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The real wild card – Middle East and its impact on oil

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Monday, October 24, 2011

Today all eyes are on Europe, but there is another part of the world where there are several events that have happened in 2011 and will continue to happen over the next several months that will definitely have implications globally in the medium and long term. With all headlines talking primarily about Europe the incidents in Middle-East are getting short bursts of airtime.

But, Middle-East according to me is a wild card. I can say with certainty that we will only have uncertainty in the Middle East for the foreseeable future.

There are a lot of incidents that have happened from the beginning of this rather extraordinary year starting with the vast and inspiring gathering in Tahrir Square and now a bloody end to Muammar Gaddafi. Each of these incidents in isolation will not have a global impact, but when you combine them with the fact that 60% of the global oil reserves are in the Middle-East and Africa then suddenly the scenario starts looking a bit ominous. With really no serious alternative to Oil despite years of research and billions of dollars spent on alternate energy, it is only but natural to have a secular view that Oil prices will continue to be pressured upwards. We all of course know about the demand side coming from the Emerging markets, but let us not forget the potential challenges that could erupt on the supply side.

The timeline of events in the Middle-East in 2011:

January 2011: TUNISIA: The cyberactivist group “Anonymous” announces Operation Tunisia in solidarity with the protests by striking a number of Tunisian government websites with “direct denial of service” attacks, flooding them with traffic and temporarily shutting them down. Saudi Arabia officially announces that it is hosting Ben Ali and his family for an unspecified period of time.

January 2011: EGYPT: Activists in Egypt call for an uprising in their own country, to protest against poverty, unemployment, government corruption and the rule of president Hosni Mubarak, who has been in power for three decades.

February 2011:  BAHRAIN: Anti-government “Day of Rage” in Bahrain. Bahrain police storm Pearl roundabout, the focal point of protests, on a Manama square, to clear activists camped out there. At least seven people are killed.  Bahrain declares martial law, a day after Saudi troops enter Bahrain.

Mar – till date 2011 SYRIA: In March at least 200 people march in Damascus and there are reports of at least 23 dead around the country including, for the first time, in Damascus. President Assad sacks the governor of the northern province of Hama after mass demonstration there, eventually sending in troops to restore order at the cost of scores of lives. Assad still has not fallen — and for all the expectations that he would be unable to hold out, he has held out quite well to this point.

May 2011: OSAMA BIN LADEN: In a televised address, Mr. Obama announces Bin Laden’s death after months of secret planning and operations.

Feb – Oct 2011: LIBYA: LIBYA’S National Transitional Council announced elections and the formation of an interim government and declared itself liberated after 42 years of rule by Muammar Gaddafi. It ended with his capture and death last week. It all started with the arrest of human rights activist Fethi Tarbel starts a riot in Benghazi in Feb and Anti-government militias taking control of central coastal city of Misrata after evicting forces loyal to Gaddafi. Then with NATO and U.N. Security Council combining forces it only was a matter of time for Col Gaddafi to lose control.

Feb – Apr 2011 OMAN: In Oman, Sultan Qaboos has acquiesced in protesters’ demands that he release nearly 300 dissidents arrested since the Arab Spring protests began in Oman a couple of months ago

June 2011 SAUDI ARABIA:   The kingdom is spending $130 billion to pump up salaries, build housing and finance religious organizations, among other outlays, effectively neutralizing most opposition.

June 2011 YEMEN: President Ali Abdullah Saleh wounded in a bombing on his palace in the capital Sana’a. The attack comes after widespread protests, the killing of hundreds of demonstrators and violent battles between army loyalists and defectors. Saleh evacuated for treatment in Saudi Arabia but confounds expectations by returning to Yemen, where he repeats promises to resign that few believe.

October 2011: Hamas reached a deal with Israel on Tuesday for the release 1,027 prisoners in exchange for Shalit, who was captured in 2006 and has since been held in the Gaza Strip. The Palestinian prisoners will be released in two phases.

October 2011:  Mr. Obama said Friday that the estimated 40,000 U.S. soldiers still in Iraq would return home by the end of the year, after the failure of tense and protracted negotiations with the Iraqi government to amend an existing military agreement between the two sides to allow for a contingent of combat troops in the country beyond Dec. 31.

October 2011:  U.S. agents disrupted an Iranian assassination-for-hire scheme targeting Saudi Arabia’s ambassador to the United States

There are multiple moving parts in the region and many of the unexpected events of recent weeks including the sudden peace arrangement between Hamas and Israel add to that uncertainty. But the biggest one in my opinion is the planned American troop withdrawal from oil-rich Iraq after spending close to USD 1 trillion in real money, losing 4,481 troops and having 32,195 soldiers injured with 20% of whom have serious brain or spinal injuries. Until the fall of Saddam Hussein following the U.S. invasion in 2003, Iraq was known as the “Shield of the Arabs” because it prevented Iran from expanding its influence westward. With Saddam gone, Iran will easily be able to re-emerge.

Iran is the leading conventional power in the region with more than 500,000 troops on the ground and this time around, taking very measured and careful steps.

Stratefor describes the Bahrain uprising as a test of strength for the Iranians. Shiites rose up in Bahrain against their Sunni rulers with at least some degree of Iranian support. Saudi Arabia, linked by a causeway to Bahrain, perceived this as a test of its resolve, intervening with military force to suppress the demonstrators and block the Iranians. To Iran, Bahrain was simply a probe; the Saudi response did not represent a major reversal in Iranian fortunes.

The main game for Iran is in Iraq. The Iranians will not be in control of Iraq, but they have sufficient allies, both in the government and in outside groups, that they will be able to block policies they oppose, either through the Iraqi political system or through disruption. They will not govern, but no one will be able to govern in direct opposition to them. Iraq in recent months has moved closer to Iran. Iraq, for example, has supported Iran’s right to nuclear technology and advocated U.N. membership for Palestinians. Prime Minister Maliki and his party were in exile in Iran for 10 years. Many of the Kurdish leaders, including the current president of Iraq, was in Iran. Many of them speak fluent Persian. They have long and ongoing ties. Muqtada al-Sadr, when he finds that things get difficult for him in Iraq he head backs to Iran. So all of these political officials have been nourished and sustained by Iran.

The potential rise of Iran in the Middle-East and its resulting discomfort to the US is easily demonstrated by the fact that Secretary of State Hillary Clinton warned Iran against assuming that U.S. would allow it to flex its muscles. She said that Tehran “would be badly miscalculating” if it interpreted the Iraq withdrawal as a sign of diminished American military commitment to the region. U.S. is quickly trying to make its moves by trying to persuade Europe to put tough measures on Tehran’s central bank, Iranian airlines and port companies in an effort to increase pressure on Iran.

But, as Frederick Kagan, a scholar at the conservative American Enterprise Institute who helped craft the Bush administration’s 2007 Iraq troop-surge strategy said “I don’t see how you can talk about containing Iran, when you leave Iraq to its own devices in such a way that it has no ability to protect itself. There is no upside to this decision.

President Obama used some rhetoric which was more intense than he usually does in response to the alleged assassination plot on the Saudi Arabian ambassador.

There are also reports that the United States will this week commence huge military maneuvers aimed at Iran, with a massive air fleet patrolling middle eastern skies ready to land at any time, in response to Iran’s involvement in an alleged assassination plot that experts have labeled dubious, amidst fears that US and Israeli targets could be hit by attacks.

The Arab Spring events in Middle East have been transformational, and have been led by the youth of the country who want a future, a job and above all dignity. But, how the future will shape up is not at all clear today. The uprising was really not about democracy, but all about economic development, distribution of wealth and prosperity. Will the region act more matured in its way it positions for the future and focus on co-operation and development so that the youth in the countries get a future. I guess there is a strong probability that this might be the case. But, with US leaving the region who will fill the void and ensure that the region unites?

There is a serious possibility that Iran will manage to take a dominant position in Iraq. In Iraq, Iran sees an opportunity to extend its influence westward. Syria is allied with Iran, and it in turn jointly supports Hezbollah in Lebanon. The prospect of a U.S. withdrawal from Iraq opened the door to a sphere of Iranian influence running along the southern Turkish border and along the northern border of Saudi Arabia. It will be interesting to see how the Saudi’s position themselves with Iran. They are ultimate pragmatists.

There would be a dramatic change in the balance of power in the region and it would also be something that would reshape the global balance, as the world is dependent on oil from this region and is going to cooperate with whoever has it. I am of the view that this will possibly ultimately mean that the western world will have to potentially find a middle-ground and forget the past and deal with the region on a more matured basis. Iran will possibly understand that this would be an opportunity for them to lose. They clearly have the upper hand in the region now. The ultimate solution will end up being a compromise where all sides get a fair deal, but it is unlikely that the path to that solution will be a straight line.  

To conclude, I feel that supply side issues will keep oil prices supported. In the medium term Oil price range will be higher in the USD 100 to 150 range rather than below USD 100 for a sustained period.


Written by Sayanta Basu

November 1, 2011 at 5:25 pm

Euro Region Leaders Statement on Resolving Crisis

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Thursday, October 27, 2011

The Eurozone summit that ended today was the fourteenth in 21 months and the markets feel that this time around the Euro leaders have found a solution and the global equity and credit markets are all rallying in unison.

The headlines were expected. Anything less than what was achieved would have been very disastrous.

As Angela Merkel put it “The world is watching Germany and Europe. They are looking to see if we are ready and able to assume our responsibilities during Europe’s worst crisis since the end of World War II,”  The announcement of the deal helped lift the euro, with investors reacting positively to the outlook for the region’s growth and single currency.

“The Eurozone has adopted a credible and ambitious response to the debt crisis,” a visibly tired French President Nicolas Sarkozy said at a news conference early in the morning in the Belgian capital.

Let us look at the achievements in the last 24 hours:

–           Europeans agreed to increase banks’ capital adequacy ratios — the amount of cash that banks must hold in reserve — up to 9 percent by June of 2012. The European Banking Authority said leading banks in 13 countries will need to come up with an additional €106.4 billion in so-called core Tier 1 capital by that date. The EBA said it based its evaluation on a sample of 70 banks across the continent. But how will the banks get all this money is a question?

–           Private-sector holders of Greek government debt will take a 50% write down on the value of their holdings. The official statement from IIF “The IIF agrees to work with Greece, euro-area authorities and the IMF to develop a concrete voluntary agreement on the firm basis of a nominal discount of 50% on notional Greek debt held by private investors” does not clarify how they are going to get it done.

–           The firepower of the European Financial Stability Facility will be increased by as much as five-fold or about €1 trillion. At present, the €440-billion fund has between €250 billion and €275 billion available after bailouts of Greece, Ireland and Portugal. The expanded EFSF may be used for credit enhancement for sovereign bonds or for setting up special purpose vehicles to finance operations. The question is where will the EUR 1 trillion in cash going to come from? The EFSF consists only of guarantees and is not a cash injection that can be used to buy the bonds. 

–           German parliament voted overwhelmingly to bar any further expansion of European bailout structures that might require a greater contribution by Germany even though they agreed to leverage the EFSF. The motion passed by German lawmakers states that the EFSF cannot be financed through the ECB and with a leveraged EFSF, the central bank will no longer need to buy bonds on the secondary market. So what happens if the EFSF cannot get the desired level of funding? Where is the backstop?

–           Signal from leaders that the European Central Bank will maintain bond purchases in the secondary market. This was really in contrast to what the Germans want. 

–           A commitment from Italy to do more to reduce its debt. Mr. Berlusconi has pledged to balance the country’s budget in 2013. But will Mr. Berlusconi be in power till then?

The question now is how will all these broad brush directions be actually implemented?

Will all the banks play ball? What about the credit-rating agencies. Can they interpret the position taken (now very public) the position taken by the European leaders really not voluntary?

How the decision was made: Euro-area leaders who called Dallara into a meeting at about midnight, forcing a break in their 10-hour summit, said that while the bond transaction will be voluntary, the decision resulted from an offer he couldn’t refuse. “It was the fiercely delivered wish by Merkel, Sarkozy, Juncker, that if a voluntary agreement with the banks was not possible, we wouldn’t resist one second to move toward a scenario of the total insolvency of Greece,” Luxembourg Prime Minister Jean-Claude Juncker told reporters. That “would have cost states a lot of money and would have ruined the banks.”

The next question is where will the EUR 1 trillion come from? The response at G20 meeting for a potential IMF solution was not encouraging. Opposing new funds for the IMF, finance ministers from the US, UK, Japan, Canada and Australia rejected the idea. Tim Geithner, US Treasury secretary said the Fund had “very substantial resources that are uncommitted”.  India, Russia and Brazil ruled out contributing to the Eurozone bailouts – though it has been reported that Chinese leaders were considering offering help. So now the European governments are trying to approach China as the main investor in the EUR 1 trillion funding.

What was very clear in the G20 meeting was that Europe needed to find their own solution to the crisis.

The agreement fell well short of offering a comprehensive solution to the financial problems facing Europe. What is very clear is that Europe, even though for its bold statements, have really not applied its resources to solve the route of the problems. There is little desire to take the steps necessary to save the structures of modern Europe. Europe needs about EUR 1.5 to 2 trillion of resources to ensure that it can withstand all risks and can help turn Europe around over time. And there are only two credible parties which can provide that degree of support in unison – ECB and Germany. But the Germans have very clearly stated in the Wednesday parliamentary vote that they will not provide any more support and using the ECB to buy the bonds is not an option. The only thing Europe has for sure is EUR 440 Million of guarantees, half of which has already been utilized.

So really .. Do we have a solution!!!! All that Europe has managed to achieve through great showmanship is as usual postpone, the pain hoping for some magic solution. As 2012 rolls in, the European sovereigns and banks have to roll over their debts who will buy their papers and at what price? The current statements only give the markets a hope which will keep the RISK – ON trade alive for a while till the markets realize that the solution is very far from the promise.

Stratfor summarizes the situation very well … “Despite failing to articulate the specifics of any credible financial resolution to Europe’s debt crisis, this was about as good of a political response as Europe could hope for given the circumstances. By alluding to — but not mandating — a restructuring, no crushing pressure has been put on the banks, yet. By not announcing the details of how the European Financial Stability Facility will be expanded, European leaders have denied critics for now the opportunity to proclaim failure. That Germany, the one country whose participation is required in any solution for Europe, is pursuing its own interests in such a brash manner does not bode well for Europe’s future.”

Written by Sayanta Basu

October 31, 2011 at 5:05 pm

Tight Lending Puts India’s Growth at Risk

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Earnings disappointment is a huge risk to the markets expectation from Indian companies.

Infosys may be the harbinger for not so good corporate news going forward.

Inflation, high interest rates, political challenges and one can continue the head winds that the Indian corporate will face going forward.

The crude oil prices are hovering well above the $100 mark, and with no indication of that cooling in the near term high Inflation would continue to worry the developing economies.

With the inflation numbers revised upwards from previous projection of 7% to 8% by the RBI, interest rates would continue to remain higher. In a regime of high interest rates the cost of credit for major Indian companies increases.

Also other factors such as political turmoil and other global challenges are getting tougher to grapple with.

FII Flows:

Even though flows into EM markets was positive, there is marginal outflow from India specific funds as reported by fund-tracker EPFR Global in the week ending April 13. So the picture from fund flows seems mixed.

Technical Picture:

The 5930 level on NIFTY has now become critical and today’s reversal keeps the bearishness of the market intact.

A break below 5730 will definitely open up test of the 5200 lows and potential break of that.

Only above 5950 and 6000 levels will we be comfortable that we are only in a range and not in a bear market.

Written by Sayanta Basu

April 21, 2011 at 4:38 pm

Posted in Market Watch

Tagged with , , , ,

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Written by Sayanta Basu

January 5, 2011 at 6:09 am

Posted in Bear market