Part One, demand loops ....

Regarding oil demand; it's hard to predict because there are many feedback loops that come into play at varying times for different reasons. The most obvious example is the drop in miles driven in the US because of a $2/gallon rise in pump prices in the past year and a half. Most prognosticators in the media and in business never considered that demand for gasoline would drop in the US for any reason.

Fooled ya!

With China, there is a 'hybrid' part- demand- part- command economy. The Chinese government will continue to try to keep a floor under growth ... but this does not necessarily translate into fuel demand the same way growth in the US drives consumption.

- It is just as hard to measure Chinese growth as it is to measure Saudi petroleum reserves. Good figures are not available. The Chinese lie. It is hard to see the Chinese continuing to have the same rate of growth when there are serious coal and fresh water shortages. The Chinese also have serious transport bottlenecks; they have built miles of freeways - which are jammed with traffic - when they needed to build railroads. Without more transport, there will be an inability to ship more goods out or raw materials in. We are at 'Peak Chinese Production' right now.

- The Chinese currency (Renmimbi) does not trade internationally. Nobody can really tell what it's worth as a result. The Chinese claim an exchange value - dollars to renmimbi - but that is an internal valueation that is set by fiat; that is, that valuation is set by the Bank of China. It is a kind of currency tax ... that has allowed the BOC to accumulate a trillion dollars. Nevertheless, any measure of China's economy by means of the value of its currency is an abstract exercise.

- The Chinese buy oil with American dollars it receives from its manufacturing sector in the currency exchange process AND from the influx of 'Hot Money' which is cash from hedge funds, investment banks and institutional investors seeking short- term yields. Much of this hot money is excess liquidity produced by the US Federal Reserve as well as dollars sold into the currency markets by other international players for various reasons. The Chinese reserves of dollars and the hot money are a distortion in the pricing mechanism that is also hard to measure.

- There is little relationship to the value of the dollar reserves held by the Chinese and the value of Renmimbi. The Chinese are using dollars as 'Monopoly money' because there is no other demand requiring a substantial outflow of dollars, leaving the Chinese to do with dollars as they wish. This spent on petroleum would be 'virtual demand'. I suspect these Chinese dollars are driving the futures exchanges. If, for some reason, the Chinese need dollars to sell they would unwind their futures positions. If they have a large position and the demand for dollars great, the result would be a significant drop in crude price even if actual demand on the ground in China remained the same.

- An outbreak in violence in western China, for example, would increase the value of dollars. Under this circumstance, the dollar might become very strong and the Chinese encouraged to sell dollars at a good price ... but petroleum valued in dollars would become proportionately cheaper. All this while physical demand in China remained level. At the same time, a large outflow of Chinese dollars into currency markets would tend to depreciate the dollars' value because of supply and demand. The different feedback loops make demand prediction difficult.

- The Federal Reserve is working as hard as possible to prevent a 'grand mal' debt deflation in the US ... they are doing this by flooding the eoconomy with liquidity. This process exports inflation. Increased consumption in OPEC/Middle East countries is funded in depreciating dollars. This is one reason why Saudi inflation is running 12% a year. Six percent of their own plus six percent of US inflation inherent in every buck.

All of the above create feedback loops that effect demand. For instance; if the dollar loses more value, the producers may require payment in other currencies, such as the Iranian demand for Euros from their European customers. Since Euros aren't a big part of Chinese currency reserves, the Chinese would have to buy Euros. This would put a value on Renmimbi ... since the Chinese are experiencing their own inflation, the Renmimbi would lose value too ... it's a matter of supply and demand. There are just not that many Euros out there in the currency markets. The result is; either the Chinese lose 'wealth' through the devalueation of their currency (priced at the wellhead) or they lose wealth through the currency exchange.

The Chinese alternative is to support the dollar ... which they are doing right now, by buying US Treasuries with dollars.

The bottom line; spending money on money is not spending money on petroleum.

One of these days the idiots in charge of the US government will figure out the stranglehold the US has on the oil producers and act accordingly. Since the idiots in charge gave us 'suburbia' I really doubt anything will change from a policy standpoint. Oh, well ....