Daily Sources 1/21

1. Feng at Information Dissemination notes that Ukraine is one of China's more important partners in terms of military cooperation. The Ukrainian defense minister recently made a week-long trip to China where they discussed military cooperation and Ukraine figures heavily in several on-going improvement projects by the PLA including naval aviation training and large transport. Also, according to Feng, China relies upon Kiev for a considerable portion of the engines that they use for planes, helicopters and chips. It is an interesting piece and worth a look. He asks whether Ukrainian inclusion in NATO would be predicated upon less cooperation with Beijing. I'm not in a place to know, but just now, despite the Shanghai Cooperation Organization, I'd suspect that developed world leaders are beginning to regard Beijing as a more responsible partner than Moscow.

Under that rubric, China would join Eastern European states as a kind of ring around Russia, meaning that Ukrainian participation in NATO wouldn't necessarily require limiting military ties to China. Such an outcome was, in my mind, unthinkable prior to the Russo-Ukrainian gas row, but now I think it possible, if not particularly likely. (It was unthinkable simply because in terms of raw power, the real displacement in terms of balance is coming from China, and that is hypothetically the change that needs to be rebalanced for.) Either way, strong NATO-China-newly independent states military relationships are possibly the preferred, perhaps even the likely, outcome for several of the newly independent states. Iranian participation in the SCO, though, would be a serious roadblock to that outcome. (Tehran applied for full membership in March 2008.) Meanwhile, Amanda Jordan at Bloomberg reports that German utilities informed the wire that they were receiving full shipments of gas today after Gazprom turned back on the taps yesterday. It is hard to understand how full deliveries could have been resumed so quickly had Kiev truly stolen all the so-called "technical gas."



Meanwhile, Karen DeYoung at the Washington Post reports that Army Gen. David H. Petraeus told journalists that deals for new supply routes for troops in Afghanistan have been agreed to with the relevant partner states. The supply route through Pakistan was complicated by its vulnerability to Taliban forces, allies inside Pakistan itself, and Pakistan's uneasy political situation. Petraeus declined to say where the transit route would be located, but recently concluded an eight day trip through Tajikistan, Turkmenistan, Kazakhstan and Kyrgystan and a potential route might actually originate in Russia and run through Kazakhstan and Uzbekistan to Afghanistan.

2. Rama Lakshmi at the Washington Post reports that US nuclear power corporations are, despite the nuclear cooperation pact between the US and India passed by Congress last year, hitting roadblocks in terms of arranging deals in India as per a business junket which visited with high-level officials in New Delhi last week.

"'The simple reality is that the French and the Russians are ahead of us. They know the sites that have been identified for them to set up business,' said R. Michael Gadbaw, a member of the delegation and a professor at Georgetown University Law Center. India has assured the United States that it will give at least two sites to US companies to generate a minimum of 10,000 megawatts of nuclear power. But Gadbaw said the US companies do not know where those sites are. Another hurdle is amending India's atomic energy law to recognize patents for private companies. An amendment to this law may take more than a year."

The nuclear deal with India and getting the Nuclear Suppliers Group to agree to exceptions for New Delhi was a tremendous foreign policy success for the Bush Administration--an Administration I am not often inclined to praise--and this particular story is probably no more than a hiccup in the process of building a tighter security and commercial relationship between India and the US. But if US priorities include a security ring in Eastern Europe, Central Asia and China--driven in part by domestic constituencies--designed to temper irrational ambitions in Moscow, how does that work from the perspective of New Delhi's security concerns--and thus those of their ex-patriots here in the US?

3. Henry Meyer and Ayesha Daya at Bloomberg report that Nouriel Roubini, Dr. Doom, one of a fairly small set of economists who saw the current crisis playing out the way it has ahead of time, believes that the US financial sector is facing credit losses of $3.6 trillion.

"If that’s true, it means the US banking system is effectively insolvent because it starts with a capital of $1.4 trillion. This is a systemic banking crisis"

he said today at a conference in Dubai. Roubini said that Europe's financial sector was in the same boat, which suggests that the vast majority of global invested capital is in the hands of organizations which are bankrupt.

"Oil prices will trade between $30 and $40/b all year, Roubini predicted.

'I see commodities falling overall another 15-20%,' Roubini said. 'This outlook for commodity prices is beneficial for oil importers, it’s going to imply that economic recovery might occur faster, but from the point of view of oil exporters, this will be very negative.'"

I am unclear on why Roubini thinks the commodities complex will only suffer 15-20% losses if the bulk of liquid global capital is tied up in insolvent organizations.

It seems to me, as a non-economist, the primary reason that it is so hard to determine the direction of oil prices just now is because it is not clear how long this deflationary period is going to last. I think that we may be bumping along the bottom here in terms of oil price, but if there is a second wave of financial crisis, impeding the flow of money, making existing debt more painful to retire, indeed, making the simple act of exchange itself difficult, then I do not see why $30/b is the bottom. And in that vein, Ambrose Evans-Pritchard, of the perennially alarmist UK Telegraph, writes that he is "seriously alarmed" and that the slide in "sterling has turned disorderly."

"The danger is blindingly obvious. The $4.4 trillion of foreign liabilities accumulated by UK banks are twice the size of the British economy. UK foreign reserves are virtually nothing at $60.6bn."

But England cannot simply allow the banks to default, because it is a center of global finance, and if it does so, it will set off a global panic pushing the entire world into deep depression.

"England has not defaulted since the Middle Ages. There is a real risk it may do so now."

I distrust alarmist talk, generally speaking, but I do find this scarily convincing just now.

And part of the reason I find it convincing can be found in Brad Setser's latest post in Follow the Money, where he shows that the US deficit is increasingly be financed by very short term debt--which he reports is usually a sign of danger. Here's a graph of his which nicely illustrates what he is talking about:



If the US, as opposed to the worries of Evans-Pritchard, defaults, what does that mean for the dollar? The answer to that question is a possible line of thinking on price for oil.

4. Megumi Yamanaka at Bloomberg reports that sales of power to industrial consumers in Japan fell at an annual rate of 13% in December, the latest evidence of the scale of contraction in the manufacturing sector. It is the largest drop ever recorded--separate data on power sales to industrial customers was first compiled in 1972.

5. Ahmed Rouaba at Bloomberg reports that Algerian Oil Minister Chekib Khelil told the media that there were no plans for OPEC to meet prior to the scheduled March 15 conference. Alonso Soto at Reuters reports that today the Ecuadorian oil minister, Derlis Palacios, told journalists that Quito saw no benefit in cutting production again. Quito produces about 500 kb/d for export, and would lose money were it to be asked to cooperate with a further reduction in supply. IRNA news agency reported today that the Iranian oil minister, Gholamhossein Nozari, reiterated his argument that OPEC could not rebalance the market alone, and that non-OPEC producers would need to cooperate. The problem, of course, with calls from Tehran for non-OPEC cooperation is that no data shows that Tehran itself is cooperating with the OPEC mandated cuts, but instead that it is cheating and continuing to produce at pre-December 17 levels.

6. Last week there was a rash of analysis about the impending implosion of the Mexican government, all across the ideological spectrum. What I didn't realize was that the stories were driven by the release of a report by the US Joint Forces Command on worldwide security threats. Diana Washington Valdez at the El Paso Times reported on the 13th that the "command's 'Joint Operating Environment (JOE 2008)' report, which contains projections of global threats and potential next wars, puts Pakistan on the same level as Mexico." In the poll of readers that the paper hosted, out of 24,812 people, 63.27% thought that the Mexican state could collapse in 2009, because "the drug lords are taking over." Indeed, and the proximate cause is the drug lords. But there hasn't appeared, in any media that I caught, any discussion of how the ultimate cause is likely at least in part America's drug prohibition and reluctance to prosecute consumption, focusing instead on distribution. Nor, in any foreign affairs analysis that I have seen, has anyone discussed the notion that America's second Prohibition is exporting instability to its neighbors, South America, South Asia, and Central Asia. The JOE 2008 can be found here. I have yet time to read it, of course, but it should be interesting.

7. Benoit Faucon at Dow Jones Newswire reports that analysts are arguing that Israel's offensive in Gaza will have an effect upon its status as an energy corridor--that is the attractiveness of the trans-Isreal pipeline which has endpoints at the Mediterranean port of Ashkelon to the Red Sea port of Eilat.



(The map above has little relationship to the actual path of the pipeline, it just aims to illustrate where the nodes connected by the pipeline are located.) The pipeline has a 400 kb/d capacity, and generally oil is shipped from the Black Sea or Ceyhan to Ashkelon, piped to Eilat, and then shipped on from there. The pipeline apparently has a potential design capacity of 1.2 mb/d, but development has been complicated by the vulnerability of the port of Ashkelon to Hamas rockets. The conflict with Hamas, however, has damaged relations with Turkey, with which Tel Eviv wants to connect the trans-Israeli pipeline. Worth reading in full.

8. Nick Snow at the Oil & Gas Journal reports that the DOE awarded the first contracts to directly purchase crude since 1994, and the SPR will take on roughly an additional 6.16 million barrels of oil from May 2009 - January 2010.

9. Yves Smith at Naked Capitalism concludes if the National Association of Home Builders is right, then "housing price will fall to 53% of their peak level, so the decline through this year will be 47%."