The New Prize
Scottish Justice Secretary Kenny MacAskill and Abdel Baset al-Megrahi - the so-called Lockerbie bomber - must feel at this stage that they are pawn pieces on a large chess board in which they have little or no control.
They both garnered their moment in the spotlight, whether they wanted it or not. The story of Megrahi’s release kept on getting waves of momentum on both sides of the Atlantic from leaks of British government memos, the families of the victims and heads of state in Washington, London and Tripoli.
It is fair to say there might have been some disagreement over the fine print of diplomacy, because there were plenty of glitches. A hero’s welcome in Tripoli poured fuel on the fire of discord especially in the U.S.
No doubt the debate will pass and news organizations will eventually move on without the closure that many of those closely involved were seeking. What will remain a constant with regards to Libya is the desire by western governments and their oil and gas producers for a share of the spoils below ground.
The events over the past ten days had me thinking of Daniel Yergin’s seminal book on the energy industry called “The Prize”. It is not light reading, but the Pulitzer Prize winner does put all the pieces of the puzzle together.
Libya is Africa’s largest holder of proven oil reserves according to OPEC’s official estimates at 43 billion barrels. It is producing less than two million barrels per day and only uses about 10 percent of that for domestic purposes. Equally as promising for Libya is its natural gas potential. The country is already sending exports to Europe via Italy through the Melita gas pipeline.
This is where politics and economics converge. After then Prime Minister Tony Blair’s meeting with Colonel Muammar Gaddafi in 2004, sanctions were lifted and a whole boatload of energy companies (56 by Libya’s count) lined up to get involved in what remains one of the most promising, yet under explored energy nations.
BP has a two billion dollar natural gas exploration project in the works. One might even call it a race to catch up with Italian energy company ENI – which has had operations in Libya going back a half century. They now have agreements stretching out to 2042 and 2047 for oil and natural gas development.
Mr. Gaddafi’s visit to the G8 meeting in Italy by host Silvio Berlusconi was smart politics, even if the Libyan leader took the liberty to pitch his tent near the grounds of the meeting. That is a luxury not afforded others at the summit. We should not forget that a year ago the Italian Prime Minister’s gesture to pay five billion dollars to Libya to make up for misgivings during their colonial rule. A footnote included in the deal says that Italy will spread out the payments for a quarter century for major infrastructure projects. Mr. Berlusconi was candid in saying that he expected Italian construction companies to benefit as well from those investments.
Meanwhile, Britain continued its own diplomacy track on Tony Blair’s subsequent visit in May 2007 which led to what was called a “natural gas cooperation accord”. Under that agreement BP will retain just over 19 percent of the income from discoveries, with the Libyan government and its sovereign fund keeping the other 81 percent, according to state oil officials.
The harsh reality is that energy demand continues to grow in Europe and, for that matter, the entire world. The challenge for Europe is that supplies need to be found elsewhere. North Sea fields are depleting at a rapid rate. The major oil giants at this juncture still hold a technological advantage over their emerging market counterparts, but how long will that last, another decade or two?
That question cannot be answered just yet, but the reality is those who own the oil and gas want to keep a larger share of the revenues. Examples of that abound in Russia, Kazakhstan, throughout the Gulf and, yes, in Libya. As their economies and energy fields are opened up to the forces of globalization, they have rightfully hardened their position to capture as much revenue as possible.
But it would appear the prize in Libya is a big one, because the level of engagement for the last five years has been nothing short of exceptional.
The Century Mark
In September 2007 western equity and capital markets were enjoying the go-go days of low interest rates, unusually robust (which turned out to be in many cases false) returns for hedge funds and consumers were borrowing heavily against their homes to fund Range Rovers and a range of boy toys.
During this window in time, the Middle East was starting to hit its stride. Most outside the region were unaware of the big and, shall I say, broader growth story that had been unfolding. Record surpluses were piling up, fortifying the already influential sovereign wealth funds.
This past week we marked our 100th program on Marketplace Middle East. Two years zipped by in part because the global economy was moving at hyper speed. It has not been a straight path forward, but a rollercoaster ride best reflected in the price of crude. We covered the ramifications of $147 oil back in July 2008 and witnessed its fall to $32 in December of the same year.
“It is has been a tremendous roller coaster ride,” said Khaldoon Al Mubarak Chief Executive of Mubadala on our first program. “The growth in Abu Dhabi, the growth in the region has been tremendous. It requires executives like me running around making sure we have the right deals, right partnerships in place and have the right sustainable growth strategies.”
The surge in prices past $100 last spring helped develop a new and almost certainly reoccurring theme, “three digit oil.” Anything over the century mark opens up a full range of possibilities. The tendency has been to compete against neighbors by building shiny new structures. In light of rapid birth rates all over the region and the burden it places on the education system, it is heartening to see that the next generation of leaders view the emphasis on construction as problematic.
“Real estate and brand new building while stunning architecturally, are not going to solve anything unless there are qualified people inside them,” said the Crown Prince of Bahrain Sheikh Salman Bin Hamad Al-Khalifa during our interview a month after oil prices hit a record high.
I am in the tent (a fairly empty one) that says the downturn, albeit painful for contractors still awaiting their payments and bankers who extended their bets, clears out the frothiness.
As the speaker of the UAE Parliament and Chairman of Mashreq Bank Abdul Aziz al Ghurair said in November when crisis started to bite, “Fundamentals of business have been built, now we can afford to reconsider where we are going next, being slowing down our growth, postponing some of projects, that’s okay.”
In sum, those who have been left standing are on firm ground and want to call the Middle East home – expat or not. The lobby of the Emirates Towers hotel may be less crowded today, but the discussions are based on prudent projections and having to do a great deal less with real estate projects.
The critical aspect of this recent and rapid downturn has been the sovereign wealth fund money staying closer to home. We are looking at a consumer market in total of nearly 500 million people. If money from the Gulf is invested in projects closer to home, barriers to investment and hard goods will continue to come down. There may even be greater impetus to create a single currency with more members in the Gulf as well.
That is not to say the SWFs have left the scene in the West. Qatar’s stakes in Porsche and Barclays Bank are two clear examples of snatching opportunities when they are presented and Abu Dhabi’s Mubadala has taken long term positions in General Electric, EADS and chipmaker AMD as it builds out its portfolio and the emirate’s industrial base. As an interesting side note, in the past two years Premier League fans know much more than they did about the Gulf and who controls the purse strings.
Regional and global private equity players are hopping on fewer planes to London, Paris and Frankfurt and instead are picking Tunisia, Jordan, Egypt and Morocco as their new destinations. Growth in all four of those countries is holding up nicely, despite the global turbulence and the tepid recoveries we are witnessing in the West.
What can we expect as we begin our work on the next 100 programs? Qatar, Saudi Arabia and the UAE will continue to drive new projects with the goal of completing not only their infrastructure build outs but their human capital development as well. Billions have been allocated, but privately government and business leaders want to see that all the plans are delivered with the results promised on the PowerPoint slides and the animation videos.
Finally, Dubai and other Middle Eastern cities are no longer dots on the map that indicate the hub and spoke transfer system of a particular carrier. We no longer think of the business day rising in Asia, skipping to Europe and finishing with a crescendo on Wall Street. The region has carved out its place, which is far beyond a passing fad or quick opportunity.
Surprises Lurking in the Shadows
The noise represents the sound of expansion -- big pylon drivers bang away day and night as yet another tower looks to fill more space in the Dubai skyline.
Depending on where you are staying, big shadows are cast from these vast skyscrapers which block the bright sunlight of the Arabian Gulf. But visitors to the region in search of high growth and opportunity are finding that even the best intentions and strong will cannot overcome what is a Western-led financial crisis.
The finance minister of the region’s most populous country, Egypt, is striking a more cautious tone right now after posting the best economic growth in two decades. Youssef Boutros Ghali is an old hand in Egyptian politics and he told Marketplace Middle East he is only hoping for the best.
When asked if Egypt can hold onto at least five and a half percent growth after hitting more than seven percent last year, Boutros Ghali hedged his bets: “I am keeping my fingers cross. We have not seen the end of this problem. We have not seen the end of this crisis. My suspicion is there are surprises lurking in the shadows. ”
There are signs of concern from most camps throughout this broad region. Just two months ago, the International Monetary Fund was predicting growth in excess of six percent. That is low by regional standards, but certainly not recession. The challenge is the pillars that were projected to support that growth -- oil, property development and financial services -- are in the danger zone.
As I was waiting for a car to take me to chair the Leaders in Dubai conference this past week a banker from Bahrain shared his thoughts with me: “We don’t know where we are going,” then drawing on the metaphor of the car he was about to jump into he said, “That is my biggest fear after knowing only growth for a decade.”
It was a brief encounter, but certainly summed up the sentiment. A great deal of information is shared in the lobbies of hotels, at the coffee bars and, yes, in the taxi queues. I always find the lobby of the Emirates Towers Hotel the best hub for gathering sentiment. A year ago while taking in an espresso there, the talk was dominated by private equity players from Europe and Asia ready to fund the latest project. Today, the discussion is about which projects get completed and which ones get mothballed.
This is the modern form of the ancient agora where real time information and gossip from business peers replaces efforts by government leaders to manage expectations.
Those participating from outside the region at Leaders in Dubai were not providing the answers or inspiration that many were looking for. James Wolfensohn, the former head of the World Bank said no corner of the world will be left untouched. He pointed to outstanding derivative trades that still need to be unwound that hover over the banking sector like a dark cloud. “I can only say we are in a tough situation” said the veteran banker.
On the trip back to Dubai Marina on the Sheikh Zayed Road, one scans the skyline to see what has been completed to date and what is still under construction. This is one of those places where it is difficult to tell how much capacity is too much. There are a lot of rental signs in place which seems to square up with a report from HSBC that house prices in Dubai and Abu Dhabi fell for the first time. That seems only logical after a four-fold surge over the last decade.
Right now, global markets are not being built on logic, but on fear. That is what has taken the Dow Industrials below 8000, oil below $50 a barrel and property prices in some markets around the world down 20-30 percent.
Barrels of Concern
When we were in school doing our maths, our teachers always instructed us to use a pencil and not a pen in case we made mistakes. It was impossible to erase a miscalculation back then. Those who are making economic and energy forecasts right now might be wise to do the same.
With as much exuberance on the way up to $147 in July, we are witnessing equal pessimism on the way down to $55 a barrel. The internal tussle within OPEC back in July was supplying more oil to meet demand. Today, the 13 members cannot scale back fast enough. After trimming production by one and a half million barrels a day since September, they are looking at another emergency meeting for the end of November in Cairo. Playing catch up with the markets is always a frustrating game, and that is the one being played out today.
If we continue along this path, don’t be surprised if the six and a half percent growth earmarked by the International Monetary Fund for the Middle East gets crossed out shortly for a lower number. That will spill over to the property sector where we are starting to see 10-20 percent falls for villas and flats in Dubai. Officially we don’t know how leveraged some of these companies are, but there is a lot of discussion off-line that provides a pretty good indication.
In the meantime, OPEC members will do their level best to find the middle ground. While on a trip to Cyprus for bi-lateral meetings, the Prime Minister of Qatar, Sheikh Hamad Bin Jassim Bin Jabr Al-Thani reiterated his call for a trading band, "We think that $70 to $90 is a fair price because you need to keep new exploration to go on and as you know, the investment in the oil is expensive.”
That appears to be the Goldilocks scenario for OPEC: not too hot, not too cold, but just right. Right now, regional producers still make plenty of money at $55, but they are losing $2 billion dollars a day from the go-go times of July -- that’s three quarters of a trillion dollars a year.
Power in Reserves
In their World Energy Outlook, the IEA projected spending of $24 trillion in energy between now and 2030 to meet the demands of the fast developing countries from Asia to Latin America. I found it interesting that only a quarter of that (he says lightly) is forecasted to be spent on oil and gas. Half is forecasted to be spent on power generation and a good slice of the total on conservation.
The IEA sees demand growing from 86 million barrels a day to over 100 million in that time frame. Make no doubt about it, with 78 percent of the proven reserves today, OPEC will be in the driver’s seat once the doom and gloom clears -- whether it is in 2010 or a tad later. Non-OPEC oil fields are reportedly depleting by six percent a year now. That is expected to jump to eight percent in the next two decades.
If that is the case and this forecast holds up, the IEA believes oil will average $100 a barrel between now and 2015. By 2030, the agency is expecting today’s barrel of oil to be priced at $200.
In the meantime, a projected $450 billion is needed to develop reserves that have been identified and even more to find those which have not. At today’s prices that is a tall order. Let’s hope that the Goldilocks scenario returns fast so forecasters can rework their numbers up, rather than down yet again.
That Slippery Feeling
A fifty percent correction in four months! At first glance you probably think I am referring to regional equity markets. Think again.
Before one can say West Texas Intermediate, crude prices have gone from a hefty record of $147 a barrel way down to the $70 range. It may have taken too long for the G7 countries and their new partners to come together with a defined rescue package. That is on the books. The world has now decided to focus on a new chapter titled "Recession 101".
The gathering of 185 countries at the International Monetary Fund and World Bank meetings in Washington provided the outline for this new chapter. Take note of the tone by Olivier Blanchard, Director of Research for the IMF.
"Growth in advanced countries will be very close to zero or even negative until at least the middle of 2009," says Blanchard, "We predict that even the fast developing countries will grow at a substantially lower rate than they have in the recent past, 7 percent in 2008, and 6 percent in 2009."
Slower growth is not the surprise; the speed of the fall and depth of the drop are. Blanchard’s ultimate boss at the IMF, Dominique Strauss-Khan, says the institution was quick to dispel the concept of de-coupling, that no part of the world was immune to the downturn. I think most would admit today in fairness, that no one really thought that this banking crisis would be so horrific.
It has Middle Eastern central bankers cutting interest rates. Saudi Arabia lowered its benchmark rate by a half percentage point after the likes of the UAE, Bahrain and Kuwait pulled the trigger the week before. Enemy number one was inflation at the peak of summer, which was replaced by slower growth. Both surely have been substituted by lower oil revenues.
Let’s take the largest producer; Saudi Arabia. At $147 a barrel, the Kingdom brought in oil revenues of more than $1.3 billion. At $70, that quickly becomes $637 million. That is a lot of money; more than a population of 28 million can spend of course, but a great deal less than a quarter ago.
According to Saeb Eigner, founder of investment group Lonworld and author of "Sand to Silicon", most Middle Eastern oil producers have been prudent with their revenue targets. In five short years they wiped out budget deficits accumulated, in part, by financing the first Gulf War. In most cases, $40-$50 has been the yardstick. It would be more interesting to discover what targets they penciled in on the margins after seeing prices trade well over $100 for a half year.
Oil ministers representing13 members of the OPEC cartel will hold what they call an extraordinary meeting in Vienna this Friday. They already agreed in September to trim production by a half million barrels a day. Not long before that, swing producer Saudi Arabia agreed to boost production in June to cap prices that were on their way to $147 in July. Back then, oil minister Ali al-Naimi said there was not an oil shortage, but the market was not factoring in a slowdown in demand. Not surprisingly, he was correct.
This leads us to the old debate within OPEC between the price hawks and doves. Saudi Arabia has always tried to counter balance members Iran and Venezuela, who have sought maximum revenues per barrel. The Kingdom has taken the view there is a breaking point where price undercuts demand. After we have witnessed the first hint of recession, one sees what the slippery slope looks like. OPEC has already cut its 2009 forecast for daily demand by a half million barrels a day.
This crisis did start in America. It has crossed the Atlantic hitting Britain and the European Union with full force. Export driven markets from China to Southeast Asia are feeling the pinch, with growth off one to two percentage points depending on the economy.
The real fear it seems is not $70, but what many privately say could be just around the corner. If one can see prices tumble by 50 percent, then another 20 percent is not outside the realm of possibility with investors still climbing a wall of worry.
Swept out into a Sea of Red
Who says we are not connected? What clearly is a banking crisis in the United States and Europe has spread like a bad virus throughout the emerging markets of this world, the Middle East being no exception.
In a span of a week, the Morgan Stanley’s emerging market index was down 23 percent. Equity markets from Shanghai to Sao Paolo fell in lock step. It is a pretty nasty tally in the region. Prior to the concerted effort to cut interest rates, Cairo, Saudi Arabia, Dubai and Doha were all down 50 percent or more from their peaks in 2008. Hot money flooded the region to tap into growth, but left local traders and investors stone cold on the way out.
The economies of the Middle East are growing nicely, regionally about seven percent this year. Oil revenues with prices between $85 and $90 a barrel are still strong by historical standards. So why are the major markets of the region drowning in a Sea of Red?
The simple answer is these economies cannot stand alone in isolation with all the chaos around them. They surged in part because investors are enthusiastic about the future. There was a double-whammy if you will since many of investment funds put money in thinking that the Gulf economies would soon abandon their pegs to the dollar. When leaders in the Gulf decided not to scrap that dollar peg, even after a fall of nearly 30 percent over the past few years, foreign investors looked for the exit.
All together now
It took too long for the central bankers of the world to grasp the enormity of the problem. After much delay, the major G-7 central banks cut interest rates by a half percentage point to send a signal of unity. A handful of the region’s central banks followed suit, with rate cuts of different proportions, due to the formal link with the dollar. At this juncture, it is the fear of a liquidity crunch, not inflation that is driving sentiment.
I am old enough to remember the power of speaking with one voice. That art, crafted in large part by Alan Greenspan, has been lost when it has been needed most. The February, 1987 Louvre Accord is a prime example. The G-7 gathered to send a signal that the dollar had fallen too far and they backed it up with coordinated intervention to make the point. A similar response came after the October, 1987 crash. In today’s much larger economy, intervention packs a softer punch, but unity is essential. Market traders usually lose a lot of money betting against central banks.
The recent meeting of leaders from Germany, France, Britain and Italy to discuss the banking crisis was a perfect illustration where coordination was in short supply. They met, went their separate ways and all had a different view of the meeting and their own individual plans to move forward. This does not bode well for the European Union or the future of the single currency. This trend also does not say a great deal about enhancing the roles of the International Monetary Fund and the World Bank. One of the two institutions could serve as the global unifier, where a set of rules for 21st century trading and capital flows can be not only debated, but agreed to and most importantly enforced. This could be the new home for an expanded G-7 that includes: Brazil, Russia, India, China and a seat for the Middle East – especially with all its liquidity.
All told there is an estimated $1 trillion dollars of development projects throughout the region. Sovereign funds in the Middle East have a reported $1.5 trillion dollars under management. That is a lot of capital. While some of that money was used in the past two weeks to inject money into their local markets and banks, it could serve as a great source of funds for Wall Street and for European markets.
This major market correction, if we want to limit the description to that, is a big test for the central bankers of the Middle East. They have been working to expand their tool kit to control money supplies, battle record inflation and keep a lid on borrowing for all real estate projects which sprout up like mushrooms in the desert.
At Cityscape in Dubai, the Middle East developers showed off the latest wares with stands costing up to a reported $8 million dollars each. One new planned development outside of Dubai called Jumeria Gardens has a price tag of some $95 billion dollars spread out over a dozen years. Think about it, that is more than the $87 billion dollar bailout by the British government of their banking system.
But there is a problem in the Middle East that is similar to the challenge throughout the world – there is a lack of confidence in western banks. The sovereign funds came on strong at the end of last year with some high profile investments. After falls of 50 percent or more, they too are in no rush to jump back into this market. Until the expanded G-7 can come together, Middle East investors and sovereign funds seem content to deploy assets closer to home.
First it was Hurricane Gustav that had CNN and other television correspondents scrambling down to the Gulf of Mexico. Then, Hurricane Ike ploughed through the Caribbean, leaving 170 Cubans and Haitians dead and causing severe damage on its way to the Texas coast.
Hurricane watchers know that storms are named in alphabetical order, building drama and suspense as they gather momentum along their path. Usually when hurricanes hit they send shivers through energy markets with fears of supply disruptions and damage to refining facilities.
In that context, this hurricane season has been a bit of a yawn, not because the storms lack force, but due to another storm which hit markets well before hurricane season began. Let’s call it Hurricane Ali, named after the veteran Saudi Arabian oil minister Ali al-Naimi. He showed up on the weather radar at the end of June by increasing oil production by a half million barrels a day, using a gathering of oil producers and consumers in Jeddah to underline his point. While it took the markets nearly a month to feel his effects, Hurricane Ali was responsible in large part for a 30 percent drop in oil prices in the last two months.
Hurricane Ali was timed -- either with great calculation or great luck -- to coincide with two other forces in the market: an acute economic slowdown and sharp criticism of oil futures speculators. After seeing a peak of $147 a barrel, today setting a floor of $100 is proving difficult. Saudi counterparts within OPEC, Iran and Venezuela have argued for greater discipline within the cartel as well as adherence to a daily production quota of 28.8 million barrels a day.
OPEC’s communiqué from Vienna this week pointed to an oversupply in the market and noted that members should “strictly comply” with their production allocations. I would not bet on it, despite the group’s efforts. Calculating production and demand is not a simple equation when every day, new figures forecast falling growth.
We already know that consumers in the U.S. and Europe are driving less as a result of higher petrol prices. The airline industry, according to sector’s trade association IATA, will lose up to $5 billion due to higher fuel costs and fewer passengers in the air.
Both these trends are reflected in macro-economic figures as well. The European Commission has dialled back growth projections for this year to only 1.3 percent and is pointing to a “significant downward revision” next year. The Paris-based International Energy Agency once again lowered oil demand forecasts for this year and the next, and I doubt that will be the last of it as the global slowdown plays itself out.
Meanwhile, a report from hedge fund manager Michael Masters does its own share of finger pointing at commodity speculators for the upsurge and subsequent fall. Masters contends that $70 oil would be a more realistic level if fund managers would refrain from buying a basket of commodities through index trades. The U.S. Congress is still contemplating a whole series of measures aimed at curbing speculators.
John Lipsky, first deputy managing director of the International Monetary Fund and a respected former Wall Street economist, is projecting that global growth will recover to 4 percent next year after a dip to 3 percent in 2008. The recovery will be driven in large part by players like China and India who are still seeing expansions of 7-10 percent.
That level of recovery would play well in the Middle East, with producers still seeing their coffers overflowing from three digit oil. OPEC members this week quarrelled over the best way to defend $100. The answer may be as simple as the Goldilocks fairy tale -- with production that is not too hot, not too cold, but just right.
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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