Addendum: oil prices, short term - variables at play

This is an addition to the previous post in which we have analysed oil prices based upon fundamentals estimates based on supply & demand. As anticipated in the same post we have warned against large changes in prices due to other variables such as geopolitics.
Since our last post the price of OIL has continued its down spiral and as of today we are sitting at a 5 ½ years low.

We would therefore like to shed some light on the current variables at play and also advise on the non sustainability of such pricing in the long run. These are exceptional times and they should be treated as such.

Variables currently pushing the OIL price down:

• Policy of containment towards Iran, Syria, Islamic State and Russia adopted by OPEC Gulf States;
• OPEC members interest in slashing fracking projects profits and delay or contain their production;
• Weaker than expected Chinese economic performance although we believe that the current statistics with regards to economic performance are not justifying the current price drop;
• Weaker demand demand than expected from the US side. 

In spite of the large reserves of some OPEC suppliers trapped into their Sovereign Funds, many of these countries have set up their countries expenditures and development against a higher price per barrel. Please be reminded that these countries are tax free regimes and their economic performance and development plans are affected directly by the price of OIL.

Further, a low OIL price and a strong dollar combination is going to hurt significantly all development projects in the Oil & Gas industry that are financed in USD, something clearly undesirable for many powerful US lobbies.

Lastly, while the mainstream media in the USA are hailing the low OIL price as a welcome stimulus to the economy this will not turn into reality. The US is facing a lethargic demand that is not supporting the recovery picture portrayed on the media. Please note that statistically any time that there was an energy tax cut in the US there has been no subsequent sign of positive stimulus afterwards.

Because of the above listed reasons we believe that the current significant price drop is temporary and far exceed the drop potentially justified by a weak US and partial restatement of Chinese growth.

We would only expect OIL at current price for a protracted period of time in the face of a recession 2009 which could be fought once again by the Feds with a new and improved set of QE cycle.

Syria, what is really at stake?

Recent events draw me into writing an opinion about Syria. It has mostly been the abundance of misinformation on the topic that motivated me to start the writing.

As we all know, in spite of the rhetoric of the media, the whole point is not about protecting neither the lives of the innocents nor US national security.

Since the beginning of time the super powers at play, although changing over time: from the Persians to the Roman Empire, through to Great Britain and now the USA, have given proof over and over that what counts is not justice but POWER: its acquisition or its protection. 

We therefore need to look at history, even recent past to be able to use the “right” yardstick to measure the reach of the events, and to look at them behind the right “lenses”.

Therefore, lets wear the “power” glasses and start analyzing some of the interests revolving around Syria. I believe that this approach is going to get us quite a bit more perspective than the usual “freedom” arguments.

The government of Syria is one of the last allies of Iran, supported by Hezbollah, and an official ally of Russia. The latter has a military base in the country that gives access to the Mediterranean, and still the latter is providing military supplies.

The country is small with negligible oil supplies. The population numbers unappreciable as its overall size economy.

It happens to be sitting on the path of a potential gas line connecting Qatar to Turkey which would be a game changer both for Turkey and eventually for Europe (news among others: http://www.thenational.ae/business/energy/qatar-seeks-gas-pipeline-to-turkey). Please don’t forget that Turkey’s cost of petrol is some of the highest in the industrialized world (#4 highest prices as of the latest available stats: http://www.fuel-prices-europe.info/index.php?sort=4).

There are current many attempts to carry gas and oil into Europe bypassing Russia, but so far the ability to turn those into reality have met significant challenges. Please refer also to the Nabucco pipeline that is supposed to connect Azeri oil with Turkey via Georgia. 

Let’s also identify some of the key factors defining who is supporting who in the conflict:

1. Gas & Oil: Qatar & Saudi Arabia on the supply side and Turkey and France/UK on the demand side against the Syrian government;
2. Access to the Mediterranean: Russia is supporting the Syrian government to preserve key assets in an important geography;
3. Containment of Iran and protection/appeasement of Arabian Gulf States (Qatar, Saudi Arabia & UAE mainly): USA in contraposition to the Syrian government.

Let’s analyze point 3 in a little bit greater detail because I believe that some of the current discourse is failing to point out the true geopolitical reach of the shale gas development in the USA and its implications for the Middle East. 

We all know that the discovery and exploitation of shale gas in the USA is accelerating by the month. This is a significant variable that is bound to change the geopolitical strategy of the USA moving forward.

News are telling us that the USA is bound to be energetically independent by 2020, just 6 years away.

At that point the USA will no longer need oil resources coming from the Middle East changing radically some of the key relationships with the Gulf States that are currently supplying the US with their oil (although not as much as thought by mainstream people).
The players that will require most of Middle Eastern oil will remain China, India, few countries in South East Asia. 

The US involvement in the region is not bound to lessen though as it will be necessary for the superpower to exercise its political and military influence to control the oil supply into third countries like China and India, the former perceived as a country to contain. Price and access will be defined by many factors, and political stability in the region will be a key factor. The ability to influence the stability (or instability) of the region is going to act as a price gauge and therefore an economic control over the countries that are bound to import energy resources.

Therefore, instability in the region might be considered an advantage for the US on two counts: manage the cost of economic resources for the countries to contain: China as well as continue selling all necessary military hardware to the players in the region: see Saudi Arabia, UAE, Qatar, Bahrain.

Russia and China are completely aware of the stakes and can’t let go of Syria. Too much at stake after having let the Libyan affair take place.

To our readers: please go behind the surface. 

Sirya is just a symbol of a new geopolitical order in the making. Energy resources and control is the name of the game. 

Russia's involvement and diplomatic leadership shown recently is bound to bring stability to a very volatile situation. The red line after all seems to have been drawn by Mr. Putin more than by Mr. Obama in this case. A resolution of the latest tension is bound to benefit the stability in the region.

We reassert our opinion that while the Middle East remains a complicated region it is also one of the regions that mostly favor foreign direct investment and that has been successfully shaken off the 2008 crisis showing proper growth over the past few years.

Middle East & North Africa unrest - a perspective

Over the recent weeks many friends, mostly Europeans and North Americans called me to get an opinion about what has been happening in the Middle East and North Africa.

I have refrained from publicly sharing any of my views since events were unfolding very fast and needed some time to analyze them and formulate an opinion.

The following is a summary of my thoughts and humble opinions hoping to be nothing more than a perspective from someone that has been operating in these markets for years and that has a first-hand appreciation for the commonalities and the differences that these diverse cultures share.

Let's get out of the way few important notions:

• Origins of conflict: first and foremost with the exception of Bahrain the events in Tunisia, Libya, Egypt, Saudi Arabia and Oman have been driven by socio economic factors and not religious ones.
• Oman: secondly, Omani protesters haven't requested for a change of the ruling family but rather a set of changes that improve the ability of employment and changes in some of the government posts.
• Bahrain: remains an exception because we have a Sunni government in country that is vastly Shi'ites and some of protests took a religious connotation especially after the clashes that took place about 10 days ago.

The risk of simplifying an analysis and group all these countries together, while useful for some reasons and to certain people, does not represent reflect the truth about the profound diversities among these countries.

AT FIRST GLANCE

Tunisia, Libya and Egypt saw a long deterioration of the conditions of the masses leading up social unrest that took many years in the making. Take Egypt as an example: the economy has been growing fast over the past few years in spite of the global recession: 5.3% in 2010, 4.6% i 2009 & 7.2% in 2008, unfortunately such growth didn't benefit the fast growing population: 20% of the population remains below poverty line, and this looks like a rather conservative estimate. It is not by chance that the majority went to the streets asking for radical changes and that the protests turned violent.

While regime changes were long in the making in Tunisia and Egypt, the unrest in some of the other Middle Eastern countries may have taken some of their governments by surprise. 

Unemployment rates among the local population breeds unrest, especially youth unemployment. At sign of first trouble the answer given by the ruling families in Saudi Arabia, Oman, Bahrain has been to prepare a package of handouts in form of government salaries increases, and to create new government jobs (Bahrain: 20,000 new jobs promised - http://www.reuters.com/article/2011/03/06/bahrain-jobs-idUSLDE72505C20110306, in a country of 1,000,000 approximately it is a significant increase). King Abdullah of Saudi Arabia returned home and immediately implemented a $37 billion social welfare package: pay rises, unemployment benefits and affordable housing.

Notably out of the lot during these troubled times have been the United Arab Emirates, Kuwait and Qatar where there was little to no sign of discontent. 

These countries have been able to share in a relatively less inequitable way the wealth of the country and last but not least the population is differently composed: a majority of expatriates workers at every level of society together with a 15-20% of passport holders.

Without getting deeper in the analysis of each single case I would like to highlight some of the risks on hand and some of the opportunities:

RISKS

• Egypt controls the Suez canal and therefore the traffic of oil derivatives and container into the Mediterranean. It is essential to have a stable Egypt to guarantee free flowing of the goods. Further Egypt is one of the most populous countries of the Arab League and presents phenomenal opportunities for growth: large and young population, need for infrastructure and good combination of agriculture and services industries;
• Saudi Arabia: any unrest in this country would send oil skyrocketing to levels never seen before. Saudi Arabia has acted as additional supplier in times of need for the West. Since the second oil shock Saudi Arabia has intervened with additional oil supply any time there was necessity to stabilize the market.
• Some forces in the West could characterize the current situation along religious lines further exacerbating the contrapposition between Islam and Christianity that seems so useful to some lobbies.
• Gulf countries: some of the measures that have been put in place to quell the unrest may prove harmful in the long run. Government jobs and subsidies hardly seem the way to create long term competencies much needed in these countries. Government jobs may prove a way to employ the youngsters short term and a way to redistribute the wealth coming from natural resources (oil & gas) but it breeds inefficiencies and promote bureaucratic tendencies. It is known in the UAE for example that many Emirati passport holders don't like to work in private enterprises and hold out of the work force to be employed by the government which provides a secure job, indexed salaries and easy advancements.
• Since the USA and many European allies actively sustained many of the families ousted during this last round of discontent it is possible that the new forces shaping up to take control in these countries may be less friendly than their predecessors towards the West. (Remember: US 6th fleet is anchored in Bahrain, Saudi Arabia is a key ally of the US, Egypt received armaments and economic support from the US and allies: Italian Prime Minister Mr. Berlusconi called him one of the wisest leaders in the world just two weeks prior of him leaving Egypt for good).

OPPORTUNITIES

• Increased internal development: this unrest is a stepping stone in the development of a country. This could be seen as an alarm bell for many ruling families in the region that could put additional resources in the development of the country and in the creation of a better leveled field for its citizen. This in turn can create a virtual circle of business opportunities for all: locals and foreign investors alike;
• SME sector: a more balance redistribution of wealth in certain countries could mean an accelerated development of economic sectors other than the one of the natural resources which in fact has been on the agenda of many Gulf countries for many years. The next step is promoting the development of a strong private sector independent from the government owned conglomerates that have been fueling the development already for many years.
• UAE as the most stable country in the region: what may be an issue for some it can be an opportunity for others. Capitals as well as tourist require stability. Since Egypt has proved unstable all tourists have been redirected to the UAE resorts: try booking a room in Ras Al Khaimah these days… Let's look at relative advantages to uncover opportunities.

Useful marco-economic data:

Country	Ranking GDP per capita	GDP per capita (PPP)	GDP Ranking	Nominal GDP	Population
Tunisia	82	9,488	76	43,863	10,549,100
Egypt	103	6,367	40	216,800	79,890,000
Saudi Arabia	39	23,742	23	434,440	27,136,977
Oman	34	26,197	68	53,782	2,694,094
Bahrain	33	26,807	96	21,733	807,000

Macroeconomic Data from:

• CIA World Factbook;
• International Monetary Fund;

Emerging markets - SME confidence higher than in developed economies

Emerging markets have been making headlines in all publications globally. The global recovery is led by emerging economies and this is a fundamental fact bound to stay long term.


I receive an average of 3-4 business delegations a month here in Ras Al Khaimah. Delegations come from all corner of the worlds since our free zone has investors from 120 different countries. While meeting businessmen part of a delegation may not be a statistically viable sample to determine the trends in a specific country, it is nonetheless a good viewpoint to develop a perspective about so many different economies. Over time, over many delegations, consistent trends tend to set in.


I was therefore very happy when on February 2nd, HSBC has published the results of the its most recent research on SME Confidence (20 markets were surveyed). The primary data was gathered last October and November 2009.
I have now the statistical confirmation of the trends I have been collecting over the past year: not only emerging markets are leading the economic recovery but SMEs are going to play a leading role in the recovery.

The report also confirmed a wide differential in confidence levels between the so called highly industrialized economies (G7++) and the emerging markets.
Emerging markets are significantly more confident than developed markets. With an index of 100 as neutral emerging markets have scored an aggregate of 121 and developed markets an aggregate of 106 (France registers below 100 at 96).


Nicholas Levitt, Regional Head of Business Banking at HSBC said: "Confidence levels appear to be back to pre-financial crisis level. The Middle East outlook correlates strongly to the global emerging market outlook, and as a major international trading hub, the region is well-placed for future growth."


From the survey we learn that the Middle East is the second most optimistic area after India.
I can related personally to this finding since every month I receive one or two business delegations from India. During my presentation on emerging markets with them I always ask: "How is business during these challenging times?", invariably I receive feedback about how the impact goes from mild to negligible.


In the Middle East the SME survey confirms:

• 47% plans to increase capital expenditures;
• 41% commits to current levels of capital expense;
• 11% are planning capital expense reductions;
• 36% is committed to increase staffing;
• 58% will keep the same staffing levels;

SMEs were also asked about their propensity to engage more in international business and the survey has confirmed the role of the Middle East as an international trading hub.

• 72% of the SMEs in Qatar planned to grow their business internationally within the next 2 years;
• 28% in Egypt;
• 19% in Saudi Arabia;

The top international locations for business for the Middle East are China, South East Asia and Europe.

While this research presents gaps[1] in its approach to define the geographical footprint, it highlights something that is at the core of the economic global shift currently underway. 

In order to validate the aspirations for internationalization of many SMEs both in the Middle East and other emerging markets it is necessary for local governments to support the development of a solid and more sophisticated banking system specifically tailored to support trade and investment.
As Dr. Butcha, vice president and managing director at A.T. Kearney Middle East, said in a recent article “A.T. Kearney has worked with governments across the world to improve the SME sector. SMEs are the backbone of any successful and sustainable economy, they are the blood cells behind successfully diversified economies and large corporations. Successful long term economic growth plans for the GCC can only succeed with strong support to SMEs...”. A.T. Kearney research in emerging markets shows that successful SMEs create jobs at a rate which is four times faster than the rate of larger corporations and create revenues and GDP at a rate which is six times faster than large corporations. This is largely due to the fact that successful SMEs tend to grow more exponentially than large blue chip and established business (more at: http://www.eyeofdubai.com/v1/news/newsdetail-38845.htm)

It is because of the essential role of SMEs in the global economy that we at Ras Al Khaimah Free Trade Zone have created a business environment specically designed to facilitate SME business. Especially the newly created "valued added services" for RAK FTZ clients are focused on reducing the "incubation" period of new companies and to put them in the condition to generate successful business in the region in the fastest and most cost effective way.

[1] the survey did not include the United Arab Emirates in the emerging markets, developed markets surveyed included only US, Canada, UK & France, results in confidence in the developed economies would have been slightly different if Spain, Greece, Italy would be included.