Are We Too Pessimistic?

At the risk of making comparisons of news stories and opinions a theme of this blog, two articles caught my eye today: Tom Friedman's op-ed in today's New York Times, "Win, Win, Win, Win, Win..." and an op-ed by Patrick Seale in Gulf News last Friday entitled, "Arab world faces uneasy new year." Friedman's piece basically bemoans a bit of news he caught on CNNMoney about truck and SUV sales picking up in December and America's failure to honestly face its gasoline addiction absent price signaling in the markets. In it he argues that the only ones who benefit from this are the large oil producers. He uses the phrase "It's a new morning in Riyadh." Seale, a British citizen and long time observer of the Gulf, has a much different outlook on things. Seale argues that the day of the oil producers is drawing to a close as the incoming Obama administration appears to be serious about developing renewable energy alternatives to hydrocarbons. These policies coupled with the global recession and precipitous drop in oil prices stand to cause some havoc for the Persian Gulf. So which view is right or are they both? One could argue that Friedman's frustration is understandable but represents a more long term view. Industry consensus is that oil prices (and therefore demand) are not likely to recover until 2010. IEA is now forecasting a return to $100/barrel by '10 but not before a further price erosion in 2009. Friedman's pessimism also ignores the the likely albeit gradual decline in SUV production and sales being forced on US automakers in the wake of the US government bailout of the big 3. Add on to this US automakers' wrestling with scrapping popular lines because of declining sales (Salon ran a somewhat humorous article on Hummers recently, linked here), and the probability of a return to "normal" grows somewhat slim.

Still, Seale's equal but different pessimism also seems somewhat misplaced. There is little doubt that 2009 is shaping up to be a difficult year almost universally with the decline in developed world having a significant impact on the export capabilities of the developing world (and here, both goods and commodities producers are likely to suffer equally.) But any conversion to alternative energies will be a slow, many decade process. Even if the new administration is able to keep its promise on patronizing and developing green technologies, fossil fuels are not going to disappear overnight. And, as the IEA forecast suggests, prices are likely to favor the oil producers in the medium to long term, not work against them.

More than Friedman's qualms (which mirror many of those in the fledgling but growing green community in the US that low oil prices are actually bad for us as a nation overall), the pessimism in Seale's article as well as the press accounts going into the GCC ministerial beginning today in Muscat surprise me by the level of defeatism. This was a region of the world who a scant few months ago was really beginning to feel its oats internationally. Riyadh was at the forefront of pushing for diplomatic efforts in the Middle East, hosting religious dialogues, invited to attend the G-20 meeting in Washington in recognition of its status as a growing international financial player, and being heralded by the British Prime Minister as being a strong candidate for a wider role in global financial institutions. The tide has turned since then with the decline in oil prices, but it isn't as if the region is suffering in isolation. No one, not even the formidable China, is optimistic about its economic future at this point. But reading the list of things that the GCC can't control in the run up from today's meeting (the global recession, the fall in the price of oil, inflation, piracy in the Gulf of Aden, the recent Israeli aggression in Gaza), according to an Omani analyst with a local paper, one wonders why the group bothers meeting. I am not suggesting that the GCC can work miracles, but going into a meeting with no hope of adequately addressing any of the problems on your agenda seems a doomed way to begin. Or in this case end 2008.

All of this makes me wonder how far the region has really come in the past seven years. I admit to being frustrated that the region would rather continue to view itself as a passive recipient of events rather than as an actor. I have no doubt that GCC intervention might be of limited utility in global events, but they are still players and should see themselves as such.

More Signs of Trouble Ahead- this time North Africa

I wish I had some good news to blog about, especially so close to the holidays, but the more I read these days the harder it is to find any ray of sunshine, at least over the next year or so.  Two reports struck me today as being particularly ominous, even though both only tangentially deal with the Middle East.  The World Bank this month released its 2009 update of Global Economic Prospects, this one subtitled, "Commodities at a Crossroad."  Although the report is not entirely pessimistic about the outlook for established commodity producers in the short and medium term, largely because of the large surpluses they were able to build up during the past five years, the Bank notes that one of the most significant effects of the current downturn will be a decline in investment in emerging markets which is forecast to fall by almost 10 percent from 2007 to 2009.  The Bank attributes this steep drop to tighter credit conditions and a shrunken appetite for risk.  The second report was a front page article in the Washington Post which reported that many countries have already begun to enact protectionist measures despite pledging an ongoing commitment to free trade at the G-20 Summit in Washington in November.  (The article also contains an excellent map detailing measures being taken globally.) 

These two reports taken together should sound a note of extreme alarm for North Africa watchers.  Morocco, Tunisia, and Egypt all have been enjoying economic growth largely through their trade links to Europe and, more recently, through a boom in investment from the Persian Gulf.  (Europeans have been important investors in each of these countries as well although in the past two years, Gulf investment flows have surpassed those from the EU, and in the case of Egypt, from the US.)  In fact, these countries have tied their economic liberalization and future development strategies to the joint pillars of exports and investment.  North African policymakers have few tools to counter this twin blow since domestic consumption in each of these countries is minimal, although before this year, consumption in Egypt was on the rise.  But in Morocco and Tunisia, domestic consumption remains stubbornly tied to the agrarian culture that formally marked the underpinnings of those economies.  In times of abundant harvests, consumers spend more, whether or not those consumers are inherently tied to the agriculture industry.  Likewise, in times of drought, consumption tends to retract.  It's been the recovery in Europe and petrodollar flows in the form of foreign direct investment and portfolio capital that have smoothed out some of the jarring movements in GDP that has been typical in North Africa.  

With so much being tied to new investment and further development in export-oriented industries, we should expect to see these economies enduring significant slowdowns in the short to medium term.  Of course with this comes rising unemployment, burgeoning current account deficits, and potential balance of payment troubles.  Although the economic downturn is being felt globally and should be worried about in many countries, North Africa holds a special place for me since it is really the birthplace of economic reform in the Middle East.  Tunisia, in particular, has been working for decades to break the resource curse and get itself on more stable footing.  I don't believe that the current slowdown will become a deal breaker for any of these countries in terms of their ultimate reform agenda, but it is a shame that after finally undertaking some serious changes (especially in the case of Egypt) this downturn will prevent these countries from reaping the fruits of their labors.

The Shifting Fortunes of Sovereign Wealth Funds

Found this article in Business Middle East this morning. Think it's so well written that I don't have much to add but for a few additional issues to ponder.

http://www.bi-me.com/main.php?id=28882&t=1&c=34&cg=4&mset=1011


If SWFs have been a significant player in M&A activity, along with private equity, what happens now? A even greater slowing of investment capital globally?

If SWF investment is turned more inwardly, what is the outlook for US bond issuances? Who buys? (As readers of this blog know, this has been one of my biggest dilemmas when it comes to financing US fiscal imbalances.)

Will the global response to SWFs change? Will developed countries be more welcoming in the hopes of attracting what capital is left available for investment?

The one caution I have is that we have not seen the last of these entities. Surely as the sun shines, oil prices will go back up as the world comes out of recession. Structural issues in the oil industry and oil trading (everything from under-investment by the NOCs and IOCs to the continued opaque nature of over the counter trading) continue to hinder market "efficiencies" and I would expect the next time prices rise, it will be even faster and less rational than the last time. So when the fiscal surpluses start piling up, expect to see Mudabala and QIA on another shopping spree.

New Investment Strategies for the GCC?

Celent, an international strategy consulting firm, last Monday released a report that made the most detailed projections for the future of Gulf investment to date.  The report, in its entirety, is available only to subscribers but a summary of its findings may be found on zawya.com (linked here: Gulf Investors Alter Portfolios to Focus on Asia Investments).  The report may not be particularly profound in suggesting that more Gulf money will flow to Asia-- it's something that many of us who cover these issues have been watching since the beginning of the oil surge 5 years ago.  Investment flows between Asia and the Middle East grew rapidly in 2007, in particular, and, until the unraveling of global credit markets and oil prices, such trends would have likely continued this year.  Particularly interesting, though, is the rate of change in asset allocation Celent predicts will guide Gulf investment between 2010-2015.  Celent estimates that by 2015 Gulf investments in the US will constitute only 30 percent of Gulf countries' portfolios (down by 10 percent from today.)  Europe will also see a decline, falling by 5 percent to total 10 percent of Gulf asset portfolios by 2015.  In Celent's estimation, the biggest gainers in these shifts will be Asia and Africa.  One wonders if Qatar was looking to confirm these predictions with its announcement of new projects in the Philippines, which could total up to $1 billion.  

Such predictions come at a particularly unfortunate time for the US.  The US in the past eight years has relied on global imbalances, particularly the huge trade surpluses being generated in China and the Persian Gulf, to fund its chronic deficits.  Even today with global imbalances unwinding, the US has no good option to finance its continuously growing deficits (which could reach as high as $1 trillion this year if the bailout and fiscal stimulus packages being discussed are all adopted) beyond debt issuances.  This report suggests one big misunderstanding in that strategy: that Gulf appetite for US debt will remain strong.  Beyond the geographic shift, Celent suggests that while Gulf investment appetite for fixed income is likely to remain steady (albeit not incredibly high), its desire for equities will decline sharply.  The second misnomer with debt issuances is that buyers still have the financial wherewith all to buy and to buy at levels previously seen.  With the sharp fall in oil prices, this is no longer the case.  The IIF is forecasting that Gulf surpluses will be whittled down to $48 billion in 2009 from a high of $321 billion in 2008.  Samba, in a recent report, is not so sure things will look smooth for Saudi Arabia if oil prices hover around $40/barrel for an extended period of time.  (Oil at $40 Will Impact the Saudi Economy)   

One last interesting thing to note about this report is its forecast for asset class allocation.  As I mentioned above, Gulf interest in equities is forecast to go down, along with allocations towards real estate ventures.  Celent forecasts some growth in deposits, but the largest growth area for Gulf investment is alternate investments.  What those alternate investments might be is unclear (at least in the synopsis of the report posted in Zawya) but I'll be curious to see how the money gets allocated.  With so much talk in the US about a possible green revolution, it would be ironic yet somehow fitting if the world's biggest purveyors of the fossil fuel economy were providing the funds for its unraveling.  

Iran's Uncertain Times

The Singapore-based Facts Global Energy yesterday released a report that had many dire predictions regarding Iran's ability to produce and export oil.  The report argues that despite Iran's own projections of bringing oil production up to 5 million barrels a day after 2015, the country is likely to see production decline to 3 million a day by 2015.  The report cites Iran's abysmal record attracting foreign investment, its growing inability to technically handle recovery in its own fields, and the combined impact of sanctions--driving away interest from legitimate businesses--and the global credit crunch has had on Iran's ability to find financial partners to begin the work of upgrading its oil facilities.  The numbers seem pretty incredible given that FGEnergy's estimates mean that Iran will be looking at a one million barrel per day decline in the next 7 years if it does nothing but maintain the current status quo.  That rate of decline seems even greater than widely recognized disappearing producers such as Syria, Yemen, and Oman.  The icing on the cake here is that the report suggests that if domestic refining capacity does come on line during this time frame, OPEC's second largest producer may cease exporting oil entirely.  

Even if FGEnergy's analysis is alarmist in its time horizon, no one argues that Iran has put itself on a path of self-destruction that can only eventually end up where FGEnergy predicts.  And the reckoning may happen even more quickly than Iran could have imagined or hoped.  During the heyday of high oil prices, a few short months ago, Iran could afford fiscal mismanagement and increasing isolation from international creditors.  A back of the envelope estimate by a respected group of economic modelers estimated last year that Iran's "break even" point budget wise was about $60/barrel.  That made it one of the most expensive countries within OPEC, but with oil spending most of its trading days of 2008 above $100/barrel, the Iranian government could breath somewhat easily.  With oil today at $45/barrel (representing a $3 increase I might add over recent trading), the situation becomes remarkably different.  Iran will need to pay attention to how and when it spends and on whom it relies for trade and investment.  Relying on Sinopec and the Chinese willingness to flaunt the US and to a lesser extent Europe's interest in isolating Iran may not be quite as easy to do in current global circumstances.  And as the Chinese look at contraction at home, defending Iran may become more of a nuisance than it's worth.

All of this, ironically, places the incoming Obama administration in a unique position.  Some analysts posit that Ahmedinejad's letter to the president-elect after Election Day this November could signal an opening salvo of interest in talking with the United States.  Certainly, the Iranians are in an economically sensitive, if not vulnerable, position right now.  Using a well crafted carrot might produce some interesting results.

The Woes of OPEC

With the news of oil prices at just about $40/barrel today and analysts like David Moore from the Commonwealth Bank of Australia predicting that it was "way, way premature" to think that the commodities markets have hit bottom in the AFP (Merrill Lynch predicts that oil could go to $25/barrel in 2009 if the recession spreads to China, according to their new report), one wonders what has happened to OPEC. The papers were filled earlier this week with ridicule for the group after they had failed to reach consensus on a production cut during their impromptu meeting in Cairo over the weekend. Business Middle East staff writers suggested that OPEC indecision heralded a return to the 1990s when the group badly misread the Asian financial crisis and let oil fall to $10/barrel. Even Saudi King Abdallah's attempt to set a marker of $75/barrel as a "fair price" for oil right before the Cairo meeting (the first attempt by any OPEC member to set a price marker since oil began its climb in 2004) was ignored outright by the market in the wake of depressing economic news out of the US. So was Qatari Oil Minister Al-Attiyah's announcement that the group would surely cut at its scheduled meeting in December.

All of this hoopla surrounding OPEC's ineffectiveness in the face of the oil price downturn confirms my long held belief that OPEC doesn't really matter at all when it comes to determining the price of oil. I recognize that this is not a particularly profound statement in the wake of falling prices, but I would argue the same to be true when prices were rising. I don't deny that OPEC makes all the difference in the world when it comes to supplying the markets but the idea that the group can effectively target a price (or control a price rise or fall) is laughable. Witness Saudi's make-or-break moment in June when they announced an out of cycle production increase (a move which they knew to be completely unnecessary to a well supplied market) in the hopes of dampening down a furiously rising price of oil. The market barely blinked an eye and continued going up. The fact that the market moved more this summer on the "wisdom" of Jeff Currie at Goldman Sachs than Ali Naimi proved to me, at least, that something very quirky way going on in commodity markets. In fact, much of this "quirkiness" was elucidated in a fascinating article in the Washington Post in August which explained that much of the price volatility in the oil markets in July, at least, was being caused by a single firm: Vitol. It's too bad not more attention was paid to the story. Stories like that raise my conspiracy hackles a bit and I wonder how much people in the business of trading really knew what was going on despite the bunk analysis they kept churning out.

So where does all of this leave OPEC, our favorite bogeyman when times are bad? In not a very good place, I am afraid. As long as market forces keep driving the price of oil down (and I am on record in this blog with the belief that markets are currently overshooting), there isn't much OPEC can do to intervene. Production cuts are not going to solve much if the market remains bearish just as increases did little to stave off the bull market. But no one, including OPEC, should get used to low oil prices. What comes down will go back up. And in this current environment, if oil company executives in both the IOCs and NOCs convince themselves that they cannot afford to investment in exploration and drilling, we're all in trouble in the long run. I have a feeling that market volatility is here to stay.

Think the OPEC topic is interesting? Check out these stories-

http://www.bi-me.com/main.php?id=28429&t=1&c=6&cg=2&mset=

http://www.bi-me.com/main.php?id=28177&t=1&c=6&cg=2&mset=

http://www.zawya.com/story.cfm/sidZAWYA20081205080721/?query=OPEC

The Problem with Pirates

Oxford Business Group published an interesting article a few days ago in response to Egypt’s announcement of its intentions to fight pirates as part of any UN-sponsored mission. (Cairo said it opposes unilateral action to combat piracy off Somalia’s coast.) Oxford Business Group, among others, suggests that piracy could become a real problem for Egypt if it deters business away from the Suez Canal. Although Egyptian officials say that piracy has not yet affected business through the canal, OBG reports that Denmark’s AP Moller-Maersk has ordered its slower ships to sail around the Cape of Good Hope to avoid the canal altogether, even though this means an additional two to three weeks. Any loss in revenue from the Suez Canal poses a special problem for Egypt as it sees its other GDP drivers—particularly foreign investment from Europe and the neighboring Gulf states and tourism—begin to slow down in the wake of a possible global recession. Again, according to the OBG report, Egypt earned $2.6 billion in revenue from the canal in the first half of 2008. In 2007, canal revenues accounted for roughly 13 percent of government revenue.

Egypt’s Investment Minister, Mahmoud Mohieldin, predicts at least a full percentage point slowdown in GDP growth this fiscal year for the country, from 7.2 percent last year to 5-6 percent is year. Much of the slowdown in the Egyptian economy is out of Egypt’s hands-just as it rode the boom in the Persian Gulf and a strong Europe (much of Europe’s trade with Asia passes through the Suez Canal and the majority of its tourists come from Europe and the Arab world) so Egypt must ride out the slowdown in its economic partners. Piracy out of Somalia, nonetheless, would seem to be adding insult to injury for a government and economy that was just beginning to factor in sustained growth. Egypt is unlikely to actually take matters into its own hands if the situation deteriorates further, but it might be time for Egypt to rediscover its African identity and exert a little pressure on its neighbor to the south.