A Nasty Economic Virus
Making the right bold decision is an art. During this severe global economic downturn, which is spreading around like a bad virus we tend to become numb to big announcements -- from record investment fund fraud in New York of $50 billion to record interest rate cuts.
It is within this context that the members of OPEC followed right on the heels of the members of the U.S. Federal Reserve Board with a historic move. As their policy counterparts at the Fed know, chasing the market is proving difficult, because consumer sentiment and therefore demand is plummeting so fast.
A cut of 2.2 million barrels a day is dramatic, especially in the context of a $100 drop in a barrel of crude in the last six months. By OPEC standards this was managed in a measured way.
After convening an emergency meeting in late November in Cairo, the group gathered in the home country of the cartel’s president, Chakib Khalil. They were joined by four non-OPEC counterparts as observers from Azerbaijan, Oman, Russia and Syria. They, too, sent signals that cuts in January 2009 would hit the market. Some production was scheduled to come off anyway, but in this case producers wanted to illustrate unity.
The reason for this sudden cosiness in the oil business is simple, a sharp drop in revenues. OPEC nations have lost nearly $3 billion a day since the peak in July; they lost half their daily revenue since the start of the year. Forty to fifty dollars a barrel is not what this group has in mind especially when there is more than $1 trillion of projects either under construction or on the drawing board in the Middle East.
The reality is OPEC members were left with little choice than to take action. Prices dropped a record $28 in the month of October. It was like the global economy was walking tentatively along with concerns about recession, and then plunged off the cliff into crisis. This rings true in nearly every sector: oil, autos, housing and shipping.
I spoke to a representative of one of the largest oil and gas shipping groups who noted tanker rates plummeted 80 percent for shipments since July. No one can remember that happening in recent memory.
As a twenty year veteran of covering OPEC meetings, it also strikes me as rather extraordinary that the dramatic action was taken right in the midst of winter when demand is about to hit its peak. Respected energy consultant, Mehdi Varzi, is one who believes OPEC is acting in a near-sighted way. He sees the global economy right now as a very ill patient and higher prices will only prolong the illness or extend the recession in this case.
Varzi for one believes we could see $60 to $70 oil by the spring. This is in line with the aspirations of Saudi Arabia, Kuwait and Qatar but not high enough to prompt companies to invest in marginal fields or fund alternative energy projects either. It is the “Goldilocks scenario” we talked about recently on our program and in this column.
When that OPEC target price will be reached is a subject of great debate within the corridors of oil companies, investment houses, buyers of energy and the analyst community. Fareed Mohamedi of consulting group PFC Energy in Washington believes a price around $70 a barrel will be postponed until 2010, due to a mix of poor market sentiment and a real drop in demand. “People think we are going to go down before we go up,” says Mohamedi, and there is a “lack of trust they will deliver.”
After a full day of reporting on OPEC’s historic cut on paper, I was called by a friend who has worked in the Middle East for 20 years and was eager to mull over the action taken by oil producers. He correctly pointed out that OPEC never manages what he calls a falling market. If downward momentum begins to build, it is very difficult to turn the tide or even set a floor underneath prices. This was true in the late 1980’s (I can remember seeing for myself the rusting oil rigs in Texas fields) and again earlier this decade when recession set in.
This sell off as both Varzi and Mohamedi discussed during our interviews is more severe than anything we have witnessed in the past two decades. The market went from a period of great exuberance to great concern in a span of just three months.
The oil market and the cloud of negative sentiment that persists is a reflection of the global economy today as a whole -- it just took much longer to hit this sector. A year and a half ago the U.S. housing market started to expose real cracks of concern, followed by the sub-prime crisis during the late summer of 2007. Six months ago we were still witnessing record oil prices, which lulled ministers into believing that demand from the East would outweigh problems out West.
A full year later after the financial crisis everyone, including those who sat around the table in Algeria, found out the hard way that no one or nothing is immune from this persistent, nasty economic virus.
Ripples off the Gulf
More than 30 years of conflict and rolling political crises do force a measure of discipline if you are to succeed in business under the worst of conditions.
It is in that context that we witness the strength of Lebanon’s banking system today -- the economy at home and even the country’s economy abroad. The last bit sounds a bit unusual, but rings true.
In a country of just over three million people, Lebanon remains both plugged into and dependent on its Diaspora. One third of its total economy is made up of the repatriation of earnings from the 350,000 Lebanese citizens working throughout the Gulf. The good news has been they were pumping record amounts back into their homeland; the bad news is the impact the regional slowdown will have on Lebanon next year.
The Lebanese economy in the Gulf, both the workforce and investment by the large construction companies and hoteliers, according to Finance Minister Mohamad Chatah, is larger than the domestic economy which is just shy of $30 billion.
Lebanon will likely finish 2008 on a high note, with growth above six percent. “There are indications the rate is even higher,” said Chatah the former International Monetary Fund Official in an interview from Beirut, “We used five percent for our budget projections for 2009 and we are likely to reduce that to three to three and a half percent.”
Chatah is not alarmist; in fact he is a common sense realist noting that Lebanon will fare much better than most. This is due in part from advance planning by the country’s central bank which kept banks out of investments that were riskier than many presumed.
To play off the phrase from former Citigroup CEO Chuck Prince, Lebanese banks were never on the dance floor when it came to some of the riskier products that were being traded. This Chatah says “paid dividends during the recent global turmoil.”
The finance minister does agree that Lebanese construction companies may be forced to retrench from some of the major Gulf projects on the drawing board due to the uncertainty, and he like many of his fellow economists, was reluctant to call a bottom to the economic turmoil.
“It is the $64 trillion question. Overall the response makes sense to us as economists and hopefully to the business sector, to taxpayers and to consumers.”
Lebanese construction groups, like those from Turkey and other parts of the region have been enjoying the go-go days of $100 oil. As we begin to put the wraps on 2008, many are looking to measure worst case scenarios for next year. What will push ahead or be put aside in countries from Saudi Arabia to the UAE and Qatar?
A much bigger question is what happens throughout the broader Middle East. A very different and positive trend in this economic boom has been the ability and the desire by major Gulf investors to look closer to home. Egypt, Algeria, Morocco, Lebanon and the Palestinian territories have been magnets for petrodollars.
DP World, the ports operator of Dubai World, has been at the forefront of this effort. Leveraging the Emirate’s history as a trading hub, Chairman Sultan bin Sulayam has forged deals from China to Peru. The group has pledged to invest over $700 million in Senegal, the same amount in the Sokhna Port south of the Suez Canal and at the start of November took over two port operations in Algeria.
If you have one of those classic maps of the world on the office wall, you would need 30 pins to cover DP World operations. Ten years ago, we certainly would not be having the same conversation.
That is both the blessing and the curse of this downturn. No-one is interested in picking up sticks and leaving a high growth opportunity. This phase, which many have labeled an Arab Renaissance, is built on reducing the dependency on oil revenues, diversifying their economies, restructuring education systems to match the 21st Century and building regulatory institutions alongside the gleaming, mirrored skyscrapers you find in every city.
To date, we have witnessed an intense competition amongst the major players of the region. The race to be first and the biggest will likely have to change.
Think of the classic fable "The Tortoise and the Hare," where the hare confident of winning the prize napped halfway through the race. This is no time for napping or sprinting.
In search of Goldilocks
The story of Goldilocks and the three bears has a little girl rummaging through a house uninvited to try all three bowls of porridge until she finds one that is not too hot and not too cold. The OPEC cartel -- producers of about 40 percent of the world’s oil -- is not living through a fairy tale, but in reality is finding it difficult to secure the right price for its crude as economies tumble into recession.
After choosing not to take action at an emergency meeting in Cairo, energy ministers have made their opinions known about what is the Goldilocks price for their product. Saudi Arabia’s Oil Minister, Ali al-Naimi, the swing producer of the group, surprised those who follow this business by declaring $75 a barrel as a “fair price” for crude today.
His Qatari counterpart Abdullah bin Hamad al-Attiyah was hot on his heels saying that colleagues were searching to stabilize prices of $70 to $80 because it is a level which will lead to investment in future production.
During the last quarter, oil has fallen more than $100 a barrel. Formal cuts of one and a half million barrels a day were announced in September and October, but it is taking a while to get those reductions implemented. In the meantime, the only thing related to oil that is going up is the amount of storage.
From his office tower overlooking the waterfront in Sharjah, Hamid Jafar, the polished Executive Chairman of Dana Gas, talks about the need for less volatility: “The worst thing for the industry and for investments is wide fluctuations, because it creates uncertainty,” says Jafar, “That’s not healthy because a lack of investment today will create a bigger spike for the medium term.”
From his headquarters in the United Arab Emirates, Jafar has fanned out in the region to develop fields in Egypt and the Kurdish Region of Iraq. Dana Gas and another company he owns, Crescent Petroleum have invested two-thirds of a billion dollars in the Kurdish gas project. Jafar is keen to see state-run oil companies accelerate their investments in partnerships with private sector firms like his. The trend in the business is the opposite. State run oil companies have been eager to control as much of their production as possible in an effort to maximize profits.
Oil industry insiders say Saudi Aramco is one of the exceptions. Neil Fleming of Platts put it bluntly on the sidelines of a London conference, “What tended to happen with other OPEC producers is they’ve milked what they had in terms of resources and revenue. The impetus to really invest in increased production was not there.”
With oil hovering around $50 a barrel, it is difficult to fully embrace the recent report from the International Energy Agency that predicts oil will average double the current amount between now and 2015. The Paris-based agency notes that a half billion dollars a year needs to be invested to compensate for the drop in production in countries like Mexico, Norway and Russia. Yes, the second largest exporter today, Russia, is seeing its fields drop by an estimated six to eight percent a year. The bulk of those investments need to go into Middle Eastern fields, where reserves are plentiful.
Kuwait Petroleum Company, for example, wants to expand production by one million barrels a day to 3.5 million in the next seven years. To do so, their Managing Director of Planning, Jamal Al Nouri said during an interview in Dubai that $60 to $70 would suffice in terms of his production pipeline.
“It is a complex combination of projects in terms of exploration, infrastructure, drilling and facilities for export and maybe securing markets outside,” Al Nouri said. KPC for example is a joint venture partner on a $6 billion dollar refinery in Vietnam.
Here is the rub. Despite their coffers overflowing when oil was over $100, the Middle East can have too much of a good thing. When prices are sustained above $90, it prompts owners of more expensive projects such as tar sands in Canada for example to go into production. That might be good for balancing supplies, but at the same time the trend reduces the influence of regional oil producers. Also, high prices push consumer nations to accelerate their investments into alternative sources of fuel.
Peter Barker-Homek is Chief Executive of Abu National Energy Company, better known as Taqa. His group owns oil and gas assets, plus clean burning power generation projects.
With a broader portfolio he is advocating that a higher price will prompt smarter investments: “I think the dialogue is moving from simply oil demand and supply balance to what is the whole global energy mix. And we have to change ourselves to a low carbon society, a low carbon planet. The only way to do that is to have relatively high pricing over the next five to ten years which will cause a migration from fossil fuel in transportation and cause us to switch to more efficient power-generation.”
So, while this blueprint for future energy is still being drawn up, OPEC finds itself only a quarter of the way through a story it was hoping not to be part of. It is called a deep correction in the West and falling demand for their number one asset. Oil producers are searching for Goldilocks, but like in the fairy tale, she remains elusive.
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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