Just for the fun of it, I did my own projection of GDP, unemployment, inflation, the price of oil, and a number of other economic statistics for 2005. The results were published in January of 2005. In this article we compare these forecasts with actual results, and discuss how confusion in the oil and natural gas markets make it difficult to predict America's economic performance in 2006.

How Did We Do In 2005?

Oil. Thomson First Call consensus estimates placed average benchmark West Texas Intermediate (WTI) crude prices at $37.67 a barrel in 2005. Frederick P. Leuffer, senior energy analyst for Bear Stearns, believed oil would drop to an average of $25 a barrel. Fadel Gheit, Senior VP of Oil Research at Oppenheimer and Co. thought oil might drop to $30 a barrel sometime in 2005, and Morgan Stanley predicted that WTI would average $36.60 for the year. My oil price forecast for 2005 was $37.00 per barrel. Many forecasters believed there would be a surplus of oil, and that declining oil prices would lead to a decrease in oil company earnings.

On the other end of the forecast spectrum, Charles T. Maxwell at Weeden and Co. thought oil would average $57 for the year. As it turned out, the average annual price for a barrel of WTI in 2005 was $56.64 (EIA/DOE data). As for refinery earnings: they went through the roof.

Congratulations to Charley Maxwell. He got it right.

GDP, Inflation and Unemployment. Here is a comparison of the data from an article I published at the beginning of 2005 with the actual results:

Given my concern about oil depletion, missing the oil and gasoline price points is a little embarrassing. And ironic. Most of the people who have read my book "Oil, Jihad and Destiny" believe my oil depletion scenarios are much too pessimistic. As it turns out, however, the events of 2005 have proven me to be overly optimistic.

My forecast for 2005 ended with this conclusion: "Producers will have the capacity to ship enough oil to cover growing world demand in 2005. Whether or not they will be able to get it to the consumer is another matter." Amen to that. Oil supplier production limitations and tight refining capacity drove petroleum prices higher in 2005. Then the devastation of hurricanes Katrina and Rita triggered transient petroleum product shortages. There was plenty of oil in the ground.

On the other hand, my calls on Current Dollar GDP, CPI Inflation, and Unemployment were not bad. Not bad at all.

Key Trends in 2005

The confrontation over oil and natural gas resources took a decidedly negative turn in 2005. Most nations have decided world oil and natural gas supplies are not increasing fast enough to satisfy world demand. At some point, there will be shortages. Competition has thus intensified over who will control the world's remaining resources.

Prices promise to be volatile. The Saudi production buffer has evaporated. There is no way supplier capacity will exactly match consumer demand. Periods of surplus (lower prices) will alternate with months of deficiency (higher prices). Oil and natural gas will also become increasingly expensive, because world oil has transitioned from a market driven by consumer demand to one limited by producer capacity. As a result, if they wish to do so, a small number of oil exporting countries are now able to control the price and availability of an increasingly scarce commodity. Long term price declines will only occur if consumer nations fall into recession.

Oil and natural gas became weapons in the quest for political power. Supplier nations are now in a position to influence the policy options of consumer nations. Supplier politicians flexed their new found muscle by making it clear they would prefer to do business with friendly (and politically compliant) consumer nations on prices and terms they fully intend to dictate. Consumer nation politicians began to squirm.

Oil and natural gas suppliers are beginning to realize that increased production is not necessarily in their selfish-best-interest. If they can keep prices high, they will be able to conserve their resources for future sales, and still have enough revenue to support their current political objectives. If this trend continues, we are at – or near – "Peak Oil".

So. What's Ahead in 2006?

I've always had a bad feeling about 2006. There are too many variables for which the data points are unknown or unknowable. From the very first time I cranked up my oil depletion model in 2003, the events of this year have exuded a bad karma. Although I have fine-tuned my model over a hundred times, the result is always the same. 2006 does not look good.

The EIA speaks. I predicted we would get through 2005 without any oil shortages. Two hurricanes almost blew away my prediction. As we enter 2006, the Energy Information Administration (EIA) has reported: "At the beginning of January, (2006) some 27.4 percent of normal daily Federal Gulf of Mexico oil production and approximately 19.5 percent of Federal Gulf of Mexico natural gas production remain shut-in due to Hurricanes Katrina and Rita." The EIA believes total domestic energy demand will increase at an annual rate of about 1.4 percent in 2006, contributing to continued market tightness and projected high prices for oil and natural gas. The price of West Texas Intermediate (WTI) crude oil, which averaged $56 per barrel in 2005, is projected to average $63 per barrel in 2006 and $60 in 2007. Retail regular gasoline prices, which averaged $2.27 per gallon in 2005, are projected to average $2.41 in 2006 and $2.33 in 2007. Henry Hub natural gas prices, which averaged $9.00 per thousand cubic feet (mcf) in 2005, are projected to average $9.80 in 2006 and $8.84 in 2007. The EIA has also projected that average, household natural gas heating bills will be up more than 35 percent during the 2005/2006 heating season. This season's heating oil bills will be up 23 percent, and propane costs will increase by 17 percent.

The EIA is marginally upbeat: "However, if we do not have another devastating hurricane season in the Gulf of Mexico, and there are no geopolitical constraints on production, transportation, and refining, world spare oil production capacity is projected to increase during 2006 and 2007, easing the current tightness in world oil markets."

For 2006 and 2007, oil in the ground is not the problem. As the EIA points out, oil production capability could increase. Unfortunately, there is an alternate reality. Corporate behavior, government action, cultural stability, economics, legal agreements, geography, weather, crude oil transportation, military diplomacy and the always potent combination of religion and politics are now more important than geology in developing oil production forecasts.

Venezuela will sell oil. But maybe not to the United States.

Hugo Chavez continues to flex Venezuela's political muscle. Using the lure of oil as a negotiating tool, he is forging closer ties to other Latin American countries. For example, his Petrocaribe alliance will provide 198,000 barrels of oil a day to 13 Caribbean nations on attractive financial terms. Paraguay and Uruguay will purchase oil from Venezuela on similar terms. Petrosur will supply oil to Argentina in exchange for goods and services. Petróleos de Venezuela (PDVSA) signed an agreement to construct an oil refinery in Brazil. A pipeline from the Caribbean to Río de la Plata will forge closer ties with Argentina, Uruguay and Bolivia. Another proposed pipeline will connect to the Pacific coast through Columbia – providing a gateway for China to purchase Venezuelan oil. The extra heavy crude oil deposits of Faja del Orinoco (230 – 250 Bbl) will be developed through joint ventures with Argentina, Brazil and Uruguay. Chaves is exploring additional deals with Ecuador, Peru, and Chile.

As a practical matter, and despite bluster to the contrary, Chavez will need to sell oil to the United States to finance these deals. But once they are completed (in 3 to 6 years), a dictator with huge ambitions will be able to use oil as a lever in his bid to control South American politics. In the meantime, Chavez will try to void an existing oil production agreement Venezuela has with ExxonMobil, and attempt to increase the price of the oil he sells to the United States.

China. A resource confrontation has erupted between Japan and China over a large undersea natural gas field that lies in contested waters between China's central coast and Japan's Ryuku islands. Another conflict with Japan is simmering over the proposed routing of a 1.6 Mbl/day pipeline from eastern Siberia to the Pacific Ocean. Both nations want the oil this pipeline will carry and both nations are courting Russia's Putin for favorable treatment.

China's leaders are well aware that the well being, national security, and international power of any nation is interdependent with its access to oil and natural gas. Political stability requires they have sufficient energy resources to support their economic growth. With focused determination, therefore, China is inking deals all over the world. They have the cash. If the United States pulls out of Iraq, China will be the prime beneficiary of Iraq's oil and natural gas resources.

India. India is trying to cement a partnership with China for the acquisition of oil and natural gas assets all over the world. But Chinese oil companies have not shown much interest, consistently outmaneuvering India in just about every oil deal. Look for India to become a more aggressive oil and natural gas investor. India's leaders know the score. Without sufficient energy resources, India's economic growth will fizzle.

Russia. In January, Russian President Vladimir Putin sent a very clear message to Europe:

We have natural gas.

And you don't.

Europeans are now on the receiving end of a very cold lesson in the dynamics of the energy market. Russia is experiencing the coldest winter it has had in 100 years (or more). So if you’re Putin, what do you do? Make sure your citizens are warm. Then send the natural gas that is left to your customers in other nations. Although Russia has denied it is holding back its natural gas, Italy's Industry Minister Claudio Scajola had to call a crisis meeting with energy firms to discuss natural gas shortages, and decreased gas flows have been reported in Hungary, Bosnia-Herzegovina, Ukraine, Austria, Finland and elsewhere.

Putin sees Russia's vast reserves of natural gas and oil as a vehicle to finance and coerce his way to world power. Hence, he continues to pursue his objective of total control over Russia's energy resources. Russia is expanding its naval fleet in the Caspian because Putin covets the area's oil and natural gas. Although this move could be opposed by Iran – which also wants to move into the area – it is more probable they will reach a cooperative agreement to split the area between them. In order to build a stronger alliance with Iran's President Ahmadinejad, Russia also supports Iran's nuclear ambitions.

Do we wonder? Why is there a sudden upsurge in diplomacy as leaders from Japan, China, the UK, France and Germany seek to proclaim their friendship for Russian President Vladimir Putin?

Europe. Snow and blizzard conditions knocked out most of Georgia's electrical power and heating fuel transport system. Explosions, blamed on Chechen rebels or Russian saboteurs (take your pick), ruptured a key Russian gas pipeline. That left the freezing people of Georgia with scarce supplies of wood and kerosene for heat. Although there are those who believe Putin is punishing Georgia for its pro-Western policies, Russia rejected Georgia's claims and declared that terrorists were behind the pipeline sabotage.

Turkey introduced the rationing of electricity. Iran reduced its exports of gas in order to meet the heat and cooking needs of its own people. Both Italy and Russia have accused the Ukraine of stealing gas that should have been transported to European consumers.

Although Norway, Denmark, Belgium, Ireland, Portugal, Spain, Sweden and the UK currently import no gas from Russia, much of Europe would suffer without Russian fuels. According to BBC News Online http://news.bbc.co.uk, Central and Western European nations currently produce about 60% of the natural gas they need. Norway, the UK and the Netherlands are the largest producers. Of the gas imported from outside the region, two-thirds comes from the Russian gas monopoly, Gazprom - the world's largest producer of natural gas. Some 80% of it was carried by the Ukrainian pipeline network, the rest of it through a smaller pipeline crossing into Poland and Germany via Belarus. Several European nations are heavily dependent on natural gas imported from Russia or gas that is transported to them via Russian pipelines: Turkey 63%, France 26%, Italy 30%, Germany 39%, Austria 74%, Greece 81 %, Lithuania 84 %, Bulgaria 94%, Ukraine 77%, Finland 100%, and Slovakia 100%. Hungary, Poland and the Ukraine were the first nations to experience a disruption of Russian natural gas. Although Russian pipelines supply approximately 27% of the gas Europe needs, that percentage is scheduled to increase dramatically. Eurogas expects that the EU will also import up to 75% of its natural gas requirements by 2020.

That assumes, of course, that Russia and Iran choose to make it available. Gazprom has made it clear that it intends to take physical control of Ukraine's vital pipeline network, which carries 80% of Russia's gas exports. That has left the major powers scrambling for alternative pipeline routes to the natural gas fields east and north of Turkey. Central and eastern European nations, along with the EU, are discussing the construction of an integrated gas storage and distribution system, including a pipeline that would transfer Iranian and Azeri gas through Turkey to Austria. Although Gazprom is charging an average of $240 per 1,000 cubic meters, Putin has made it clear that discounts will be available to friendly consuming nations. That has motivated a flurry of diplomatic effort as France, Germany, and other nations scramble to shore up relations with their natural gas supplier.

And we haven't even reached "peak gas".

Nigeria. Fighting in the Niger Delta is escalating into a civil war. An attack on the Shell Petroleum Development Company Benisede flow station left 26 military and civilian casualties. Gunmen in speedboats stormed the offices of Italian firm Agip, stealing thousands of dollars and killing at least nine people. Additional attacks have been carried out against other oil production and transportation facilities. The Movement for the Emancipation of the Niger delta (M.E.N.D) has declared it intends to destroy the capacity of the Nigerian government to export oil. "It must be clear that the Nigerian government can not protect your workers or assets", MEND has declared, "leave our land while you can or die in it".

Oil workers' unions in Nigeria have threatened to withdraw from the oil-producing region unless the government moves to improve security. Instability has led to a 15% decline in Nigeria's oil production. Nigeria is Africa's leading oil exporter and the fifth-largest source of US oil imports. However, since little of the oil money flowing into Nigerian government coffers is used to support the needs of the impoverished people in the Niger Delta, they see no reason to allow oil production to continue.

OPEC. It has been disclosed that Kuwait does not have 99 billion barrels of oil reserves. As reported in my book "Oil, Jihad and Destiny", we can put the figure closer to 48 Bbl, of which only about 24 Bbl are "proven" reserves. Kuwait, along with the other members of OPEC, chose to inflate its reserve claims in the 1980s in order to maximize its production quota. High sustained oil prices, declining capacity, and depletion combine to obsolete that strategy. In order to prolong their political power, supplier governments are becoming more interested in conserving their resources for future sale.

Iran. President Mahmoud Ahmadinejad of Iran presents himself as a tough-man dictator and Islamist hero. He wants Israel "wiped off the map", and claims the Holocaust is a "myth". According to the International Atomic Energy Agency (IAEA), Iran plans to build nuclear weapons. For what purpose? Nervous Israeli leaders are considering a military action. European leaders are squirming. America can only bluster. Venezuelan oil minister Rafael Ramirez has indicated Venezuela will support Iran's efforts to produce nuclear materials. Will Russia and China provide Iran with nuclear technology?

Iran has plentiful oil and natural gas resources and Ahmadinejad will use them to forge alliances with supportive friends. Like China – motivated by its need for oil. And Russia – which has tied the control of oil and natural gas resources to its quest for political power. Iran seeks to control the offshore fields of the Caspian Sea that are currently claimed by Azerbaijan. Iran covets Iraq's oil and natural gas resources, and is actively supporting the political and terrorist actions necessary to install a friendly regime.

Make no mistake; Mahmoud Ahmadinejad is far more dangerous that Saddam Hussein, and he has a vision – Islamist control of the Middle East and North Africa.

America. If 2005 was the year Americans discovered the high price of gasoline, heating oil and propane, 2006 (or 2007) will be the year they discover oil product shortages. Chavez is a reluctant supplier. China has made a competing deal for Saudi oil. Nigerian production is questionable. Iraq is a mess. Iran's Ahmadinejad wants to hurt the infidel. And the Washington establishment is too engrossed with political bickering to establish a credible energy program.

The Arctic. Environmentalists are opposed to drilling in the Artic National Wildlife Refuge (ANWR). Small potatoes. This smallish piece of the Alaskan coast is just the tip of the iceberg. There are those who believe the Arctic contains copious quantities of oil and natural gas. Global warming has reduced the ice pack, opening up potential sea routes through the fabled North West Passage. Canadian Prime Minister Stephen Harper plans to send military ice-breakers into the Arctic. Their mission will be to defend Canada's territorial claims against those of the United States, Russia, Norway, and Denmark.

Absent a diplomatic agreement, the United States and Canada will continue to argue over navigation and mining rights in the Artic; it's Norway versus Russia over resources in the Barents Sea; Canada and Denmark are at odds over a small island next to Greenland; Russia and the United States both covet access to the Bering Sea; and Denmark is making noises it owns the North Pole. All five nations will make resource claims in the Arctic. Russia sees the Arctic as a key to its use of oil and natural gas for the acquisition of political power. The United States will go into the Arctic as a matter of survival. Adding to the confusion, territorial claims have also been made by Sweden, Finland and Iceland.

Terrorism. Oil money flowing into the Middle East continues to fund terrorist activity around the world. Although Osama bin Laden is clearly Al-Qaeda's spiritual guide, this organization has lacked a strong operations leader. In 2005 it found one in the form of Ayman al-Zawahiri. In 2006, Iran's President Mahmoud Ahmadinejad will forge political alliances with as many of the fragmented Islamist groups as he can. Add in new Hamas leadership in Palestine, increased Muslim Brotherhood political influence in Egypt, combative Wahabbis in Saudi Arabia, cultural frustration throughout the African and Middle Eastern Muslim community, and we have the makings of a powerful anti-western coalition.

Civil war is possible in Iraq. Al-Qaeda wants to launch another terrorist attack against the United States. Islamist leaders will disrupt the flow of oil and natural gas before the end of 2007.

Feel secure?

Conclusion

The key market trends discussed in this article are the basis for the "Production Crisis" and "Political Crisis" scenarios described in my book. Although these predictions were originally made in 2003, the essential assumptions are still valid.*

A "Best Case" scenario yields a GDP of just over 3%, a CPI inflation rate of more than 4%, an Unemployment rate exceeding 5%, and an average WTI Crude oil price of more than $55 a barrel. This scenario works if we are able to avoid the obstacles described above. If not, we have to consider an alternative scenario where production, transportation, and refining shortfalls act as a brake on oil deliveries. In this "Production Crisis" scenario GDP would be lower, and inflation would be higher. Because employment tends to lag changes in GDP, we would expect to defer the full downward impact on employment until 2007. If, as in the "Political Crisis" scenario, key suppliers pull the plug on oil and/or natural gas, then GDP would suffer grievously, deflation could be the norm, and unemployment would rapidly increase over the following 12 months.

But this is all speculation. Predicting the economic results of 2006 is like shooting craps. There are too many variables with unquantifiable data points to develop a precise forecast. We are in the midst of enormous cultural conflict and confusion. Since future unknown events will drive the world economy, we can only guess which scenario has the higher probability.

In any event. 2006 just doesn't feel right. And 2007 could be worse.

* Most of my readers believed my scenarios were much too pessimistic. As it turns out, my forecast was too optimistic. And that raises a big red flag for the world economy.

The opinions expressed in this article are presented without any warranty whatsoever.

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