War, Money and Oil!

That the United States is the world's largest consumer of energy is indisputable. With less then 5% of the world's population the US consumes roughly 25% of the world's oil. An abundance of cheap oil is what has driven the US economy over the past century. Indeed the entire world has benefited from this abundance of cheap, readily available oil. But the US's insatiable demand has made them highly dependent upon a safe sure supply. Dependency upon an ensured supply has resulted in the maneuvering and conflicts, especially by the United States, that have dominated the world particularly over the past 30 years since the first oil shock in the early 1970's.

The US consumes roughly 20 million barrels of oil a day. Of that, roughly 53% is imported and about 24% of that or roughly 13% of the total comes from the Persian Gulf states including Iraq. In 1950 the United States supplied roughly 52% of the world's oil production. Today it is has fallen to around 8%. The Persian Gulf States supply about 30% of the world's production most of which comes from Saudi Arabia. The Persian Gulf States also have about 67% of the world's reserves. The US, by comparison, only has about 3% of the world's proven reserves. This makes the Persian Gulf the most important area in the world when it comes to supplying the fuel that the US economy and indeed the rest of the world needs.

Driving the US demand is the world's lowest price for gasoline. US consumers pay roughly 30 cents/litre at the pumps while here in Canada we pay around 45 cents/litre (all figures US$). In most of Europe the price is closer to $1/litre and can be even higher in other countries including third world countries. The vast differential in price says a lot about what drives the demand, the fuel efficiency of automobiles, and the size and type of car/van/SUV we drive. The demand for these products, particularly Vans and SUV's, is driven by the abundance of and a ready supply of cheap oil.

The US has another distinction. Besides being the world's biggest consumers of oil, they have become the world's largest debtor. At one point in time the US was a major creditor to the rest of the world. No longer. The US net foreign indebtedness is estimated now to be approaching $3.0 trillion. This pales Argentina, who recently defaulted on its external debt and Brazil who many thought might default. This rising and mounting external debt is being driven by the annual current account deficit now in the area of $450 billion/year and over 4% of GDP. Many argue that none of this is a problem because the US has the ability to borrow its own currency, it is the world's reserve currency and foreigners are significant and steady holders of US stocks and bonds to finance these deficits.

Money and Oil! These are two volatile areas that could potentially have a very negative impact on the United States. War in the Middle East, more specifically Iraq, could by some pundit's estimates under a worst-case scenario send the price of oil sky rocketing to $80 a barrel. At the height of the Gulf War oil prices peaked at above $40. A jump in oil prices to even $40 would have a negative impact on the already struggling global economy. A rise to $80 would be devastating. Some rise in the price of oil could be offset by production increases in Saudi Arabia or releases from the US's strategic reserves but nonetheless it would be very negative.

But a war in Iraq is more than just about a potential huge jump in the price of oil. Iraq has around 10% of the world's reserves, the world's second largest behind Saudi Arabia. Iraq is also producing only about 2.5 million barrels per day well below potential capacity of around 7 million barrels per day. It has been claimed that the real agenda of the United States is to seize the oil. Bringing Iraq up to its potential would also put pressure on Saudi Arabia and possibly bring down the price of oil. Russia and France also have huge interests in Iraq. They were the two Security Council members that had to be placated in order to obtain the recent UN resolution against Iraq.

But once a war starts there are no guarantees as to the direction it will take. A number of analysts claim it will be over in a few weeks and that once things get underway the Iraqi army will fold quickly in order to save its own skin. That may be. But war can also veer off in the wrong direction resulting in the deaths of hundred's of thousands of Iraqi's mostly civilians; it could result in the destruction of the Iraqi oil wells or there could be attacks made on the oil wells in either Saudi Arabia or Kuwait setting them once again ablaze. War in the sensitive desert of Iraq would also result in massive environmental degradation as it did in the Gulf War a decade earlier.

There is also no guarantee that whatever government replaced Saddam Hussein would be able to rule. There are fears that Iraq itself could be dismembered and destabilized with the 20% population Kurds in the North and the 60% Shiite Muslims in the South. The Kurds in the North are more interested in their own state and would stir up further problems with Kurdish minorities in Iran and particularly Turkey who would want to join them. Shiite Muslims are more generally aligned with Iran. Remember that Iraq was originally carved out of the Old Persian Empire by the British following WW1 and was created more for their convenience then it was with regard to the tribes and ethnic divisions of the day.

Despite the ease with which Afghanistan fell a year earlier the US backed regime barely controls Kabul the capital while the rest of the country has fallen back into internecine fighting amongst warlords and the drug trade, which had been largely eradicated under the Taliban, is once again flourishing. Funds that were promised to rebuild Afghanistan have been only a trickle while Kabul the capital city lies largely in rubble. Resentment is growing in the country particularly against the United States who in leading the bombing campaign pulverized what remained of the country after years of civil war and the Taliban rule.

Another wild card is Saudi Arabia. The Saudi's are refusing to allow the US to use their land as a base for war with Iraq. Saudi Arabia is the home of Osama Bin Laden the alleged mastermind of the World Trade Center and Pentagon attacks. Numerous of the alleged hijackers also came from Saudi Arabia.

There are hawks in the Bush administration that would also like to take out Saudi Arabia. By conquering Iraq the US would then have a string of military bases stretching from Saudi Arabia north to Georgia in the East and west into Central Asia in the former Russian republics and of course Afghanistan. It would also take pressure off the need for the bases in Saudi Arabia, which were the cause of Islamic objections in the first place. Iran, being surrounded, would according to theory now be acquiescent and cooperative.

On the financial front the Saudi's have threatened to sell their US securities and withdraw their funds and convert to Euros (and some say gold) if war broke out. The Muslim countries are also getting closer to the creation of a Gold Dinar (www.bankindex.com, Gold Dinar: An Economic and Strategic Response to Chaos by Michael Billington from the November 15, 2002 Executive Intelligence Review), which would be intended for use as currency amongst Islamic countries. Even one of these acts would be extremely negative for the US Dollar (and by extension be very positive for gold). Both together could cause a collapse in the world's reserve currency and begin to bankrupt the US.

Money and Oil! Is it any wonder that the US is anxious to move quickly to subdue Iraq and possibly Saudi Arabia as well before things get out of hand? By all indications it is not a question of will there be war against Iraq it is a question of when.

The charts are telling us that the US dollar is going down irrespective. And a falling dollar is very negative to the United States and to the world economy. Rising oil prices are also negative to the world economy and war would exacerbate it if only for the duration of the war. Irrespective oil prices are going up long term as rising world demand and falling world reserves and supplies will put pressure on prices later in the decade and into the next decade. The world's largest economy China is growing rapidly and 1.2 billion Chinese want cars and scooters.

We talked to Crude Ken, our man in the Calgary oil patch. Crude Ken also pointed out that the major oil companies cannot replace their current production. There have been no major discoveries for upwards now of thirty years and any new oil is hard to get at in the far North or under the sea. Crude Ken says that while he likes the integrated oils and some of the major seniors his favourites are some juniors.

Crude Ken's top junior picks are Bow Valley Energy Ltd. (BVX-TSX) (www.bvenergy.com, 403-232-0292) and Petrobank Energy and Resources Ltd. (PBG-TSX) (www.petrobank.com, 403-920-0135). Mid Cap picks are Bonavista Petroleum Ltd. (BNP-TSX) (403-213-4300) and Baytex Energy Ltd. (BTE-TSX) (www.baytex.com, 403-267-0715). Amongst the large caps mentioned were EnCana Corp. (ECA-TSX) (www.encana.com, 403-645-2000) and Canadian Natural Resources Ltd. (CNQ-TSX) (www.cnrl.com, 403-517-7345). We both agreed that we liked Suncor Energy Inc. (SU-TSX) (www.suncor.com, 403-269-8151) amongst the integrateds. Amongst the drillers we favoured Precision Drilling Corp. (PD-TSX) (www.precisiondrilling.com, 403-716-4517) and Trican Well Service Ltd. (TWC-TSX) (www.trican.ca, 403-266-0202).

We leave you with weekly charts of oil and the US Dollar. These are two major vulnerabilities to the stability of the world and the US's economy in the event of an outbreak of war with Iraq.

November 19, 2002

Charts and technical commentary by David Chapman of Union Securities Ltd. 69 Yonge Street, Suite 600, Toronto, Ontario, M5E 1K3 (416) 604-0533, (416) 604-0557 (fax) 1-888-298-7405 (toll free) email [email protected]

www.davidchapman.com

The opinions, estimates and projections stated are those of David Chapman as of the date hereof and are subject to change without notice. David Chapman, as a registered representative of Union Securities Ltd. makes every effort to ensure that the contents have been compiled or derived from sources believed reliable and contain information and opinions, which are accurate and complete. Neither David Chapman nor Union Securities Ltd. take responsibility for errors or omissions which may be contained therein, nor accept responsibility for losses arising from any use or reliance on this report or its contents. Neither the information nor any opinion expressed constitutes a solicitation for the sale or purchase of securities. Union Securities Ltd. may act as a financial advisor and/or underwriter for certain of the corporations mentioned and may receive remuneration from them. David Chapman and Union Securities Ltd. and its respective officers or directors may acquire from time to time the securities mentioned herein as principal or agent. Union Securities Ltd. is an independent investment dealer and is a member of the Toronto Stock Exchange, the Canadian Venture Exchange, the Investment Dealers Association and the Canadian Investor Protection Fund.