A barrel of trouble
A year ago, the village of Davos was abuzz with oil at $100 a barrel. The heads of the sovereign wealth funds were sizing up new investment opportunities, and the power that comes with three-digit oil -- anything above the century mark.
Wow, have things changed. Prices have dropped that amount in the last six months and from what we heard at the panel I chaired here at the World Economic Forum, the worst has not come just yet.
OPEC’s Secretary General Abdalla Salem El Badri made it clear that the cartel is waiting to see by mid-February what impact their cuts will have on prices. “We have to review this number and see how the market is going to react to this,” he said, but added the punch line, “If we still have some downward problems, then of course OPEC would not hesitate to take some quantities out of the market.”
The Secretary General was responding to the latest figures from the International Monetary Fund showing that global growth will only be a half of one percent in 2009, the worst performance since World War II.
Before the close of 2008, the IMF was predicting growth of 2.2 percent. The latest review takes into account the erosion of the Chinese economy. Premier Wen Jiabao told leaders here in the Swiss Alps that, indeed, China is facing major dislocation.
The head of BP, Tony Hayward, came up with a more blunt assessment for the year ahead: “If you take the more pessimistic view of the world, which would say there would be effectively no growth in the world at all in 2009, then I think demand loss of perhaps up to one million barrels a day will be more likely. So, it depends entirely upon the success that the world has of getting the economies of the world moving again.”
China is pouring $600 billion into that effort. The U.S. Congress signed off another $825 billion on top of the nearly $1 trillion in financial bailout funds over the past year. There is a spending spree going on, but there is no real sign yet that it will deliver the desired results.
None of the three oil-producing players on the panel, which also included the President of Azerbaijan Ilham Aliyev, would be drawn into the question of whether the bottom of the market has already been reached. They did agree, however, a price below $50 will erode investment into future production. No one was crying into their soups, but they warned if prices don’t bounce back, when demand recovers, shortages and high prices will return.
We then moved into the question about what is the magic number for future production to come on-line. The world’s largest producer Saudi Arabia declared recently that $75 would suit everyone just fine after the downturn. All three agreed a band of between $60-$80 is ideal and they had the support of the CEO of India’s largest industrial group, Mukesh Ambani and the chief executives of power producer EDF and biofuel supplier Bunge.
Even as the economy continues to sputter and more layoffs are announced, there is still a lack of consensus to build a new financial architecture. In the halls of the congress centre, I am hearing very little about G-20 cooperation and advancing this idea that oil producers and consumers should enhance their dialogue to gauge demand, spot production shortfalls and yes, plan better for the time that demand collapses.
The latter is what we are faced with today. From mid-September, when the real signs of economic calamity set in to this Davos meeting, prices have fallen $80 a barrel.
Forty dollars a barrel seems to be the new base on which to build on, but don’t bank on it. While in Davos, they could find agreement on where they would like to see prices going, no one could really answer when that will happen.
Yes we hope
"Starting today, we must pick ourselves up, dust ourselves off and begin the work of remaking America."
The words of the 44th U.S. President Barack Obama echoed through the Washington Mall. The pixie dust has settled on the inauguration. The new President has settled into the Oval Office and the work has begun in earnest.
Some felt a little let down by Barack Obama’s acceptance speech. They say it lacked the flair of his election night victory speech. I think many missed the point. I did an informal poll of businessmen and policy wonks and they all agreed with my simple premise -- this was a speech given by the Chief Executive, not the Commander in Chief. It is not the time to rally the troops, but get down to business.
The 47-year-old leader has a steep hill to climb, but he has plenty of support behind him and a bank full of goodwill abroad. After a day of celebration basking in the bright winter skies of the nation’s capital, he hit the phones calling four leaders in the Middle East. It was a classy touch and a strong signal that the region will be high on his priority list.
The challenge for this President is that he is sailing right into the eye of a colossal storm. Financial markets are good lead indicators for the next nine to 12 months ahead. They are pointing to more trouble, not less.
Our animal instinct is to think the worst, but hope for the best. This week I sat down with veteran Jordanian central banker, Umayya Toukan, to size up the impact of this downturn on the Kingdom. He is confident that Jordan, a small but reform led economy, can still grow better than four percent this year, depending on "how quickly confidence can be restored."
Toukan referred back to that nasty autumn week when banks and markets collapsed in a sea of toxic assets. He described it as an investor "panic attack". Rational thinking went out the door and survival instincts kicked in. Putting to rest those "voices" of irrational thinking Toukan says, it will take time and a period of stability.
Financial markets are not giving President Obama a honeymoon period. It seems Congress will move swiftly to approve an $800 billion plus stimulus package. Add more than $1 trillion for bank and insurance fund bailouts, and one is talking about a sizable long term burden on the U.S. economy.
This massive spending package on infrastructure and green technologies will bring the major economies together like never before. No one wants to see the U.S. sputter for long (nor Europe for that matter), so China, Japan and the Gulf countries are likely to remain loyal buyers of U.S. and European government debt.
But right now, the grand assumption is that 2009 will be terrible and that 2010 will be a year of recovery for the United States. Laura Tyson, a transition adviser for President Obama and former chair of the National Economic Council in the Clinton Administration told me in London that, "The U.S. recovery is going to be slower, longer and subdued." She too believes that the last to fall in this downturn, the developing countries from the Middle East to Asia, will be the first to recover.
"We have had a crisis which has demonstrated that the world is highly inter-dependent," says the economist from University of California at Berkeley. Those countries, she added, with giant surpluses need to "continue to stimulate their own economies and serve as stabilizing investors in the global economy."
Tyson was referring to China which sits on an estimated $1.9 billion of total reserves, and the GCC countries with a collective stockpile of $1.4 billion. Tyson a year ago in Davos expressed concern that the sovereign wealth funds might institute a "Trojan horse" strategy. They have been passive investors to date, but no one really understood their long term aims. After the signing of the so-called Santiago principles sign last October, she was clearly less concerned. Tyson even expressed the need for Washington to be more transparent in this process of state capitalism by the U.S. Treasury department in the financial bailout.
On the sidelines at the World Economic Forum, leaders will continue their work on the new financial architecture. The Group of 20 will gather again at the end of April here in London and will try to define who will lead and how they will lead. No doubt, decision making will be more collective, but the U.S. will still be in the front of this pack, during this re-balancing of the global economy, the new, inspiring President/Chief Executive Barrack Obama will not want to go at it alone.
Open up the Taps
John Keynes is not a household name. If there is any confusion, he is not being talked about for a record transfer in football, nor is he someone caught up in a Wall Street scandal. But just adding his middle name -- Maynard -- offers more clarity and, probably reminds us of his seminal work.
John Maynard Keynes is perhaps looking down upon us with a big grin upon his face. The 20th century economist was an advocate of big intervention, specifically the role of government to use the economic toolbox to mitigate the impact of downturns. These days we have different labels for what we are witnessing: prolonged recession, depression, or even repression. Keynes' theory utilized many times over the past seven decades, was later coined "Keynesian economics." It is being practiced with full force today.
A year ago, this writer and a long list of economic specialists were supporting the concept of decoupling. That is, the fast growing countries from Latin America to Asia -- with the Middle East, of course, included -- would continue their economic march while the United States and other industrialized economies cratered.
As Fred Bergsten, Director of the Peterson Institute for International Economics rightly pointed out we would witness the opposite. His argument was that the world will re-couple due to the interdependency of trade, capital and energy flows.
As a result, it is not only finance ministers in Washington, London, Brussels, Paris and Berlin dusting off their books and reading the works of Keynes, but those from Beijing, Delhi and Riyadh too. Big spending is in, budget deficits are a necessity and debt is not a worry.
Hold on a second -- not everyone is taking on water in their economic boats. The big savers of the world like China, Japan and Germany can breathe a little easier as can their counterparts in the Middle East.
“The region was saving for a rainy day,” says Middle East economist Marios Maratheftis of Standard Chartered Bank, “Gulf countries have the surpluses they can use, the ammunition to use now to cushion their economies.”
Since the rapid global growth days of 2004 when China revved up demand for oil and the U.S. was humming along, the region has been stockpiling reserves. During this window, an estimated $1 trillion was transferred to the region in terms of surplus oil and gas revenues. That sum is providing a nice cushion today, so regional governments are going into the red in terms of their annual budgets to insure their economies don’t do the same.
Maratheftis admits there are many unknowns in the region. He and many of his counterparts are predicting economic recovery in 2010. After talking to a number of leading bankers on background, I would -- excuse the pun -- not bank on this recovery.
Kuwait and the United Arab Emirates, according to Standard Chartered, seem the most vulnerable in terms of a potential recession with forecasts of zero growth and a half percent growth respectively.
At this juncture, governments are planning prudently with budgets based on oil prices of between $30-$60 a barrel. For example, the world’s largest producer, Saudi Arabia built its plan on a price of $37 for their local crude according to SABB, a division of HSBC. Seeing the growth tapering off, the Kingdom increased spending by nearly 25 percent in 2008.
Dubai recently unveiled their first official budget deficit of 1.3 percent of GDP -- a luxury in comparison to the West -- and increased spending by 42 percent.
Maratheftis believes the “budget deficits are fully justified; they are manageable and if anything they could be even larger.”
This may mean that they are probably written in pencil and not pen this fiscal year. If the economic smoke signals are worsening as many anticipate, regional leaders will go back to their monetary taps, make a few counter clockwise turns, and put more money into their budgets.
To date, the focus of that spending is similar to the stimulus package being finalized by the incoming occupant of the White House. Regional budgets have been big on infrastructure (perhaps too big), healthcare and education. These are the pillars of diversification, and they reduce over-dependency on energy.
It is difficult to get reliable numbers on actual surpluses in the region. Some are in foreign exchange reserves, others in general accounts and even more tucked away in a variety of sovereign wealth funds. While the world got used to seeing the initials SWF over the past year, they may begin to look for SDF instead, as in sovereign development funds.
The Chief Economist and Group Global Head of Research for Standard Chartered was an early mover tracking the shifts in these capital flows. Gerard Lyons says: “One actually saw a significant shift and therefore over the last year we’ve seen a greater demand within countries for the sovereign funds to spend more of their money at home.
“The next few months will reinforce that trend, namely sovereign funds, still wealthy, will be required to keep more of their money at home and spend more of their investment income at home.”
Governments are already re-deploying assets as is evidenced by these budgets. We don’t hear nearly as much about Middle East bargain hunting in London or New York for banks or trophy hotels and office buildings.
It is an evolving strategy with a domestic tilt and one that would have John Maynard Keynes smiling.
No economic opportunity without peace
In our business, we often look for the best way to tell the story; the best pictures to support a script, the best words to convey a sense of urgency.
Unfortunately, when it comes to the conflict in Gaza and the broader Palestinian Territories, we have seen this story before with the same dire consequences. The first images of the New Year with bodies being rushed to hospitals and children seeing the shock of battle did not inspire the thought of delivering on our own personal resolutions.
It was only a year ago when governments rallied around the hope of peace on the back of the Mideast conference in Annapolis and pledged $7.7 billion for reconstruction and development. No matter how you slice it, that is a lot of money for the three million people living in the Territories. The Palestinian Authority pledged to provide the institutional capacity to absorb the funds, root out corruption and plant the seeds for economic development.
Mideast Quartet Envoy and former British Prime Minister Tony Blair and Palestinian Prime Minister Salam Fayyad were following a path of real opportunity and real investment leading to real jobs. The next logical step being that real development would create the conditions for lasting peace. One cannot disagree with the intention, but the results are less than impressive. Beyond the horrendous casualties of conflict, unemployment is at more than 30 percent in Gaza and more than 20 percent in the West Bank.
Clare Spencer is a Middle East specialist for the think tank Chatham House in London. During an interview on Marketplace Middle East she said, "The whole approach to Gaza will have to change fundamentally after this."
Spencer says as long as Hamas is labelled as a terrorist organization by the United States and the European Union, we will continue to see a two-state economy -- one completely isolated with no movement in Gaza and the other under restricted movement with checkpoints and settlements in the West Bank. One essential difference between the two of course -- the Palestinian Authority controls the financial capital.
Beyond the money recently pledged by governments, the Palestine Investment Fund was set up back in 2002 to introduce transparency for the money coming in and to generate a return on assets for the government. The fund manager reports to the president of the Palestinian Authority, Mahmoud Abbas of the Fatah Party and a bitter rival of Hamas which now controls Gaza. All told the fund has more than $1 billion under management.
President Abbas and Prime Minister Fayyad have garnered the support of the international community as evidenced by the hundreds who showed up at the first Palestine Investment Conference last spring in East Jerusalem. One could not help being impressed by the energy and enthusiasm for lasting change.
A significant gesture at the conference was a pledge by Arab investment funds -- enjoying the fruits of $100 oil at the time -- to participate in the process. This was led by two real estate funds from Qatar and Saudi Arabia announcing projects of $500 million in the West Bank. I am curious to see if those deals and others on the drawing board will see the light of day after this latest twist in the long running script.
There was greater political significance behind the Arab investment. Money was pledged in part because regional leaders were hoping for a greater say in the Arab Peace Initiative and the peace process overall, according to Spencer. Basically, "We too will put our money on the table as long as our voice is heard as well," is the subtext here.
Of late, it has been Presidents Mubarak of Egypt and Sarkozy of France in an unusual East-West tandem presenting solutions to begin the long road back from conflict and tensions. That is a welcomed change, but it is just the start.
No one thinks for a minute that the timing of this conflict was accidental, just before the transition in Washington to an Obama White House. If dealing with economic repression is not enough, add a long-running dispute that has heated up to the mix.
Since mid-2007 the collective approach by the West has been to isolate Gaza as long as Hamas held political sway. What we have learned in the past two weeks is that this policy not only failed to deliver peace, it also failed to deliver opportunity for those in Gaza and the West Bank.
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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