Oil's Middle East Fallacy

A couple of weeks ago Egyptian demonstrations led to the Mursi administration being removed from office. Ironically, he was elected because of the last set of demonstrations. What Mursi and many media analysts failed to realize is that the demonstrations weren`t really about democracy, religion, philosophy or ideology but were actually about jobs.

It’s the economy stupid, that is what the Egyptian people really care about, which is ironic because without a major overhaul in their country`s entire business structure, the one strategic advantage the country has is the tourist industry.

The tourist industry brings in revenue, and supports many types of jobs throughout the Egyptian supply chain. The irony is that the prolonged demonstrations, and cases of violence reported only hurt the tourism trade even further.

This is something the military has understood, and why they are taking measures to stop the demonstrations, and get back to normal as soon as possible in order to return the country to what it was--an attractive destination for tourists once again.

It will take twenty years to reform Egypt, for example to focus on an alternative industry like technology, and becoming a technology hub in the Middle East. And even if that was the goal, to produce jobs in the country, they need money to transition from a tourist based economy to one that provided opportunities for their young people.

This is only going to come from one place, the tourist industry, so the government needs to eliminate the demonstrations at all costs, attract tourists once again, and get people back to work. Why do you think there were so many people demonstrating? It is because they didn`t have jobs to keep them busy and fruitfully employed.

The military and temporary government realize that the most important thing is the economy. Get people jobs and they are much happier. It isn`t about governmental corruption--all governments are powerful and corrupt. It`s the economies that don`t provide business opportunities and jobs that make citizens unhappy and unruly.

Why the Middle East Supply Shortage Argument is Vacuous

Point #1
This brings me to the recent price spike in oil as a result of the Middle East demonstrations which have happened every year for the last four years. There is always some reason in the Middle East why oil has to spike higher by $5, 10, 15 dollars a barrel.

Whether it is Israel bombing a few weapons caravans, Egyptian demonstrations, Syria's civil war, Libyan insurgents attacking Embassy personnel, etc. However, this is all noise, and completely irrelevant to the supply of oil in the marketplace.

When was the last time in 30 years that the world actually had a supply disruption from the Middle East? Never. The reason why there have been disruptions in recent years, and the Fed president James Bullard put it quite well, is the last time oil spiked on Middle East nonsense is that whoever is in power needs money, and oil is the one commodity that these countries have with which to get money.

I don`t care if a bunch of mercenaries took over power in some oil rich country, you can bet they are going to be selling oil to support their need for money. People in power will protect the oil infrastructure at all costs, because it gets them money which controls their livelihood.

If there is a powerful overthrow of a previous regime, the conquering power will then protect the oil fields so that they can then stay in power through the money generated from the oil resources. This is why you will never have a major supply shortage in the oil industry from Middle East flair ups.

Point #2
Here is the adjacent point that makes this even more salient, if let`s say something crazy happened like the Saudi oil fields were attacked and damaged, and some crazy group started burning the oil fields. That is the sort of far-fetched event that would actually have to happen to actually have a major supply shortage from the Middle East.

This is just a hypothetical because one call to the US would bring in all hell, and the oil fields would be protected by US troops. But let us assume that this event did happen. Oil prices would immediately spike, but the conundrum is that prices would be so high due to speculators, that nobody across a broad spectrum could afford any oil, and the entire global economy would come crashing down into a depression, and then you couldn`t give the stuff away because of the damage of the depression to the world`s economies.

You wouldn`t need Middle East oil at all, because there would be more than enough supply in the rest of the world for what is left of the global economy. Most people just fail to understand this point. Oil is only valuable in the current scale of supplies at a certain price point. Once it goes too high it destroys the very demand that is necessary for its widespread adoption as an everyday staple by consumers.

Above certain price points the majority of people simply cannot afford it, at which point it has no demand on a large scale. Thus the global economy implodes, causing no need for gas anymore because nobody has jobs in a global recession.

This is the Yin and Yang of the oil industry which 99% of business people fail to realize about the commodity. The scale of the oil market ultimately limits its upside in price, and it is only valuable if there is a vibrant market for its use.

Too high prices set by a catastrophic Middle East real supply shortage actually spell the death of the demand for the very commodity that at first spikes because of said event. It is the ultimate paradoxical rationale for why any real supply shortage in the Middle East is actually meaningless for the price of oil.

Under both scenarios the price of oil will ultimately be lower. This is the major misunderstanding of the oil market, and historically during the first Iraq war people made a fortune, shorting the spike in oil prices.

Oil only remains valuable given the scale of the market, if there actually is a large, thus scalable market in place to provide consumers for the wide spread production of the commodity.