I hope this weekly dispatch from the Casey energy team provides you with some insight and interest in all things energy. If so, and if you live in or near Vancouver, you should consider attending one of the two upcoming events where I will be speaking. First, I'm heading to the Cambridge House Investment Conference on January 22 and 23, along with other Casey Research editors including Louis James and Jeff Clark. Investment conferences like this are indispensable for the engaged investor: You have the opportunity to meet management teams from more than 500 companies, as well as to hear industry leaders present their thoughts on current trends, investment techniques, and commodity forecasts. For Casey readers, this year we are making it easier for you to learn from our in-house experts by setting up a Casey Pavilion, where our editors and some distinguished guests will be giving talks and having panel discussions.

For more information, check out the full list of Casey Pavilion events. If you will be in Vancouver on January 22 and/or 23, you should make time to come by the show. Register now at the Cambridge House website – the show is free if you register ahead – and mention that you learned about it through Casey Research.

Two months later I will be at another Vancouver resource investment conference: the World Money Show, from March 27 to 29. This free conference is designed to give you the information and tools to profit in the year ahead. Visit the World Money Show Vancouver website to register.

Thanks for reading,

Marin Katusa

Chief Energy Investment Strategist
Casey Research

The Unbearable Stubbornness of Gas Subsidies

The series of events that just transpired in Nigeria makes for a familiar tale – and a telling lesson. The tale tells of a poor, developing nation endowed with oil riches that, on the advice of international economists, tries to eliminate gas subsidies. The lesson is that the populations of oil-producing nations will inevitably erupt in rage against any such notions.

Nigeria is the biggest oil producer in Africa, pumping out 2.2 million barrels of crude oil a day to sit 10^th in the global crude-production standings. But the average Nigerian gets little benefit from his country's oil riches. There is an enormous gap between rich and poor in Nigeria, mostly because 80% of the economic benefits from producing all that oil flow to just 1% of the population. Politicians in the country's infamously corrupt government have pocketed billions in oil profits, while three-fourths of Nigeria's 160 million people live on about a dollar a day.

For the poor, a fuel subsidy provides the direct benefits of cheap gas plus an important indirect benefit: a small sense of ownership in a national resource. That statement is true from Venezuela to Nigeria, from Indonesia to Ukraine. And if ever a politician – undoubtedly a member of that elite group who has felt the benefits of a thriving domestic oil industry – tries to take those benefits away, there will be hell to pay.

Nigerians have been enjoying subsidized fuel since 1973. Subsidized gasoline not only reduces transportation costs, it also lowers food costs and fuels the millions of small generators that provide homes and shops with power in a nation with a failed power grid.

The subsidy was eliminated on January 1. Within a week fuel prices had more than doubled, shooting up from $1.70 a gallon to at least $3.50. Demonstrations against the dramatic price increase soon turned into riots. By January 8, Nigeria's labor unions had launched an indefinite, nationwide strike in protest. Then police shot three people dead and wounded 24 others while dispersing protestors in the commercial hub of Lagos. The next day the strike gained momentum, with banks, gas stations, and airports closed down. Oil workers did not join the strike, though they threatened to do so, immediately adding a premium to the Brent benchmark price of oil.

On January 16, President Jonathon reduced the subsidy cuts in a terse announcement, saying he recognized that people were rightfully angry about the suddenness of the change but adding that "other interests beyond the implementation of the deregulation policy have hijacked the protests." In response, the Nigeria Labor Congress and Trade Union Congress told workers to return to work. It seems the crisis has abated.

Subsidies will now reduce the price of gas to about US$2.27 a gallon, still more than 50¢ a gallon higher than it was 16 days earlier. With fuel prices still elevated and the government having deployed troops into the streets to quell what many viewed as valid demonstrations in a young democracy with a sensitive history of military coups, many Nigerians are not appeased. And President Jonathon insinuated that the partial subsidies reintroduced on Monday are temporary and will be phased out in perhaps April, at which point the riots could well start again.

An Economic Idea Lacking in Social Graces

The government of Nigeria spends about $8 billion a year on fuel subsidies. Getting rid of this financial burden would be an "important first step" in stabilizing the country's finances, according to a 2009 International Monetary Fund report. The IMF and other global financial institutions are opposed to fuel subsidies in general because the biggest benefits do not go to the poor, but to the owners of large cars and big generators.

To look only at the absolute size of the benefit, however, misses a major point. For the poor, the fraction of their income that goes to pay for fuel is much greater than it is for those who own the big cars and generators. As such, it's the poor who feel the elimination of subsidies the most, and it was the poor who rioted in Lagos.

Of course, erasing an $8-billion drain from Nigeria's balance sheet would allow the government to spend money on badly needed public projects, and that is precisely how the government explained its move. But to the poor – whether rural or urban – the subsidy is one of the only benefits they glean from their nation's strategic oil wealth. Corruption has stolen most of the other benefits: Nigeria's roads are cratered with potholes; many live without access to clean drinking water; and electricity is unreliable where access to the grid even exists. Why should they believe the money the government would save by not subsidizing fuel would actually pay for infrastructure, when so much of Nigeria's wealth simply disappears down the black hole of corruption?

More generally, taking away ingrained fuel subsidies from a developing country is like taking a crutch away from a cripple. After years of subsidies, Nigerians are completely reliant on cheap gasoline, from nationwide economic systems all the way down to personal needs. Even if taking away the crutch is the only way to force a patient to use his injured leg, it is nevertheless going to make him hopping mad (pun intended) because it will hurt like hell.

Don't blame Nigeria for trying: failed attempts to remove fuel subsidies are written in the histories of many oil-producing nations. In Bolivia, protestors burned photos of President Evo Morales and vandalized government buildings in late 2010 after he tried to cut fuel subsidies; Mr. Morales backed down within days. In 1989, Venezuelans incited days of riots in which hundreds of people died, to protest a rise in fuel prices. Now, even though he has openly criticized his country's subsidy program, President Hugo Chavez presides over one of the most generous fuel subsidies in the world.

The examples go on. In Jordan, widespread demonstrations forced the government to rescind its proposal to eliminate fuel subsidies. In Indonesia, a 30% increase in fuel prices led to bloody riots, even though the government sweetened the shift with direct cash-support programs for the poor. Such tactics can work: Iran has eliminated its fuel subsidies but cushioned the blow with cash payments of roughly $45 a month. Other Middle Eastern countries stuck paying fuel subsidies they can barely afford, such as Egypt, are looking at Iran's plan as a model.

Nigeria's Struggles Run Deep

Most situations are more complicated than they first appear, and such is certainly the case with Nigeria's fuel subsidy riots. The country is also facing a surge in religious violence: at least 85 people have been killed in bomb and gun attacks since Christmas Day. An Islamic group named Boko Haram is behind the attacks and is targeting the country's Christians, who primarily live in the north. The group's name translated from the Hausa language means "Western education is a sin."

These attacks are threatening to fracture the country's sensitive north-south, Muslin-Christian divide, a religious fault line that has sparked sectarian violence responsible for killing hundreds of thousands in the past. While sectarian stresses rise, the fuel-subsidy protests provided an outlet for Nigerians, emboldened by the Arab Spring, to vent their grievances against a deeply corrupt ruling class and an incompetent government.

Whether Nigeria – a dynamic but troubled country encompassing a wide range of ethnic and religious groups – can hold together is becoming a pressing question not only for Nigerians but also for the world. It would be devastating to see Nigeria descend back into the sectarian violence that killed a million people between 1967 and 1970. On a more banal level, another civil war would almost certainly disrupt the country's oil machine, a possibility that is adding yet another premium to current oil prices. Of the 2.2 million barrels of oil produced in Nigeria every day, 1.9 million are exported; 800,000 of them are sent to the United States. It is yet another example of how relying on oil produced in unstable countries on the other side of the world is not a recipe for US energy security.

So here's to hoping against hope that Nigeria's leaders can dig themselves out from the pressing weight of sectarian divisions, endemic corruption, and massive infrastructure needs and keep their country together. Just one piece of advice: leave the fuel subsidies alone.

[Petroleum-producing nations will increasingly be forced to keep more of their oil to fuel their economies. Coupled with production numbers falling in almost every country that exports crude, $5/gallon gas is a fait accompli. But it's not all bad news, as there's a way to capitalize on this inevitability.]

Additional Links and Reads

Saudis Target Triple-Digit Oil Price for the First Time (Financial Times)

The Saudi Arabian oil minister said the country wants to keep oil prices near US$100 a barrel; this is the first time the kingdom has targeted a triple-digit price. The price point is also $25 above the last price named by a Saudi leader($75 per barrel in late 2008). Saudi Arabia needs high oil prices to sustain the big increases in public spending it announced in hopes of forestalling any of the political unrest sweeping the Middle East from landing within its borders. King Abdullah announced two populist programs of handouts and boosts to public spending within the last year, at a total cost of $129 billion. Based on those increases, the Institute of International Finance estimates that the break-even oil price the kingdom requires to balance its budget will jump from $68 last year to $110 in 2015. Only a decade ago Saudi Arabia could balance its budget with oil prices averaging $20 to $25.

The Brinkmanship with Iran in the Strait of Hormuz (CBC News)

As Iran continues to threaten a blockade on the most important oil waterway in the world, sentences an American to death for alleged espionage, and celebrates anti-Westernism with Hugo Chavez, the world continues to wonder just how this latest standoff with the Islamic Republic will end. This article provides a nice overview of the threats, accusations, sanctions, and options facing Iran and its opponents in this high-stakes game.

US Sanctions a China State Energy Trader for Iran Sales (Reuters)

The US government sanctioned China's state-run Zhuhai Zhenrong Corp., Iran's largest supplier of refined petroleum products, as well as Singapore's Kuo Oil and FAL Oil Company, an independent energy trader based in the United Arab Emirates. The move is largely symbolic, since Zhenrong does not likely have much US business exposure, but it sends a strong signal to Beijing and China's other, bigger import giants like China National Petroleum Corp. that the US government is serious about vigorous sanctions enforcement and wants China to curtail its Iranian trade. Zhenrong has been a major buyer of Iranian crude since 1995, buying about 240,000 barrels per day.

China Will Fudge Iran Oil Sanctions (Reuters)

China is Iran's biggest oil customer, buying 600,000 barrels a day, but now the US – and potentially soon also the European Union – wants the Asian giant to curtail its trade. What is China to do? This columnist expects China to do something it is very good at: obfuscate.

South Korea, Oman to Cooperate to Stabilize Oil Supply to Seoul (Reuters)

Another Asian nation is also struggling to find a way to comply with Iranian oil sanctions. South Korea is the world's fifth-largest crude oil importer and usually buys 10% of its oil from Iran. Oman, which usually supplies 2% of South Korea's oil, is stepping up to help ease the tension, backed by the United Arab Emirates.

North Dakota surpasses OPEC Member Ecuador in Oil Production (Bloomberg)

The Bakken is booming. In November, North Dakota's daily crude output topped 500,000 barrels for the first time, a 56% increase over last November. The state now produces more oil than OPEC member Ecuador and, if production rates continue to climb apace, North Dakota could soon overtake California and Alaska to take the number two spot in US-state oil production.

Wind Firm Vestas to Cut 2,335 Jobs (CBC News)

Just days after our last Energy Daily Dispatch, which was about how subsidies created an artificial boom in the green sector (which is now starting to fail), the world's biggest maker of wind turbines announced that it is laying off 10% of its workforce. The company is based in Denmark but received about $51 million in federal tax credits in the US, where it invested more than $1 billion in four facilities in Colorado. This is the second year that Vestas has laid off workers: in 2011 the company laid off 3,000 workers after posting a 24% drop in third-quarter profits.

As Shale Deposits Multiply, Energy Self-Sufficiency Becomes a Reality (The Globe and Mail)

For a bit of lighter, happier reading, this article rounds up a series of shale gas news bits that altogether make it seem possible that unconventional energy deposits might just enable countries to find their energy needs domestically. The news bits include a US Energy Information Administration report that concludes that "the global supply of shale gas might be several times more abundant on a planetary basis than the proven reserves of conventional gas"; confirmation from the Massachusetts Institute of Technology that shale gas will make "a big difference" in energy prices in coming decades; and news that Poland will make its first deliveries of domestic shale gas this year.