The G-8 meeting in the Umbrian hills of Italy served less to inspire unity, and more as a historical turning point, marking the passage of a tired institution.

The G-8 or “Gee-Otto” as the Italians say is misleading by both description and substance. For one, the members are no longer the leading industrialized nations, with China now the second largest economy in the world. Number two, the G-8 does not and cannot live life in isolation. In fact, 16 leaders were invited, with China’s President Hu Jintao needing to duck out early to attend to protests back home.

There was little agreement from the core G-8 on the next steps to combat the worst downturn in six decades. Germany’s Chancellor Angela Merkel called for an exit strategy from the deficit spending and pump priming to inflate the global economy.

A global climate change commitment remains challenging -– despite verbal commitments -- as the developing countries focus instead on job and wealth creation. This should not be at the expense of the environment. As mobile phone technology helped developing countries leap-frog after years of underinvestment in that sector, so too can rapidly evolving green technologies. Environmental policy is a prime example of why the G-20 is a more modern body and why the door should be shut on the creaking G-8.

We will get a better idea if the G-20 can stand on its own in September when leaders gather in the old steel town, now modern research and development hub, of Pittsburgh. One cannot miss U.S. President Barack Obama’s motivations here. Observers can almost hear him saying “You too can modernize with the times as did the old rust belt of America.”

While this summit was short on real solutions, there was a non-binding consensus on what is a quickly evolving fair price for a barrel of oil. The range of $70-80 was floated at the meeting and a spokesman for Russia’s President Dmitry Medvedev confirmed this raised few objections. Like most G-8 efforts, enforcement and follow through may be difficult, but the Goldilocks scenario –- of a price that is not too hot nor too cold –- is gathering momentum.

At the recent European Union-OPEC Meeting in Vienna, a similar consensus emerged from the closed door sessions. When oil prices slid from a peak of $147 a year ago down to $35 in December, OPEC members decided to shelve 35 of 150 projects on their books. What we have not heard since this recovery to $60 plus is whether more and more of them will come back on-line.

Middle East in Italy

Summit host Silvio Berlusconi, under fire at home for what may have happened at his private parties, wanted to use this meeting as a means to shore up poll ratings. Rather quietly, the billionaire also extended invitations to help secure Italy’s long-term energy supplies.

Leaders from Algeria, Egypt, Libya and Turkey attended this G-8 meeting. Three of the players are key natural gas exporters to Italy, the fourth, Turkey, is a key transit hub for both oil and natural gas.

A few interesting facts to be aware of: Algeria ranks fourth in natural gas exports today; a large share of that gas ends up in the Italian market. Not surprisingly perhaps, Italian contractors are playing a major role in Algeria’s natural gas development with two of the first nine tenders going to Italian companies.

There is a similar storyline playing out in Libya, where it is the largest holder of proven oil reserves in Africa, estimated at 41 billion barrels. Libya plans to expand oil production from 1.8 million barrels a day to three million in less than five years. It too is starting to ramp up natural gas production.

Prime Minister Berlusconi had a two-pronged strategy when he visited Libya last summer. He apologized for Italy’s 30-year colonial rule and committed to a $5 billion compensation package spread out over two decades. The money will be used to modernize Libya’s infrastructure and very likely cement Italy’s relationship in this neighbourhood where energy is plentiful.

Berlusconi was not reserved in saying during President Qaddafi’s recent visit to Rome last month that Italian companies should have priority or be “prima fila,” the front row, for future contracts.

The G-8 may be short on concrete solutions for the global economy, but it may very well have served a purpose for Italy and by extension the European Union when it comes to energy.

Labels: berlusconi, g-8, libya, oil prices

Global downturns have a way of forcing action. What was perhaps overly ambitious in the past could be papered over as long as investors believed in the future and money was available. The climate has changed dramatically and so too has the response from business and government.

Case in point is Emaar’s proposed merger with government run Dubai Holdings, with Dubai Properties, Sama Dubai and Tatweer under that umbrella. For those not familiar with some of the landmark projects under these property brands, they include: the Burj Dubai, Dubai Towers and the giant Dubailand entertainment complex.

For one, this will create a $53 billion entity if it comes together as planned by autumn -- sizable by any global standard. Number two, expectations have changed in the region in part because of what Dubai Inc. has done over the past few years, having introduced a greater level of transparency into the process.

The word got out that there was something in the works, so instead of waiting until the structure of the deal was complete, Emaar and others decided to flip the switch. As a result, there remains a great deal of uncertainty whether a consolidated property group will be net positive to existing shareholders.

As the desert sands settled so too did the wave of negative comments surrounding the transaction. Robert McKinnon, Managing Director of Al Mal Capital believes that "from a property market perspective it is absolutely necessary and good for the market." McKinnon says the aim by the government is to clear up the property market in two years instead of letting it linger for a decade if not longer. McKinnon raised a valid question about the valuations which will be used as part of this process. Being too generous now with valuations in the short term, will not pay dividends long term.

Ask Japanese investors what their experience was in the 1990s, which many still refer to as the lost decade. The fact the Japanese government decided to muddle through that decade without taking bolder measures though is a good lesson for everyone in the region today. This Dubai merger is designed in part to put a brave face on what has been a painful 40 percent correction in property values over the past year. Everyone will be eager to see which projects survive the merger process at the end of the day.

Even in Saudi Arabia the default by two well-known family entities in the Kingdom is being handled in a much more transparent fashion than would have been the case just a few years ago.

The Saad Group and Algosaibi restructuring of more than $6 billion in debt will incorporate nearly 40 different lenders. At least a dozen banks have come forward to say they do indeed have exposure to what many commonly refer to as the "problem" but they added it won’t be mission critical to their operations.

This debt restructuring is a tricky one for Saudi regulators and for the region in general. As family entities and not publicly traded companies, Saudi central bank officials say the long arm of the law may in these cases have limited jurisdiction. Unless laws were broken, regulators in this more transparent environment will not likely play a major part in the process.

Officials told me there is no systemic risk to the banking system, but it will indeed be painful for those who chose to lend at such prolific levels. It does not take a genius to read between the lines, that government bank bailouts won’t be in the works even if this first round of numbers is lower than the final tally in a few months time.

What perhaps has not changed, if we use the Emaar merger and the debt restructuring as our benchmarks, is the desire by government officials to remain behind the scenes as both plans take shape. It is not difficult to reach officials on the phone or approach them in person, but few if any want to be on the record before they feel all the paperwork is in order and they are confident the worst is behind us.

In this era of globalization and internet chatter, the region is indeed introducing greater transparency, but full disclosure may still be a ways off.

Labels: downturn, middle east, transparency

The temporary migration is officially underway. Arab businessmen swap 45 degree temperatures on the Arabian Peninsula for the very pleasant 25 degrees in the City of London to garner perspective for the year that was and where we go from here.
There is a certain irony in annual summer escape to London. Only nine short months ago during the third week of September, depositors in this financial capital were wondering if they could find a safe haven for their hard earned cash. This week at the Arab Banking Summit they were in their comfort zone gauging the state of their union and the state of global banking.

As one senior Arab private banker noted, we are still feeling the tremors from the earthquake. But all told, the 280 banks in the region, 80 of them in the top 1000 worldwide, are faring much better than their Far Eastern and western counterparts.
The region is still growing, which provides some comfort with projections of 2.5 percent this year, 3.5 percent next year. This allows a base from which to work through non-performing loans. But all told, regional banks are sitting atop more than $2 trillion in assets and about half of that in deposits. Leverage was not in fashion the past few years and this allowed a few in the audience to say “I told you so.” One banker kindly suggested I take off my headsets during the heated comments pointing the blame at the “Americans.”

As a long term resident of London who now spends up to ten days a month in the region, I take little offence when Uncle Sam comes under attack. But the banker made a valid point. While Wall Street is probably responsible for three-quarters of the banking crisis, the U.S. economy has had to absorb only 25 percent of the fall out. This was an equal opportunity crisis which spread its virus pretty evenly around the globe, hitting the large institutional investor and the small retail client with equal measure.

These ministers and bankers also feel the discussion of the green shoots of recovery is lulling many back into the business as usual mentality. Compensation levels were and remain out of touch with normal society; they see bonuses creeping back up again and restless shareholders seeking 10-20 percent returns on capital, when the global economy is struggling to come back.

Many of the participants talked about returning back to basics, which means knowing your customer, their appetite for risk and most importantly the bank’s appetite for risk. This is clearly where there was misalignment. The challenge now is insuring that the proper road to recovery and yes regulation is followed.

This meeting took place as the largest debt restructuring in Saudi Arabian history --some $6.3 billion to two of the largest family companies in the Kingdom is unfolding. It was revealed that BNP Paribas and Citigroup top the list of 37 creditors with exposure to this restructuring. Hard lessons still need to be learned.

These isolated incidents aside, the region has benefited greatly from traditionally high capital requirements and restrictions put in place to block exposure to the high risk instruments created over the last decade in London and on Wall Street.

So the region will be forgiven for thinking it shouldn’t follow the trends in the West. One Arab executive even pleaded with his European counterparts to avoid the gravitational pull across the Atlantic. To make a new interpretation on the famous phrase from scorned financier Ivan Boesky, greed is not good at all cost.

These bankers are eager to see the next phase of response to the crisis. There is some legitimate scepticism about whether the G20 will indeed follow up on the long laundry list of remedies to the global financial system.

Supply side economists went out of fashion long ago and there is a strong belief that the region will have a nasty aftertaste from the deficit spending within the industrialized countries right now. With high deficits to finance for years to come, less money will find its way to the region in the form of foreign direct investment.

This region continues to open up to the outside world to foster long term development, but as we work our way through the next few years, it will be funding closer to home that will need to be available.
The conservative Arab approach to banking is still paying dividends.

At this critical juncture, the economy is certainly not “front and center” of the protests in Iran since the future of the young republic, as some suggest, is at stake.

But make no mistake, the phrase that former Clinton political strategist James Carville coined during the 1992 U.S. presidential campaign, “it’s the economy stupid” applies here. More specifically, it is the mismanagement of vast natural resources and economic isolation due to the country’s desire to develop its nuclear capabilities that has hurt the country.

Iran, according to research from OPEC, ranks number two in proven oil reserves and number two in natural gas reserves. That puts Iran in the top slot on combined total energy reserves. Today, Iran officially says it produces 4.2 million barrels a day of crude, but actual production according to leading energy analysts is about a half million barrels a day short of that.

The reason is quite simple. Iran as a result of economic sanctions has been isolated from the essential tools for development: technology and capital. In business terms, Iran has been a political hot potato that nobody in the West was willing to touch.

Take the world’s largest gas field to illustrate the point. French energy giant Total finished off its work on phases 2 & 3 in the South Pars field at the end of last year. Negotiations on the next phase have been dragging on for a few years, until the National Iranian Oil Company signed a $4.7 billion deal with China National Petroleum Company earlier this month.

Total’s straight talking Chief Executive, Christophe de Margerie said last summer that the political risk was too great. Still trying to keep the prospects warm, a company spokesman this week said negotiations are still underway. China sees only the upside, with little political fallout due to its size and seat on the U.N. Security Council.

But China’s foray into the Iranian energy sector does not solve what has been an ongoing problem for the country. The international oil companies (IOCs), at this stage at least, possess the technology and know-how that Iran desperately needs. With technology and capital, veteran energy analyst Mehdi Varzi said Iran could be producing six million barrels a day, not four. You do the simple math, but at $70 a barrel, we are looking at another $140 million in daily revenues.

Natural gas fits into another category, but we can see neighbouring Qatar growing at least eight percent this year based on the growth generated on the other side of the same giant gas field. Iran with skilled partners should be doing the same.

Top line economic growth in Iran has been a promising 5.7 percent over the past five years, but as those in the developing world know, it is woefully short when two million young Iranians enter the workforce each year. They want opportunity, they see the world differently through the internet and they expect their leader to manage what has been handed to them, whether it is power or natural resources.

While the current President has publicly thumbed his nose at capitalism and the forces of “western” globalization, the leadership has been in fact acting in quite a capitalistic fashion. In the last few years, the government has privatized a host of strategic companies ranging from copper to telecommunications. The financial services sector opened up this year, but the government still owns and operates about three-quarters of the economy.

Recognizing that the state is not the best manager, the government passed Article 44 into law which calls for 80 percent of the economy to be in private hands in the next decade. As Tim De Borde of the London based boutique investment bank and fund manager Turquoise stated on our program, “Iran has been so isolated, but change is occurring.” That is why the fund sees opportunity and has posted average gains of 13 percent a year for the past five years with its Iranian investments.

The problem for the Supreme Leader is that change is nearly unmanageable now because Iran took too long to open up. When that finally did happen, the President and chief communicator did not inspire a lot of risk taking by the major energy companies or banks who feared probes by Washington – some of which are still open today.

Barack Obama offered an olive branch to Iran, cleverly delivered from afar before the elections. During his speech in Cairo President Obama talked about the region’s overdependence “only upon what comes out of the ground”. Many countries have accelerated the pace of reforms, based on the luxury of their energy reserves.

But in Iran, the sums have not added up. The current government has built its budget on overly optimistic energy prices and massive subsidies. As a result, capital investment to support future production has been lacking and political pressure has been building.

A market of 70 million consumers and an abundance of natural resources are appealing, but only if the risk-reward ratio is manageable. Today, it is not.