Millennial Conflict

In the Middle East, however, many are viewing the Iraqi election
primarily as a new, potentially more violent chapter in the war
between Shiite and Sunni Muslims — an ethnic/religious conflict
born with the death of Muhammad’s grandson during the battle
of Karbala of 680 AD, over thirteen centuries ago.

Both of these interpretations are largely correct, and both are
being hotly debated throughout the region. But only one will
determine the course of history.

If democracy prevails, it’s assumed that, in the best-case
scenario, the region’s oil supplies will flow freely, the
world economy will continue to grow, inflation will not be inflamed,
and investors will prosper.

If the Shiite-Sunni conflict prevails, however, the picture changes
drastically. In this worst-case scenario, the Sunni population rises
up in a broader rebellion, Iraq bursts into civil war, the conflict
spreads to neighboring countries in the Persian Gulf, and the world’s
most critical oil supplies are severely disrupted.

Which will it be, and when will we know?

I dare not venture a forecast. Iraq and the region are too volatile,
too full of surprises and shifting far too frequently.

But there’s one aspect of this conflict that is crystal clear
to me: We must not be lulled by today’s televised images
of dancing in the streets in Baghdad or Basra.

Over the past two years, we’ve seen similar images all too
often.

We saw dancing on the street after the fall of Saddam Hussein’s
statue in Fardus Square on April 9, 2003.

We saw it again with the capture of Saddam Hussein on December
13, 2003.

And we witnessed similar celebrations to mark the transfer of power
to the Iraqi interim government on June 20, 2004.

Each time, the festivities were said to symbolize a new beginning
for Iraq; and each time, they set the stage for a steeper decline
into anarchy.

Brent Scowcroft, national security adviser for the former President
George Bush, puts it this way:

“The Iraqi elections, rather than turning
out to be a promising turning point, have the great potential for
deepening the conflict,” firing up the divisions between Shiite
and Sunni Muslims, and gripping Iraq in “an incipient civil
war.”

The Christian Science Monitor adds:

“With growing tension between Iraq’s
majority Shiites and the Sunni Arab minority who have always dominated
the country’s government, low Sunni participation [in the
election] is likely to further divide, rather than unite, Iraq’s
two most important constituencies. Further division, in the worst
case, could nudge Iraq closer to civil war.

“The leading Sunni political parties are now
positioning themselves to reject the vote and its consequence …
as unfair. If there is high turnout among the country’s Shiites,
as expected, that assembly will be packed with Shiite politicians
who suffered mightily under Saddam Hussein’s Sunni regime
and could write a constitution that emphasizes majority rights at
the expense of minorities.”

And according to a National Intelligence Council report, a Shiite-dominated
Iraq is then likely to encourage greater activism by Shiite minorities
in other Mid East nations, including Saudi Arabia.

Yet, throughout the West, the depth and deadliness of this millennial
conflict is severely misunderstood and grossly underestimated.

Also underestimated: Its potential to disrupt the steady supply
of oil from a region which is the largest single source of oil for
the world.

Does everyone forget the Iranian revolution, the fall of the Shah,
and the rise of Ayatollah Khomeini? What about the subsequent surge
in world oil prices that triggered the worst inflation and the highest
interest rates in American history?

Similarly, why don’t more people remember the bloody years
of war between Sunni-dominated Iraq and Shiite Iran, fomenting hatreds
that are still very much alive today?

Fortunately, right now, most Shiites about to assume power in Iraq
are vowing to maintain a secular government and to share power with
their Sunni rivals.

But is this because they are steeped in the discipline of democracy?
Or is it because the danger of a civil war is so great they are
forced to throw some crumbs to the Sunni opposition, while temporarily
repressing deep animosity and venom.

I fear it may be mostly the latter. If so, the Shiites’ attempts
to appease their Sunni counterparts will be rejected, the political
process could backfire, and the entire nation could burst into a
conflict that is simultaneously religious, ethnic, regional, political,
social, economic … and bloody.

Persian Gulf Region Has
Over FORTY-SIX PERCENT
of World’s Oil Reserves

If you think all this is too far away to be meaningful to your
daily life, think again. The Persian Gulf region is the world’s
primary source of crude oil. Consider the facts:

Iran, the world’s first Shiite-dominated republic, plus Iraq,
now to become the second, together control over 15.3% of the world’s
oil reserves and over 8.3% of its production, rivaling the reserves
and production of Saudi Arabia.

The region as a whole, including Iran and the Saudi peninsula,
control over 46% of the known oil reserves on the planet and nearly
30% of the yearly production.

If you survey the entire globe, you will find no other single region
with anything near this kind of a stranglehold on the world economy.
Nor will you find any other region that is more politically volatile
or vulnerable.

The single most consistent, underlying source of this vulnerability:
The millennium-old Shiite-Sunni conflict now threatening to erupt
in Iraq and potentially infect the rest of the region.

• In Iran, which borders Iraq to the east and is devoutly Shiite,
  there are many who will directly support the Shiite majority in
  Iraq.
• In Saudi Arabia, which borders Iraq to the south and is devoutly
  Sunni, there are likewise many who will sympathize with Iraq’s
  disenfranchised Sunni minority.

Between these two powerful neighbors, the warring parties in Iraq
will have no trouble seeking refuge, establishing foreign offices
and making foreign political alliances. Nor with will they have
difficulty acquiring money and weapons to fight to the death.

The frequent attacks on Iraqi oil facilities since the Sunni uprising
began over a year ago are merely a sneak preview of the threat to
those facilities in the event of a civil war. And those, in turn,
could be the prelude to broader attacks in the entire region.

Consider this map. In it, the dark and light brownish areas have
majority Shiite populations, while the balance of the countries
shown are predominantly Sunni.

I am not predicting that the entire region will be consumed in
civil war. But the map gives you a broad overview of how divided
the region really is.

Moreover, the map belies the fact that ALL countries in the region
have a mix of both Muslim sects: Kuwait has Shiite minority
of 27%; Saudi Arabia, 3.3%; Oman, 12%; and the United Arab Emirates,
16%.

And in most — but not all — of the countries, the hatred
and resentment between the two Muslim sects run deeper than those
associated with virtually any other ethnic conflict in the world
today.

Conclusion: Regardless of any near-term correction in the price
of oil, the millennial conflict between Shiite and Sunni Muslims
will continue to be a fundamental, underlying factor that indirectly
drives oil prices higher.

Worldwide Shortages

While the turmoil in Iraq deepens, the rest of the world is quickly
running out of oil:

In Saudi Arabia, officials recently boasted
that they can still crank up oil production significantly beyond
current levels. In reality, production has largely peaked at five
major oil fields in Saudi Arabia discovered between 1940 and 1967
that are still responsible for about 90% of Saudi oil.

At the same time, what remains of Saudi Arabia’s oil reserves
is becoming progressively more expensive to develop and produce,
with Saudis often relying on water-injection techniques to improve
production, a sign the fields have aged considerably.

In the United States, oil production
peaked 35 years ago, in 1970. One factor: Environmental restrictions,
although reduced under the Bush Administration, are still blocking
expanded production.

In Mexico, a primary U.S. supplier, proven
reserves have plummeted a whopping 72% over the past two and a half
decades.

In Venezuela, also a major source for
the U.S., continuing political turmoil under President Hugo Chavez
has stifled production, with grossly inadequate investment in an
aging oil infrastructure.

Fact: We are more dependent on foreign oil today than at any time
in modern history; and among the foreign suppliers, the Persian
Gulf remains, as before, the primary driver of world markets.

Focusing on the here and now …

• Winter is back with a vengeance, driving up demand for heating
  oil and natural gas, depleting supplies and is expected to leave
  the market tight even after the winter is behind us.
• OPEC is tightening the taps. In December, OPEC members agreed
  to cut output by 1 million barrels per day. And yesterday, even
  as millions of Iraqis were going to the polls, they were again
  making plans to cut production to offset any post-winter decline
  in demand.
• Worldwide demand keeps rising, with the International Energy
  Agency (IEA) recently raising its global consumption target for
  2005. The increase wasn’t large — the IEA now says
  demand will rise by 1.44 million barrels per day this year instead
  of 1.4 million. But this agency consistently underestimated demand
  in 2004, and so far, seems to be repeating that pattern now.
• And, regardless of the election outcome in Iraq, Iraqi petroleum
  output will continue to suffer due to terrorist attacks, sabotage,
  and outdated infrastructure. The country pumped an average of
  just 1.9 million barrels per day in January, still far below
  the 2.48 million before the war began.

The Consequences

No, oil prices won’t go straight up. Sharp setbacks are normal
and to be expected. But the threat of more civil unrest in Iraq
and the potential for spreading Shiite-Sunni conflict in neighboring
Persian Gulf nations can only add to the upward pressure on this
market.

So brace yourself for a series of virtually unstoppable consequences:

• Higher gas prices at the pump. After
  a lull last year, they are already rising. Expect new, all-time
  highs in 2005. Also going up: Heating oil (despite the winter’s
  end), diesel, jet fuel, natural gas, and more.
• Rising inflation in U.S. consumer prices.
  The core inflation rate in the U.S. (even excluding oil) is now
  running at triple the pace of 2003. With oil and energy prices,
  it’s even worse. And never forget the fact that oil and
  energy are major components in the cost of a wide variety of goods
  transported and sold in America.
• Higher interest rates. This week,
  the Federal Reserve’s Open Market Committee members will
  likely announce the SIXTH in a series of interest-rate hikes.
  Until now, their rate hikes have been small — just a quarter
  or a point. But in the language surrounding their decision to
  be released this week, don’t be surprised if they hint at
  faster rate hikes in the future.

In this environment, it pays to keep most of your money safe, liquid
and short term. Plus, anyone without hedges — investments
designed to rise when inflation and interest rates go up —
could be caught flat-footed.

Good luck and God bless!

Martin D. Weiss, Ph.D.
Editor, Safe Money Report
Chairman, Weiss Ratings, Inc.
martinonmonday@weissinc.com

Martin Weiss
and “Martin on Monday” are non-partisan. Third-party ads do not necessarily
represent their opinion and should not be interpreted as an endorsement.