CME and renminbi collateral

While the focus has been on MF Global, the CME announced that it will allow the Chinese currency to be used as collateral for futures. Symbolically this is very significant. The center of financial trading capitalism will say that a controlled currency can be used to meet margins. This shows how far the renminbi has come and how powerful the Chinese economy and financial system is to the global finance world, but it does seem odd that a controlled currency that does not freely float can be used as viable collateral. 

The old game between Saudi's and Iran's oil interests continues

Reading the book The Oil Kings: How the US, Iran, and Saudi Arabia Changed the Balance of Power in the Middle East by Andrew Scott Cooper it is obvious there is a strong rivalry between Saudi Arabia and Iran to determine who will be the driver of OPEC and the lead regional power. This rivalry is being played out once again in current oil price dynamics.

Saudi Arabia has increased their production, the most in 30 years, to offset any disruption from the Arab Spring as well as any embargo on the Iranians by the EU. Saudi production is above 10 million barrels a day with latest reporting showing a 1.3 million barrel increase form earlier in the year.

OPEC is having their meetings on December 14th and it is unlikely that they will agree on production quotas. Saudi's increased production over the objections of Iran and five other members in June to offset the shortfall in Libyan production. OPEC Production is close to 3 million barrels per day higher than the total target. Everyone in OPEC is a cheater realtive to their targets.

If there is an EU boycott from OPEC's second largest producer there will still have to be purchases made from other countries. The EU accounts for 18 percent of Iranian exports with Asian accounting for the bulk of the Iranian oil sold. Of course, more oil will go to Asia, but the adjustment process can have an impact on prices in the short-run. By producing more the Saudi's do not allow any disruption in oil to convert into greater Iranian revenues which can be used to enhance its regional power. A key policy objective for the Saudi' is to use oil policy to maintain political pressure on Iran. Nevertheless, the impact of an EU boycott is very dangerous to oil markets and will increase the risk premium in these markets.

The shifting geopolitics of oil - the best rocks at the best terms

The oil world for the last 40+ years have been driven by a search in the Middle East and emerging markets. The cheap oil was outside the politically stable developed world. Cheap oil made the political risks of working in difficult regions of the workable, but the oil dynamics are changing. Political risk has not decreased in many high reserve countries. The cost of oil in these countries are on the rise, but most importantly, the increase in reserves in many developed countries have changed where drilling capital will be committed.

The reserve increase is a direct result of technology. This is the cornucopian story which we have discussed. Innovation will drive real prices. There is natural cycle. As the cost of drilling increases, both actual and political, there will be a change in behavior toward technology and investing. Money will be placed in R&D to reduce production costs. If these technologies are sound, there will be a shift in investment focus. the same will occur with investing around the world. Higher political risks will reduce the amount of investing in any country or region. The fact that many of the cheap sources of oil are controlled by state oil companies makes case for why private companies are moving back to the developed world. Put these two together and you will find that new technology will increase reserves in previously expenses areas and lead to the shift away from politically risky areas.

The technologies of has lead to the vast developments of oil sands, shale gas (fracking), deep water drilling and shale oil through horizontal drilling. The developed world and places outside the Middle East are where new reserves are being found. Australia is becoming a leader natural gas developer. Canada now is second in reserves. The US may become a natural gas exporter. Brazil may become an oil and gas powerhouse in Latin America. The story of oil is - "go west" 

All eyes on the ECB?

The fiscal side of the EU is stating that they have done their part to solve the debt crisis. We have heard that before, but the burden now seems to be shifting to the ECB to take more action. The ECB has lowered rates and have offered some extra liquidity provisions. This may continue over the coming weeks as the central bank determines the market reaction to any sovereign debt deal. 

It seems as though the ECB does not want to be dragged in to a solvency policy and will continue to behave like a lender of last resort. All of this makes sense. To early a provider of liquidity will not force other contingencies to develop; however, the current difficult situation of European banks is still growing and being too late to adapt monetary policies could actually be the ruin of the euro.