Andrew McKillop:

VHeadline.com oil industry commentarist Andrew McKillop writes: Financial analysts, of the quotable variety, like to show they have hands-on predictive capability in “What if” situations.

Their actual forecasts, it goes without saying, are always wrong but — miraculously — they keep their jobs!
Their key method is based on ‘elasticity’ notions, which might sound scientific but really is nicely dressed, by-gosh-and-golly number calling.

With oil prices and economic growth, the finance analyst community cranks out a huge range of forecasts on the “What if” impact of say ‘oil staying near US$50/barrel through 2005′, or ‘falling to a reasonable US$30/bbl in 2005′. Or why not $22-28/bbl we could ask?

Morgan Stanley’s chief analyst Steven Roach did this in Sept. 2004, asking himself: ‘What if oil stays near $50/bbl ?’ instead of falling to his reasonable price of $36. His desktop gave the answer in a flash: a 0.3% fall in Morgan Stanley’s predicted number for world economic growth in 2005, from 3.9% to 3.6%.

According to Roach, for $14 up on the oil price you get 0.3% less growth than you first thought you were going to get. The economic growth elasticity is always negative for an oil price rise, in official mythology. In the real world, real economy its the exact and entire opposite of this — oil price rises spur growth — but I have yet to market my desktop program for this. Few finance houses contact me.

The ‘price elastic’ notions used by the coterie of hands-on ‘experts,’ who always get things wrong, were honed up in the early 1980s, along with the desktop programs to deliver the pat answers.

A key or ‘epochal’ event leading to this creative program writing was none other than the 1979-80 Iran crisis.

As with the fairy tale New Economics of the time, everything had to be simple enough for new breed politicians to communicate a downsized future to their voters, and find something to hang the blame on: oil fitted this role really well. From then on, any budding finance analyst had only to tap in the oil price price on his desktop, and get the number for how much less economic activity we “automatically” get from an X% increase in the dollar price (not Euro or Yen price we can note!) of oil.

In the above Steven Roach number calling: plus $14 = minus 0.3%.

Most other analysts like to hype things up, for the press rooms, and double or triple their “expert forecast” for the price-elastic fall in ‘expected growth’ that ‘What if’ high oil prices will cause, if they stick. Further hype is added by forecasting the gory things that might happen to stock market indexes or the gold price, for example.

Some finance experts don’t stop there. These ‘What if’ oil price jumps could even affect, say, the Sony share price. How is this ?
High-priced oil could result in Michael Jackson’s lawyers asking him for more cash, for special oil supplements to run their limos or heat their swimming pools. If Jacko couldn’t pay, his trial defense could weaken, he might go to jail, and his suits on Sony Music might fail; the Sony share price should rise. Real finance experts, of the most erudite type, could therefore push their forecasting, and generate the number for the positive elasticity of Sony’s share price with an X% rise in the oil price.

Few or no experts … until the past few weeks … have tried this the other way around: What if oil supply falls, pushing up oil prices?

The regular, run-of-the-river forecasts, as above, are based on oil prices being cranked up by the evil OPEC cartel, by somber hedge fund rings on the NYMEX, by acts of God or Allah, by accidents, bad weather, strikes in Nigeria or whatever. But an actual physical cut in oil supply would, or at least should crank up oil prices. What if we get an X% cut in supply?

What is the Y% jump in oil prices (with of course a Z% fall in expected economic growth)?

These numbers are now being crunched — for the Iran bombing party, aka Liberation, War on Terror, globalization, or whatever. Among the first to the microphone and into print, is ING Financial Markets analyst Mark Cliffe (writing in ‘The Independent’, London, 30 January).

Cliffe was perhaps spurred by the leaks, then announcement of Dick Cheney finally taking his private oil company (aka Halliburton) out of Iran. The Cayman Island subsidiary, although it turned about US$40 million profit in Iran through 2004, is ceasing all activity in the country; when Dick goes, his hands will be squeaky-clean … and the bombing can start a decent interval later.

As Cliffe wrote: “US military planners may have to allow for the possibility that an attack on Iran’s nuclear facilities would be the prelude to an all-out invasion. If so, as in the case of Iraq, a winter assault early in 2006 would be the first practicable opportunity from a military point of view.”

He then went on to crank his desktop, and it gave these figures: “a $12 per barrel increase in the oil price, taking West Texas crude up to more than $60 per barrel; a 14% drop in the Dow Jones, taking other stock markets with it; a plunge in bond yields, taking US 10-year yields down by around 0.75%; and a 10% drop in the US$.”

He neglected to add what would happen to the Jacko show trial or Sony’s share price, but ING Financial Markets will likely not sanction him for this oversight. We can also help him out with the gold price: back in 1979-80, in the first Iran crisis, gold hit about US$1,375-per-ounce in 2005 dollars. But this was a protracted crisis, and also the US lost face, as the world lost about 3.5 million barrels/day (Mbd) of oil supply — which was only quite slowly rebuilt.

Today, Rumsfeld is ordering ever better bunker buster bombs, the fast track way of bringing democracy. This, in theory at least, should limit “financial ripples” on the markets. With fast track liberation, Iran would soon be producing much more oil than before invasion, exactly like the finance analysts forecast for Iraq.

Reality only slowly sinks into finance analyst woodentops, perhaps filtering up from Yahoo! newsbytes, or between the cute download ring tones on their mobile phones.

Liberated Iraq in 2004 produced maybe 1.5 Mbd on average (on US official figures), between pipeline hits … and this could get a lot worse before it gets better. Before liberation, Iraq produced about 2.25 Mbd.

Liberating Iran — which might dare to resist liberation — could generate a loss of 1.25 Mbd from world oil supply on the same, increasingly long-term, basis.

That is: the oil supply elasticity of liberating Iraq was a cut in its actual daily average oil production, by 33%, or 0.75 Mbd on 2.25 Mbd, on an increasingly long-term basis. Current, pre-liberated Iran produces around 3.6 Mbd of crude, but is a net and large importer of refined products.

Our desktop program has to figure out the crude loss against the product gains to the Free World, which is tricky. Liberating Iran, as already said, could meet with ’surprising resistance,’ for the basic reason that people don’t like being bombed, or invaded.

China may not thrill to this leap forward for mankind of the Bush variety, because it has a 10-year, US$250 billion contract with Iran for LNG supply.

The UN debate before Iran bombing could be as ‘non consensual’ as that before Iraq bombing. When the bombing starts, the initial loss of crude to the markets could be all of Iran’s current supply, of around 3.6 Mbd. In other words, supply elasticity of -100%.

How the ‘evil OPEC cartel’ will make that up, and inundate the world with cheap oil, is a difficult question. The simple answer is OPEC cannot make up that cut at all.

Could Saudi Arabia increase its net export supply to around 14 Mbd in weeks, after the phone call comes in from the White House?

Could Putin’s Russia increase its net export supply to 8 Mbd when Vladimir gets that call from his Crusader friend?

This is more than ‘rather unlikely,’ it is impossible.

So we have to move on and up to more lurid, that is realistic and likely forecasts. In no way can the evil cartel or Russia make up losing Iran’s crude supply. Based on the French IFP’s lengthy analysis of world market supply, and its forecast of non-OPEC supply in 2005 not exceeding 50-51 Mbd under the best case scenario, OPEC has to be providing up to 30 Mbd right now, on IEA figures of world demand at 82 Mbd.

Even with that near-ultimate production number for OPEC, world oil stocks are being worn down, if slowly.
Taking Iran out will create a big hole in this fragile equation. Stocks will be drawn down in a way we have never seen — even during the 1979-80 Iran crisis – and prices can only double, and then go on increasing as long as Iran remains out of the equation.

Prices would not move to US$60/bbl, but to $90/bbl. This would be a genuine pain-and-suffering price for the world economy, unlike $50 or even $60/bbl. Any protracted resistance by Iran’s army and its 74 million people, and perhaps from certain, large, well armed neighboring or allied countries, could push the gold price far above $750-per-ounce.

That also would go on increasing when the White House announced an ‘end to hostilities’ on CNN … but not on the ground, Iraq style.

Interest rates would first have to be raised in the US … at 1%-a-time, to stop the dollar eroding its way into a meltdown.

Stock market collateral damage would be way above Cliffe’s figures, in the 30% to 50% loss region, relative to current numbers.

Even worse, Iran’s supply would have to be restored … one way or another … within at very most 6 months.

If this did not happen, winter 2005-06 would need physical rationing and allocation of world oil, because prices would have no meaning; the supply would not be there, period.

For all these reasons, therefore, Iran bombing must be seen as pure madness, a flirt with total economic and financial meltdown, and not just one more ‘regime ‘change’ party for bombing freaks and war criminals.