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The Axis of Oil

By Sean Brodrick

Gold has just zoomed past the $700 barrier.

It is sending shock waves throughout the financial markets ... signaling serious turmoil in the world ... and reflecting some of the greatest threats to America’s dominance in decades.

One of the most frightening: The powerful Axis of Oil emerging between Venezuela and Iran.

In February, Nicolas Maduro, head of the Venezuelan parliament, stood beside Gholam-Ali Haddad-Adel, speaker of the Iranian Parliament, and declared:

“From our souls, we feel that our two nations are brothers and that together with other peoples we are carrying the flag of dignity and sovereignty.”

Meanwhile, Venezuelan President Hugo Chavez lavished praise on Iranian President Mohammad Khatami, describing him as:

a champion of freedom, justice, and peace, someone who has always wanted the best for all nations.

And these kind words aren’t coming out of the blue. They were uttered in the context of a rapidly evolving strategic and economic alliance:

First, back in March 2005, the two countries signed several agreements worth $1 billion.

Second, they committed to mutual cooperation on geological and mines projects, whereby Iran’s expertise will help Venezuela develop its resources.

Third, according to Retired Venezuelan Vice Adm. Jose Rafael Huizi-Clavier, the mining arrangements are so broad that they clear the way for Chavez’s government to provide Tehran with uranium for its nuclear program, tapping Venezuela’s uranium deposits near its border with Brazil.

Fourth, Iran and Venezuela also included a pre-contract on an oil project in the Gulf of Venezuela, the offshore gas field of Mariscal, and another oilfield with four blocks in the region.

Fifth, the relationship deepened in December, when state-owned oil company Petroleos de Venezuela (PDVSA) signed a deal with Iran’s state company Petropars to explore the heavy oil deposits in Venezuela’s Orinoco River basin. There are more than a trillion barrels of crude locked up in the tar sands there in a deposit called the Orinoco Belt.

Venezuela’s government believes that includes 235 billion barrels of undocumented recoverable deposits. If it can get that crude reclassified and added to its 80 billion barrels in conventional oil reserves, Venezuela would have bigger reserves than Saudi Arabia ... its standing in OPEC would rise ... and it could emerge as a major power in the global oil markets.

Sixth, Venezuela is lining up with Iran in its showdown with the West, opposing any restrictions on Iran’s access to nuclear technology.

When the International Atomic Energy Agency (IAEA) voted in September to report Iran to the Security Council, only one nation voted against the move: Venezuela.

And when the issue came up again in February, only Venezuela and Cuba, a new member of the IAEA, were against the resolution.

Here’s the crux of the problem ...

While Venezuela Jumps into Bed with Iran, It’s Starting to Divorce Itself from Traditional Customers

Venezuela will now start relying more heavily on partners like Iran to help it refine the Orinoco tar sands. At the same time, it’s chasing out other multinationals with rising taxes and the outright nationalization of oil properties and equipment. Consider the facts:

Venezuela already jacked up royalties to 16.67% from 1% on the country’s four major projects. And just this week, Chavez announced a new plan to raise the top rate to 33%!

Under the same plan, Chavez also wants to boost the tax rate on profits earned from Venezuela’s oil. The rate is currently 34%. Chavez wants to increase the rate to 50%!

These come on top of a recent increase on the taxation of oil fields developed by foreign oil companies. The rate went to 83% from 56.6%.

Chavez also wants PDVSA to increase its stake in the four major projects to 60% from 40%. To do this, Venezuela is forcing foreign companies into 20-year “mixed enterprise” contracts, in which PDVSA becomes the dominant partner.

Adding insult to injury, Chavez is calling on the “junior” partners to come up with some of the $70 billion needed to develop the Orinoco oil and tar sands belt. Foreign oil companies have already invested more than $17 billion there.

Venezuela’s Energy and Oil Minister, Rafael Ramirez, says he expects the increase, and a doubling of the government’s share of production, to take an additional $2 billion from oil companies annually.

All of this makes Iran the perfect partner. Iran can help get the Orinoco Belt tar sands reclassified. It can help get those deposits to market. And it’s quite willing to do both, especially if it’s a chance to kick (tar) sand in Uncle Sam’s face.

The end result: An even stronger Axis of Oil.

Big Money — and Bigger
Power — Riding on Oil Prices

What does a strongman caudillo in South America have in common with an Islamic zealot in the Persian Gulf? A lot:

Both regimes hate the United States.

Both regimes subsidize domestic gas prices to keep their citizens happy, putting great pressure on both governments to continually boost export revenues.

Plus, both naturally depend heavily on rising oil prices. Oil revenues brought $50 billion into Iran last year alone. And Venezuela — the world’s fifth largest exporter — reaped $22 billion in annual taxes and royalties from PDVSA alone. Every dollar rise in the price of a barrel of oil is more money in their coffers.

So anyone who underestimates their financial clout, their political zeal and the consequences of their actions could be making a grave error.

And with virtually no slack in global oil supply and demand (at just over 85 million barrels per day), it doesn’t take much to upset the equilibrium and send oil prices skyward.

Together, Iran and Venezuela pump about seven million barrels of oil per day. That’s about 8% of total world output, or 23% of the total pumped by OPEC last month. Working together they can shake the market. Heck, they can shake the world.

That gives the Axis of Oil tremendous leverage. They can keep prices up simply by injecting steady doses of fear into the global oil markets. Indeed,

During a visit to India last week, M. H. Nejad Hosseinian, Iran’s deputy oil minister, said crude oil prices should hit $100 a barrel this winter even if nothing goes wrong. If simple supply and demand is enough to drive prices up that high, imagine what Iran’s target for oil is if things do go wrong!

More Possible Members forThe Axis of Oil?

Cuba, Venezuela, and Bolivia have signed a trade agreement to counter the U.S.-led drive for a Pan-American free trade agreement.

Venezuela has also joined Mercosur, the South American trade bloc led by Brazil and Argentina. And Chavez is trying to encourage other countries to join his more thorough integration plan called the Bolivarian Alternative for the Americas, or ALBA.

Chavez’s anti-Western strategies are also becoming contagious:

Ecuador recently approved a law that allows the government to renegotiate contracts with oil companies. The contracts will give the government half of the revenues from oil sold above a certain level.

In, Peru, the leading presidential candidate, Ollanta Humana, is promising to nationalize gas reserves (the fifth largest in South America) if he wins the runoff election. Chavez is enthusiastically endorsing Humana, so much so that Peru withdrew its ambassador from Venezuela, charging that Chavez is interfering in Peru’s internal affairs.

Bolivia just nationalized its natural gas industry. Anyone on Wall Street who was surprised by this hasn’t been paying attention. President Evo Morales was elected on a promise to nationalize the natural gas fields. Now, he’s doing exactly that.

Bolivia’s energy reserves (48.7 trillion cubic feet of natural gas) may be small compared to Venezuela’s. But it’s the trend that’s the problem:

It’s so bad, Barrick Gold says Pakistan — the country where Osama bin Laden hangs out when he’s not in Afghanistan — is a more stable place to do business than Bolivia or Venezuela.

Down the road, Hugo Chavez plans to build an empire of energy. And he’s using a pipeline to do it ...

The Longest Pipeline in the World

This is where the Axis of Oil turns into the Axis of Gas. Chavez is bent on building the Gran Gasoduto del Sur, or the “Great Gas Pipeline of the South.” This pipeline will have a capacity of 150 billion cubic meters per day and will snake from Puerto Ordaz in eastern Venezuela to Buenos Aires in Argentina. That’s 6,215 miles — the longest pipeline in the world and a $25 billion project.

Let’s get real — the project has “boondoggle” written all over it. Still, with Chavez swearing this will create a million jobs, other governments are lining up to support it.

Chavez plans to export gas to his neighbors first, then to “friendly countries,” including China and India. As for the U.S.? Sorry, Uncle Sam. Chavez says the days when Venezuela “was an American colony” are over.

Enter China!

Last year, Venezuela signed an agreement to sell 120,000 barrels of fuel oil a month to China. It’s just the start. Venezuela wants to sell more — not only to China, but to all of Asia.

And China will likely buy all the oil Venezuela can pump, as China’s booming economy kicks its energy consumption into overdrive. China’s GPD grew 10.2% in the first quarter. Its oil imports jumped by more than double that pace — over 25%.

China’s trade with Latin America was $40 billion in 2004, an increase of 54% from 2003.

China is investing more in Latin America than any region outside Asia, according to a 2005 study by the consulting firm Booz Allen Hamilton — $4 billion, compared with $300 billion by U.S. companies.

But it’s just the first phase.

• In 2004, Chinese President Hu Jintao announced that China planned to invest $100 billion over ten years in Latin America.

• Chinese companies are getting contracts to run oil fields in Venezuela, and PDVSA is buying 28 oil drills from China Petro Technology & Development, Prospecting and Production.

• And let’s not forget that China is making deal after deal with Iran for energy and weapons, too. In fact, while the U.S. has blacklisted Iran, Russia and China are busy pursuing huge deals with Tehran worth billions of dollars, helping it develop its oil and gas fields and selling it weapons.

Meanwhile, U.S. corporations are being scared off by the socialist wave washing over the region.

So there you have it: Two enemies of the U.S. — Iran and Venezuela — developing an Axis of Oil. Plus, America’s biggest political and economic competitor, China, eager to partner with them at all levels.

Bottom line: The Axis of Oil is the oil weapon of choice — a gun pointed right at Uncle Sam’s tender underbelly. This tells me U.S.- Iranian negotiations will likely fall apart.

Two Urgent Questions:

What if Venezuela starts selling large amounts of oil to energy-thirsty Asia, and tells Uncle Sam to go find its oil elsewhere?

What if the showdown with Iran escalates into a shooting war, and Venezuela announces an embargo to support its “brother” nation? Is the market pricing that in?

My answers: Just the fear of these scenarios unfolding could help drive oil prices much higher than $100 a barrel. And I’m not even figuring in hurricanes in the Gulf of Mexico or potential terrorist attacks.

Some things I recommend:

1) Check your portfolio for southern exposure: Make sure the U.S. energy and mining stocks in your portfolio don’t do a lot of their business in Venezuela, Bolivia, Ecuador, or Peru. Even if they’re good stocks, and even if the danger passes, they could be hurt in a general sell-off.

Remember, there are still South American countries that are great for business — Brazil and Argentina among them. And despite recent wildcat strikes, Mexico should get past its problems and its investment climate could even improve. But right now, I wouldn’t touch Venezuela or Bolivia with a 10-foot pole.

2) Buy the right energy stocks: By this, I mean the smaller energy stocks that are still growing organically, that can grow in places that are more geopolitically stable than South America, and that can still work in that region without being targeted by political opportunists. Some major oil companies are just too big and too vulnerable to socialist blackmail. Look for smaller, more nimble explorers and drillers that stand to make a killing when oil goes to $80 ... $90 ... and beyond.

3) Play the China/Latin America boom: Foreign companies may find it more difficult to do business in Venezuela and Bolivia, but there are some great South American companies that won’t have that barrier. These are the companies that are likely to reap a whirlwind of profits as Chinese investment dollars pour into South America.

One way to get broad exposure is the T. Rowe Price Latin America fund (PRLAX). This no-load mutual fund is up 17% so far this year. It gets four stars from Morningstar. And it has a total expense ratio of 1.29% — lower than the category average.

Its top holdings include Petroleo Brasileiro, the best of the South American oil companies, as well as America Movil, Companhia Vale, and Cemex, a big Mexican cement company.

Good luck and good trades!

Sean Brodrick is an analyst and contributor to Money and Markets. Petroleumworld not necessarily share these views.

Editor's Note: This article was originaly publish by MONEY AND MARKETS
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Petroleumworld 05/28/06.

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Copyright©2006 Sean Brodrick. All Rights Reserved.

 

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