OPEC Showdown

A big showdown is looming when OPEC meets in Caracas on Thursday.

The media has been saying Venezuelan President Hugo Chavez will use the meeting to push for OPEC production cuts. And he probably will.

But I think theres a lot more to the story than that. So let me tell you something you wont read in the papers … I think Chavezs real goal in Caracas is convincing OPEC to dump the U.S. dollar for pricing oil!

Instead of dollars, Chavez would like to price oil in a basket of currencies, possibly with special emphasis on euros.

While few others see this move coming, here are the signs that I see:

First, Saddam switched his oil to euros six years ago. It was just a symbolic gesture but it got the ball rolling.

Then, Venezuela transferred a large portion of its foreign reserves out of U.S. Treasuries and into euros last year.

Now, Iran is readying its own oil bourse, which will also price oil in euros.

Plus, Chavez recently declared his intentions to do the same. His own words:

We are free to choose between the dollar and the euro … Venezuela might also consider that at any time.”

Why Would the Rest of OPEC
Go Along with the Plan?

Because a declining U.S. dollar hurts Arab oil sheiks who do tons of business, vacationing, and shopping in other currencies.

Given the dollars fall, their revenues are worth less every day. And thats not just when theyre shopping in Europe. Its almost everywhere Japan, China, even Latin America.

As of February 2006, OPEC held a whopping $84.9 billion in U.S. Treasuries.

And that excludes OPECs holdings through British banks.

In short, now, the value of their holdings are plunging with the dollar. Thats going to make them more receptive to dumping the U.S. currency for pricing their oil.

Over half of our imported oil comes from OPEC. Would OPEC want to hurt the U.S., its best customer? Maybe not intentionally. But if the U.S. dollar keeps declining, OPEC will come under growing pressure to cut its losses.

And Venezuela doesnt care if the U.S. gets hurt or not. Chavez is convinced that he can replace U.S. demand for oil by selling to Chinas booming economy.

Now, I dont know if Chavez will get his way. But even if OPEC just considers his proposal, it could light one heck of a fire under oil prices.

And dont forget where Chavez is coming from: Hes not just aiming to switch currencies. Hes also aiming to shift strategic alliances and establish a power block thats outside of the dollars realm. (See The Axis of Oil.)

What About Production Cuts?

OPEC may not buy it. But the story of Venezuelas oil production reminds me of the ancient Chinese practice of a death by a thousand cuts.

Indeed, things just havent been the same since Hugo Chavez crushed a 2002 strike in the oil industry by replacing knowledgeable workers with his cronies:

Production has plummeted 20% since the strike!
Rigzone, a publication that follows the industry, says as many as 10,000 Venezuelan oil wells are now mostly useless.
Venezuela cant even meet its current OPEC quota its allotted 3.2 million barrels a day but can only manage 2.5 million barrels per day!
In fact, state-owned oil company Petroleos de Venezuela SA (PDVSA) is buying 100,000 barrels of oil per day from Russia to avoid defaulting on deliveries to clients.

The Potential Fallout,
And How to Play It

If OPEC moved to pricing oil in a basket of currencies, particularly a euro-heavy basket, there would suddenly be a lot less demand for greenbacks.

That would send the value of the dollar already weighed down by the staggering U.S. deficit and mountainous current account deficit plummeting.

My three-point action plan …

First, consider putting a portion of your money in precious metals. After all, rising energy costs drive up inflation, which drives up the price of gold.

More to the point, if the value of the dollar is going to slide and I believe it is there are great funds like streetTRACKS Gold Shares (GLD) and iShares Silver Trust (SLV) that let you invest in metals without buying it physically. Im not saying this should be a major part of your portfolio, but a small portion wouldnt hurt.

Second, consider putting money in a good oil and gas mutual fund. One that I like is the Profund UltraSector Oil & Gas (ENPIX). It uses leveraged instruments to deliver 150% of the performance of the Dow Jones U.S. Oil & Gas Index.

So far this year, it has returned 19.9%. This no-load fund gets three stars from Morningstar, has a total expense ratio below the category average, and is near the bottom of an uptrend.

Third, look at Canadian royalty trusts. Our favorite remains Enerplus Resources Fund (ERF). It has nearly 3,000 natural gas wells and 2,000 oil wells. Whats more, Enerplus pays a hefty dividend more than 8%!

My parting word is: keep your eye on energy. With Chavez stirring up trouble in Caracas at the OPEC meeting … with the Middle East possibly blowing up in our faces at any moment … and with Tropical Storm Aletta initiating the start of storm season, prices could take off at any moment. Smart investors will be positioned to ride the updraft.

Good luck and good trades!

Sean Brodrick

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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 Sean Brodrick, Larry Edelson, Michael Larson, Nilus Mattive, and Tony Sagami. 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. Regular contributors and staff include John Burke, Colleen Collins, Amber Dakar, Ekaterina Evseeva, Monica Lewman-Garcia, Wendy Montes de Oca, Jennifer Moran, Red Morgan, and Julie Trudeau.

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