Dear A-Letter Reader,
On March 21st Iran was scheduled to launch the world's first oil trading exchange that would have set prices in euros rather than dollars. Many analysts feared this would have spelled disaster for the greenback since oil is the world's most popular commodity and requires most nations to hold vast reserves of dollars in order to purchase it. If oil were to be suddenly settled in euros, the global need to hoard dollars would diminish considerably, eliminating one of the key supports for the US dollar in the currency market.
The doomsday scenario did not come to pass, as Iran failed to construct the necessary infrastructure for a successful launch of the exchange. It is still insisting on opening a Persian Gulf oil bourse with the southern Iranian island Kish as its base of operations according to a report by Iranian state-television on Saturday. 'The issue has already been agreed upon and the oil ministry has been instructed to open this bourse in the Persian Gulf island of Kish,' Economic and Finance Minister Davoud Danesh-Jafari said. However, at this point, the issue of an Iranian oil exchange to challenge the New York and London markets appears to be more of a P.R. stunt rather than a viable competitive threat.
Even if the Iranians managed to open up for trading, the key question remains: who would trade with them? Given the recent antagonistic rhetoric of the country's political leaders, many investors would likely shun the bourse for fear of not having their trades honored. Successful financial markets require trust and cooperation and Iran's antagonistic actions over the past several months (especially their insistence on developing nuclear capabilities) have engendered little goodwill in the world community.
But dollar bulls should not be so quick to breathe a sigh of relief....
Dollar Dodged a Bullet, But Not the Firing Squad
While the immediate threat of the Iranian oil bourse may have disappeared, the greenback remains highly vulnerable to rising oil prices. Indeed the irony of the matter, is that despite the failure of the Iranian oil bourse, crude itself is trading higher now than when the issue of the Iranian oil bourse first gripped the attention of the financial markets.
Political instability in Nigeria and ever growing demand from China have put an ironclad bid underneath the commodity. To understand why, one only needs to look at the report of the Chinese National Development and Reform Commission. It noted that China produced 11.2% more electricity in Jan-Feb period of this year than last. But China's crude oil output only rose 2.5%. Since electric power generation demands energy to get the turbines going, this means China is experiencing a massive deficit and therefore increased demand for crude on the world's markets.
T Boone Pickens-a man whose hedge fund generated over $1.5 Billion in profits over the past 5 years-projects that very soon world demand for oil will increase to 87 MM barrels per day while world supply will only be able to produce 85 MM barrels per day.
In fact, as China continues to grow, oil analysts calculate that it will create demand for an additional 20 MM barrels per day if it simply matches the current per capita energy consumption of Mexico. As we drove the highways of Southern Florida this weekend, we couldn't help but notice that gasoline prices - which only a few weeks earlier were near the $2.50 gallon level - were now inching towards the $3.00 barrier. We believe that the $3.00/gallon gasoline will have a serious negative impact on US consumer spending going forward and that in turn will weigh heavily on the US dollar.
Finally, while the Iranian oil bourse is history, the country's destabilizing effect on the oil markets may just be beginning.
Just this week, Iran announced that it has successfully fired a high-speed underwater missile capable of destroying huge warships and submarines. The Iranian-made missile has a speed of about 350 kilometers an hour underwater, claims the Iranian navy. If this is true, it means the missile can travel three or four times faster than a torpedo and according to Iranian navy the missile has a " very powerful warhead designed to hit big submarines...even if enemy warship sensors identify the missile, no warship can escape from this missile because of its high speed.".
Even more dramatic, Iran tested this missile in the Straight of Hormuz - the narrow passageway in the Persian Gulf that borders Iran and through which 25% of the world's oil supply flows. This is also a very provocative move given that the UN gave them 30 days starting last week to stop their nuke program. More turmoil in both the oil and the currency markets is the likely bet.
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