest, Weiss Research and its staff do not hold positions in companies recommended in MAM. Nor do we accept any compensation for such recommendations. The comments, graphs, forecasts, and indices published in MAM are based upon data whose accuracy is deemed reliable but not guaranteed. Performance returns cited are derived from our best estimates but must be considered hypothetical inasmuch as we do not track the actual prices investors pay or receive. Contributors include Marie Albin, John Burke, Beth Cain, Amber Dakar, Michael Larson, Monica Lewman-Garcia, Julie Trudeau and others.

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