Commodity Investing

Energy Mercantilism: Is “Private Oil” Threatening the NYMEX?


Energy Mercantilism: Is “Private Oil” Threatening the NYMEX?

by Donald Miller, Investment U Research
Thursday, January 25, 2007: Issue #631

Rapid expansion in China and India has led the governments of these countries to make sweeping changes in the way they buy oil. In many cases, they are beginning to circumvent the traditional distribution networks of the New York Mercantile Exchange (NYMEX), and other bourses, entirely.

In fact, they’re undermining them, “locking up” supplies by purchasing crude from oil-producing countries directly – behind closed doors…

These deals last years, often taking large oil reserves off the market for a decade or more. And, though it will be difficult to know by how much, they could potentially impact the future price of crude. Consider the following:

  • Angola committed to supply China with 200,000 barrels of crude per day at $60/barrel for the next 10 years, in return for Chinese investment in infrastructure projects such as railroads, roads and bridges.
  • China National Petroleum Corp. has entered joint development agreements with Sudan, which is expected to produce as much as 300,000 barrels per day. Another Chinese firm, Sinopec Corp., is erecting a pipeline from that complex to Port Sudan on the Red Sea, where the Chinese are building a tanker terminal for shipping raw crude to the Chinese mainland. Altogether, Sudan provides 10% of Chinese petroleum imports.
  • India already imports about 24 million tons of crude from Saudi Arabia every year, which is 26% of its total crude imports. It has stated a desire to secure long-term contracts to assure delivery in the future. Indian public sector firms have participating interests in oil and gas projects in Vietnam, Sudan, Russia, Iraq, Iran, Myanmar, Libya, Syria, Australia, Ivory Coast, Qatar and Egypt.

This strategy is coming to be known as “Energy Mercantilism” in which producers and consumers are bypassing the marketplace altogether.

And the free markets that have historically determined the pricing and allocation of oil suddenly face a new uncertainty: Now that oil prices are being locked in outside of the marketplace, not everyone will pay the same price. It directly counters market pricing, and destabilizes the supply/distribution channels that currently determine how much we pay for oil.

Energy Mercantilism: The “State-Run” Energy Market

The world relies on an open marketplace to set the price of energy. For decades, the NYMEX has been the epicenter of oil trade.

But China and India, in cooperation with a key supplier, Russia, have turned the tables by making bilateral agreements to lock in long-term supplies at set prices, or by forming consortiums to guarantee supply.

And these “private” oil deals are beginning to roll in

In Russia, Vladimir Putin has been squeezing Europe by withholding supplies of natural gas while negotiating for exclusive pipeline deals. In 2003, he dismantled the Yukos oil group who had expanded dealings with the West. He has explicitly stated that Russia will demand bilateral long-term supply contracts with consuming nations, so Russia could guarantee stable demand for its exports.

Recent testimony before the Congressional Committee on National Security, Emerging Threats and International Relations outlined how China’s three state-owned oil companies “have managed to establish control over about 3 mb/d [million barrels a day] of crude production, which could reach up to 6 mb/d by 2008.”

In November 2005, Chinese President Hu Jintao toured Latin America and completed a number of economic deals, including an oil deal with Argentina. Hugo Chavez, the President of Venezuela, has said Chinese firms would be allowed to operate 15 mature oil fields in eastern Venezuela, which could produce more than one billion barrels. Chavez has also invited Chinese firms to bid for natural gas exploration contracts.

The fact is, 90% of world reserves are controlled by national oil companies, as opposed to market-driven public companies.

Exxon Mobil (NYSE: XOM), for example, is the largest publicly traded oil company. And it ranks only 14th in proven reserves, directly below 13 national oil companies, including those of Iran and Venezuela.

Conclusions on Energy Mercantilism and Global Oil Markets

A task force for the Council on Foreign Relations (CFR), a highly respected Washington think tank, recently released a report that contains dire predictions for our economy and global oil markets.

Led by ex-CIA chiefs John Schlesinger and John Deutsch, the group reports that the United States will be unable to achieve energy independence any time in the foreseeable future, even with massive injections of ethanol, wind power and other alternative fuels.

Noting the potential ramifications of Energy Mercantilism, the report recommends radical conservation initiatives, possibly including higher gasoline taxes and gasoline rationing.

It also calls for the implementation of “an active public policy to correct these market failures that harm U.S. economic and national security.”

“Most oil and gas resources,” the report states, “are controlled by state-run companies, some of which enter into supply contracts with consumer countries that are accompanied by political arrangements that distort the proper functioning of the market.”

The fact is, more and more oil buyers and sellers are hooking up directly, outside of the marketplace. And in many cases, they’re including other “payments” into the transactions – direct investment, infrastructure development and trade agreements.

It’s not certain how Energy Mercantilism will impact the price of oil, in real terms. But it will be an important trend to watch. We will continute to follow it, and be sure to bring any material developments to your attention.

Good Investing,

Don Miller

Today’s Investment U Crib Sheet

  • Investment U’s report also includes the details of a China-Iran deal worth $70 billion over the next 25 years.
  • The New York Mercantile Exchange (NYMEX) was created, as most exchanges were, to provide “a place for buyers and sellers – such as farmers and grain dealers – to meet, set quality and quantity standards, and establish rules of business.” Today, the NYMEX is the world’s largest physical commodity futures exchange, and strives for “price transparency.”

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