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Monday, March 14, 2005

OPI UDATE: RISKY BUSINESS: IRAN, VENEZUELA AND THE RISK PREMIUM AHEAD

The price of oil has remained above fifty dollars for the past several weeks as demand side pressures have kept prices strong. However, as winter recedes and the U.S. driving season is still weeks away, one might expect softer prices. In addition, there is some indication that OPEC will decide on a production increase at its meeting in Tehran on Wednesday. But all is not soft in the oil market. Supply side pressures may be just over the horizon as foreboding developments in Venezuela and Iran push up the ever-present risk-premium and keep prices high.

The price per barrel of oil topped $55 briefly today, before closing up 6 cents at 54.65. Most of that price pressure came on the demand side, as much of the northeastern U.S. continues to experience below average temperatures. The price finally eased on remarks by Saudi Oil Minister, Ali Naimi, who said the Organization of the Petroleum Exporting Countries should boost its output ceiling by 500,000 bpd at its meeting in Iran on Wednesday. Kuwaiti officials expressed a similar sentiment. Softening on the demand side should continue, barring any indication of increased world economic growth. An upward revision in Chinese growth estimates last week, for example, helped push crude prices further into the $50 bpd range.

Things aren't so sanguine on the supply side, however. The ‘risk premium’ in the price of oil --an increase in the price of oil based solely on the fear that a terrorist attack or other political event will disrupt supplies-- will likely increase in the coming weeks as events in Venezuela and Iran unfold. The tit for tat between the U.S. and Venezuela continued today as senior U.S. officials announced that the U.S. was creating a ‘containment’ policy for dealing with left-leaning Venezuelan President Hugo Chavez. According to Roger Pardo-Maurer, Deputy Assistant Secretary of Defense for Western Hemisphere Affairs, a ‘containment policy’ is being developed for Venezuela at the request of U.S. President George Bush and U.S. Secretary of State Condoleezza Rice. Pardo-Maurer said Venezuelan President Hugo Chávez was employing a “hyena strategy” in the region. The U.S. has charged Chávez with supporting followers of Bolivian indigenous leader Evo Morales in their attempt to force the resignation of President Carlos Mesa of Bolivia last week. Chavez is also accused of having supported Rebel forces in Peru.

Chavez has also been cultivating some friendships that the U.S. finds quite unfriendly. Chavez has continued his close relations Cuba's communist dictator Fidel Castro and it is probably no coincidence that the U.S. policy comes just one day after Iranian President Mohammad Khatami finished a three day visit to Venezuela to see President Chavez. Khatami and Chavez signed 23 agreements covering energy relations to tax issues -routine stuff as far as bilateral relations go.

However, Iran and Venezuela's respective relations with the U.S. couldn’t have been far from their minds. U.S. relations with Iran hit another low over the weekend as the U.S. in entered into the failed EU-3 (Germany, Britain, France) relations with Iran. Iran immediately rejected the U.S. proposal to diffuse the crises over its nuclear activities by promising to lift an embargo on aircraft parts and to support Iran's entry into the WTO. Iran was not impressed and said that its nuclear activities would continue unabated. Hugo Chavez immediately chimed in, supporting Iran’s claims that its nuclear program is peaceful only and calling the U.S. policy vis-à-vis Iran as “imperialist.”

With three U.S. carrier groups steaming back to the Mediterranean, an attack on Iranian nuclear facilities seems increasingly likely. While the U.S. will almost surely bring the issue to the U.N. Security Council before acting, the council outcome will not determine the U.S. decision. Win or not in the council, the Bush administration is likely to do use force if it deems it necessary to stop the nuclear program. Whether or not Venezuela will once again step to Iran's defense and attempt to punish the U.S. by slowing or halting imports to their largest buyer is not clear. As much as he may want to, he needs the U.S. as much, and likely more, than the U.S. needs him.

But a funny thing the risk-premium built into the oil market, nothing actually has to happen to push up the price. Simply the possibility of such a disruption -in either Venzuelan or Iranian supplies- will do the trick.

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