Destruction in demand
"It is too easy to be pessimistic," is how one senior financial executive from the Gulf put it over dinner in London. My accountant from New York is taking negativity to the extreme, saying he has only invested in land, having no faith in financial instruments.
It is challenging at best to see the glass half full at this juncture. Even with stimulus packages being cobbled together, two key ingredients -- confidence and capital -- are clearly missing. As a result, this slowdown is spreading far and wide.
During an exclusive interview with Marketplace Middle East this week in London, the Secretary General of OPEC Abdalla Salem El-Badri pointed to the challenge ahead, "There is destruction in demand; there is no doubt about it."
The Secretary General says the worst case scenario is that demand drops by up to a half million barrels a day this year. The International Energy Agency is projecting consumption will drop by double that amount -- or a million barrels a day. If that is the case, daily demand will be below 85 million barrels a day, and holding onto $40 a barrel will be difficult.
El-Badri, as the great equalizer in the organization, is trying to prod producers inside the 12-member group and outside, amongst the key Non-OPEC players, to trim their sails. "We really need more from our member countries," says El-Badri, noting that 800,000-900,000 barrels still need to come off the market to hit the promised cuts of 4.2 million barrels a day, announced back in December.
Once those cuts are delivered, "if the market did not react, I think we have to balance the market,” said El-Badri. He pointed to the amount of stock, which today is floating on the sea or sitting in bunkers. "The stock at this time is about 57 days. This is five days above the 52 day average; if we want to take the five days out of the stock, then we have to cut more." That is as clear as it gets, whether the group that controls 40 percent of the world’s supplies is prepared to do more.
At this juncture, they are the only players doing so. The IEA still believes that non-OPEC production will go up by 400,000 barrels a day this year. OPEC is not keen to play the role of swing producer all the time or in this case of "swing reducer."
"I am taking this opportunity to ask Norway and Mexico to join us, because if the market collapses, it is not to the benefit of anybody," said El-Badri. This follows consultations with Russia’s President, Dmitry Medvedev, to do the same. This is a case where market share may override near term revenue shortfalls.
The International Monetary Fund, in a special regional report, notes that Middle East producers could see their revenues drop by $400 billion in 2009 due to demand destruction. The IMF urged oil producers to spend their way through the downturn so that the infrastructure build-out continues and confidence remains. The Fund sees regional growth at 3.6 percent this year, down from 6.3 percent in 2008. That is certainly not bad, and is a dream-like scenario compared to Europe or the United States right now.
The Secretary General, like many others, is hoping that the emergency actions taken today will mark the bottom of the cycle by mid-year, with the first hints of recovery by the close of 2009. I believe that is the best case scenario.
Lower interest rates, stimulus plans and tax cuts don’t do a whole lot if businesses cannot get access to capital. That is the quandary today. In the meantime, medium and long term planning and investments are being shelved.
"Because of demand destruction, and also because of financial problems, we are postponing about 35 of our projects from 150 projects, and I think that if this price continues, more projects will be delayed," said El-Badri. The reality is that no one seems willing to pony up more money if they don’t see revenues bouncing back to justify it. That is why there seems to be a building consensus to find what we have talked about on our programme, "The Goldilocks Scenario."
"I think that $40 will not permit us to invest to have a reasonable price where you can invest, where you can have another source of energy then from $70-$80 a barrel, is fair," said El-Badri.
There was a hint of disagreement within the Organization on this point. The President of the group Chakib Khelil thought that $40 was a "good price for the moment." Privately others said it is too painful for those desperate for revenues and probably counting on $60 or more.
As El-Badri noted we should be thinking a few years down the road, "There will be no additional capacity when the economy will pick up. Then you will not find additional capacity."
ABOUT THIS BLOGJohn Defterios’ blog accompanies the weekly business program, Marketplace Middle East (MME) that is dedicated to the latest financial news from the Middle East. As MME anchor, John Defterios talks to the people in the know, finding out their opinions on the big business moves in the region, he provides his views via this weekly blog. We hope you will join the discussion around the issues raised.
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