What Lies Ahead: A Perfect European Storm

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"The energy component of Europe's economic picture is punctuated by one overarching fact: Oil and natural gas, the two dominant energy flows, must be secured from somewhere else."

During the sweltering summer of 1787, a meeting took place in Philadelphia that led to the creation of the U.S Constitution.

About two-thirds of the way through this meeting, a young delegate from New York by the name of Alexander Hamilton rose and presented a radical plan for the new government. This plan dissolved state boundaries, advocated a president for life and advanced a dominant central government as the sole legislative agency of consequence.

Now, Hamilton was a nationalist.

But I have always equated his Philadelphia plan as more of a cattle prod to awaken his audience. Hamilton wanted to nudge the debate off dead center by pointing out that there were options far more radical than the one being discussed at the time.

In that, he succeeded.

Today, here in Germany, I am getting the eerie feeling that a similar negotiating ploy is about to be advanced again.

But first, I need to set the stage.

It is 1 a.m.

Today is a holiday across the country, and the financial markets will be closed. So will everything else, for that matter. The the Frankfurt stock exchange (DAX) won't open on Monday, either.

That may be a good thing. Because if the meetings these past few days are any indication, a significant problem has developed on the European energy landscape.

And it will shortly make its appearance on the other side of the Atlantic.

Some of this should have been expected. It was partially telegraphed by the renewal in the widening spread between Brent oil prices set in London and the lower price of West Texas Intermediate (WTI) set in New York.

We have become accustomed to this difference by now.

Remember, despite being a slightly lower quality grade of crude oil, Brent has traded at a premium to WTI for the past 376 consecutive trading sessions (since Aug. 10, 2010).

That spread tells us that prices are higher in Europe because Brent has a wider global usage as the benchmark of choice than does WTI. More daily, frequent oil trades in more parts of the world are discounted to the Brent rate.

As pricing pressures accelerate in the demand-generating parts of the world, or production costs rise where the predominant traditional oil reserves are located, they will reflect in Brent sources first.

But another dynamic has struck Brent as well.

This one addresses the situation in Europe itself.

A Perfect Storm Is Brewing

The energy component of the economic picture over here is punctuated by one overarching fact. Oil and natural gas, the two dominant energy flows, must be secured from somewhere else.

There are other sources of power, of course.

Germany may have decided to wean itself from nuclear energy, but France generates the vast majority of its electricity from this source. Germany will embark on an ambitious program of solar and wind power.

Still, even if it is successful, this move will place a significant new financial burden on the dominant continental economy and pass on higher energy costs to consumers.

Some of the problem over here results from a credit market plagued again by nearly the same problems we discussed last year. Meanwhile, the European Union embargo of Iranian oil imports set to take effect on July 1 is already creating a number of sourcing issues for debt-ridden economies like Greece and Spain.

All three of these forces are contributing to a repeat of continental angst.

It has been apparent over the past several days. The storm clouds are forming over my meetings in Frankfurt.

No Time for Political Grandstanding

As Germany takes time off for the holiday weekend, however, we will continue the conversations. In five hours, I will be moving off to a new location outside the city—right through Easter morning.

We are moving our conversations to historic Friedberg Castle.

Well, actually, the move is to a facility on the castle grounds formerly operated by the U.S. Army.

Today it will be under assault, in a manner of speaking, by an assemblage of bankers, financial and energy analysts, policy makers and their staffs.

Well known to personnel managers and efficiency experts, the idea is to have a "retreat" to help everyone think "outside the box." This one is supposed to hash out a provisional action plan to confront the approaching energy crunch.

The attempt is more difficult than might be expected.

One thing that has become quite clear over the past two and half days of Frankfurt meetings. And it is a rather disturbing realization.

Not even a bare consensus has emerged on even prioritizing the issues we face, let alone how to solve them.

How does one initiate policy proposals if the target is still out of focus?

Unfortunately, there is little time left for a casual academic discussion. This is a pressing situation, and it will shortly become even more so.

Just about everything will be up for consideration.

What will not be there are the useless self-aggrandizing suggestions made during election campaigns, the sort of utterances that must fit into a 30-second commercial or a sound bite.

This is not simply an American political shortcoming. It is also the case over here as the French move into the final stages of their election cycle, and parliamentary elections loom elsewhere.

That is not to say political realities are ever far from the discussion. Whatever comes out of these sessions must fly in Washington, Paris, Berlin, London and—even more the case in these days of European Union ascendency—Brussels.

However, while political maneuvering may be part of making policy, the politics of electioneering assuredly does not.

We must develop a concrete path, not a stump speech.

What will be on the table are a range of approaches: alternative energies, unconventional sourcing, trade bargaining, greater government control, market restrictions on futures trading and shorting in energy commodities (especially oil) and the trump card of them all.

Military action. . .

The Global Last Resort

In the mix of a very loose agenda is a U.S. plan devised in 1977 that draws a rectangle in the Persian Gulf.

It starts in the north around Basra in (southern) Iraq, moves down a western border through the oil provinces of (eastern) Saudi Arabia and an eastern border through the (western) regions of Iran, to a southern base in the United Arab Emirates (smack next to the Strait of Hormuz).

It is still on the books. And it has one purpose only.

It is a plan for military occupation to control the supply of oil.

Now, when the U.S. created this plan, it considered the Iranian portion the least of American concerns. The Shah was still in power, and he was a staunch U.S. ally.

The situation there these days makes any such approach far more costly and unlikely.

Especially in an election year.

That it is even still around, much less on the agenda of this meeting, indicates two things you need to keep in mind as we move forward into this eventful summer.
  • First, all options are being explored because of the strongly held view that the situation will only be getting worse.

  • Second, genuinely few short-term options will be of any help. Alternative and unconventional production will take too long (nice ideas for several years down the road, but not now). Increasing government regulations, restraint on futures contracts or greater restrictions on trading will endanger what is left of a free market.

I cannot imagine any military occupation makes sense, or that it will become part of any recommendation.

In my judgment, this is the modern equivalent of what Hamilton proposed some 225 years ago.

Unless a plan is forged, guys, there are available solutions that are much, much worse.

Yet aside from symbolically avoiding a war, I have another pressing matter—he real reason Marina and I came over here.

It sure would be nice to spend at least some of Easter Sunday with the grandchildren.

Sincerely, Kent

Kent Moors, Oil & Energy Investor

P.S. For months, Kent has discussed the Brent-WTI spread and what it means to global politics and financial markets. But, if you give him a minute, he'll also explain how you can profit.

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