Oil, Opec and the Revenge of Rosneft's Sechin

Wednesday, November 24, 2014: Ali Al Naimi, the former Saudi oil minister, signals that Saudi Arabia was changing its oil production strategy from oligopolist – as the main swing producer that keeps oil prices high – to capitalist, and would go for market share. This would lead to lower crude oil prices. The Venezuelan foreign minister, Rafael Ramirez, replied that the prices at the time of about US$62 per barrel would not allow for the necessary investment in oil production capability and would lead to a massive price surge when oil demand increased in the future and that there wasn’t enough spare capacity to meet that demand.

This has been an oft quoted warning by many others over the years.

May, 2015: the Rosneft chief executive and close Putin adviser Igor Sechin states that Opec is dead. Rosneft is Russia’s main state-owned oil company. Opec being “dead” means that Mr Sechin does not believe that oil prices can be managed. Keep this in mind – the most powerful man in Russian oil said a little over a year ago that oil prices cannot be managed.

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Oil: A Tale of Obfuscation

With the recent Opec meeting we have once again been bombarded by a lot of analysis, often misguided and incorrect, both in the lead-up to the actual meeting and then after it is over. The main culprit is the phrase “cost of oil [production]”.

Let us try to understand this so we can sift through the hype and see if there are any nuggets of wisdom to be found. Our first tool is understanding the difference between average cost and marginal cost.

Let us consider as an example a company like Microsoft that develops and sells software. Whenever Microsoft develops a new version of its Windows operating system, it costs money to pay for the software developers, the buildings they work in, the computers they use and all the support staff, such as finance and HR.

Let us assume it takes US$100 million to develop the new OS. This is usually called the fixed cost or capital expenditure.

If Microsoft ends up selling 1 million copies of this software, then one might think, as a first calculation, that the average cost of the software is $100 per copy and that it should not bother selling if the price is lower.

The problem here is that the actual cost of producing a copy of the new OS for sale, which is usually delivered online, is negligible once it has been developed.

This is called the marginal, or variable, cost.

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A review of my financial analysis

One of the problems with news articles is that it is easy to write something and then not be held responsible for it as the story develops. I will try to change that with this article.

I wrote an article recently on how the consequences of Brexit were overblown and how the idea of an EU 2.0 might make sense. The idea of EU 2.0 evolving the current framework against Germany’s wishes to match today’s economic realities could be triggered by Italy.

Recent reports show that France is also jumping into the fray but on Italy’s side, basically over the issue of bank regulation. With Britain on the way out and Italy and now France unhappy with Germany’s overly conservative stance, we may see the more constructive evolution of the EU to version 2.0 rather than the complete meltdown that the current path is heading for, a national equivalent of Lord of the Flies.

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The Trump Trade

As the US president-elect Donald Trump begins assembling his team, it is becoming clearer what his proposed policies might look like. This in turn allows us to begin fleshing out an investment plan.

To begin with, the election of a president of the world’s most influential nation in politics, economics and culture always creates uncertainty. A relatively known politician who has held several political positions over a long time, such as Bill Clinton, creates the least uncertainty as one can usually extrapolate his behaviour.

A less well-known politician with a short political life, such as Barack Obama, will cause an increase in uncertainty. Relevant for us is the example of his attempted disengagement of America as global policeman, or, in political jargon, the beginning of the end of America as the indispensable nation. This was a bit of a shock in our region.

Mr Trump is a complete game changer in the sense that he does not have a political career that investors can review to glean information from, he did not outline any detailed policies instead giving his vision, and he was courting what appears to be a completely new demographic that is focused on issues the traditional two parties have ignored. These three issues create tremendous uncertainty and therefore the first conclusion is that geopolitical and economic risk premiums need to go up. If they don’t then you are not being paid properly for your risk.

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The Ministry of Silly Walks to battle Trump, the TRA and the UAE banks and free zones.

The election of Donald Trump as the next president of the US has caused a ripple or two in world political and economic markets. As I discussed about Brexit, such knee-jerk responses create opportunities.

For example, Mr Trump’s promise to ban all Muslims from America would, one might think, cause stock prices in the travel and hospitality sector to drop seeing as Muslims comprise one quarter of the world’s population. In such a case the correct response would be to short these stocks. But that is the sucker’s play because this equity trade assumes that the American travel and hospitality sector cares about its clients and provides them with some form of quality service levels. Can you see the problem here? I wonder if that is where UAE bankers go to train.

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‘Learnt hopefulness’ will keep us from success

We’re coming in for a hard landing on the economy – sadly it isn’t external events, such as the drop in the price of oil. It is our ingrained habits, learnt over the past decades and difficult to change.

Martin Seligman, a psychiatrist whom I have written about before, coined the term “learnt helplessness”. Basically, his analysis started with an experiment in which two groups of dogs where subjected to pain.

One set could stop the pain simply by moving from one area to another. The other set were subjected to pain regardless of what they did. In the end, the latter group simply gave up, lay down and did nothing.

I believe that we suffer from learnt hopefulness. Whatever happens we, unlike Mr Seligman’s subjects, have been rewarded.

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EU 2.0

Politics often plays a major role in influencing global economies and financial markets. Because of the size of its economy, the US takes the lead in political influence, and in seven days the most significant event in American politics, the election of the next president, takes place.

One of the main tenets of any American presidential campaign is the creation of jobs by improving the economy. These days the campaigns seem to resort to three economic pillars – and a xenophobic one.

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Improving statistical analysis improves decision-making

This article was originally published in The National.
This article is published in Arabic in Al Ittihad as نصائح دون طلب .

I often hear advice given by the likes of the IMF and other national economy research institutions that the UAE has too many Emiratis working in the Government, and that the Government should incentivise them to work in the private sector. Someone reading such conclusions from world-respected researchers might automatically think that this makes good sense. I, on the other hand, am automatically suspicious of foreign institutions giving unsolicited advice.

The trouble with looking at a single statistic is that it is like driving by looking only at your rear-view mirror. It is important but certainly not enough to drive safely.

The idea behind the advice to incentivise Emiratis to work in the private sector is that, first, it reduces the budget burden on the Government and, second, that private enterprise is more efficient at commercial activities than government institutions.

The first point only makes sense if the proportion of Emiratis employed by the Government is greater than the Government’s share of GDP. In our country, it is clear the Government has a much higher proportion of GDP than countries with less commodities, and which are not growing as fast. The idea of advising that there are too many Emiratis employed by the Government needs to at least be compared with the statistic of the Government’s share of GDP.

If such a statistic exists, it certainly isn’t in the IMF report.

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UAE Lagging as a Financial Center According to Indicators

I am in New York, the primary financial centre in the world, visiting asset managers. The smallest of these managers has a total of about US$500 billion under management. According to the World Bank, the total market capitalisation of domestic listed companies in the UAE was about $195bn at the end last year. The UAE has two primary stock markets, a federal level market regulator in the SCA and at least two offshore financial centres in the DIFC and ADGM, each of which is regulated independently of the other and the SCA.

Maybe looking at total numbers doesn’t make sense as different countries have different GDPs. Fortunately for us the World Bank provides market size as a percentage of GDP. For the UAE, the total market cap of domestic listed companies is 53 per cent of GDP as of the end of last year; for the US it was 140 per cent. For Singapore, a country often held up as a model for the UAE to learn from if not emulate, market cap is 219 per cent of GDP.

For Saudi Arabia, which many assume lags the UAE in fin­ancial innovation, the number is 65 per cent. What saddens me is that the world average is 99 per cent and in terms of the size of our markets relative to GDP we are roughly half the global average.

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A long-term plan for a stronger UAE economy

Eid Mubarak.

It has been difficult this year to find topics on the economy or business to be positive about. For Eid Al Adha I feel that a more optimistic article is called for. So let us look to the future and to what might be.

One happy future is having oil prices to return to US$100+ and remain there. That would have an immense positive effect on the economy. But then that isn’t looking to the future. With, among many other factors, shale oil production costs dropping and Iran increasing output capacity, this isn’t an optimistic future. It is a fantasy.

I, however, believe that we can have an optimistic future without the need for massive oil price increases. I am not saying that it is an easy path but it is a realistic one. It consists of bringing together a host of solutions and interweaving them into a single integrated plan for the economy. You will recognise individual ideas that I have discussed in detail already. Now it’s time to put these pieces together into a plan.

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