Friday, February 12, 2016

CHINA'S SLOWDOWN: the "flu" is now inevitable, which means that the world needs to be ready for "pneumonia".

Over last Summer someone said that when China sneezes the world catches a cold.
I believe that China has gone beyond sneezing and it has a "flu", which means the rest of the world is about to catch pneumonia.

While all media outlet are focusing on China as it was an isolated problem kindly note that the Chinese economic slowdown and the cover up over real economic performance is ONLY one of the several problems currently plaguing the global economy: distorted monetary policies, failed monetary experiments like the EUR, geopolitical risk in the Middle East just to name a few.

For the purpose of this writing though we will focus only on the reasons why an economic slowdown of the Chinese economy is so impactful on the global economy.

In statistical terms the picture below gives you an idea of the commodity consumption of China in 2015:

China Commodities Consumption 2015

China has been fueling an unprecedented INVESTMENT-LED infrastructure expansion that has been prompting an economic expansion across all emerging markets.
Merely as an example Australia benefited greatly from the Chinese economic expansion by exporting its iron ore and adding capacity along its way.

To understand the value of 1% of economic Chinese below are the GDP rankings based on PPP valuation.
Since 2008 China has been contributed the largest share of global growth, the IMF has been projecting that China would contribute double the global GDP growth than the USA. And China and the USA together are expected to generate as much growth output as the rest of the world put together with the third largest contributor being the European Union if taken as a WHOLE.

BUT the game is now coming to an end. Or better yet, the bluff has been called and as China tries to make a transition into a middle income country global economy is about to face significant headwind.

The official GDP numbers published by the Chinese authorities keep on being revised down, nobody believes the official numbers anymore and everybody tries to estimate the REAL value of the Chinese GDP.
Estimates on the street depending on the outlets range from -1% to +2.5%.

Indicators confirming the Chinese slowdown lie in the amounts of commodities truly absorbed by the economy. On the ground witness confirm that China is no longer absorbing the same amount of commodities as before, in many cases output production is cut.
I.e. Chinese steel is now dumped on the international markets decreasing price.
Kindly note that as recently as yesterday the oil contango widened signaling a further oversold sentiment. The contango in the front end of WTI crude forward curve widened to the highest level since 2008. This signals a significant sell-off in the physical market as demand is weak and inventory levels are high. (for a definition of "contango" kindly follow this link)

The most affected by the slowdown will be the commodity exporters that used to supply China with their raw materials:

  • Australia: China accounts for 1/3 of all Australian exports;
  • Sub Saharan countries: 1/8 of total exports goes to China; but the impact will be concentrated since five countries account for three-quarters of all of Africa’s exports to China: Angola, the Democratic Republic of the Congo, Equatorial Guinea, Republic of Congo, and South Africa.
  • Latin America: China has surpassed the US as the most important trading partner for Latin America.
Next in line to be affected are the European luxury brands that have counted on the Chinese market for a silver-lining in the face of a general slow growth global economy.
The EU is China’s largest trading party, and China is the second-largest trading partner of the EU after only the US. The Chinese slowdown is therefore reflected in the profit warnings issued by European companies such as Burberry and BMW as their sales in China slows down.

Last but not least FINANCIAL MARKETS will be dragged down by the evident slowdown.

It is likely that one of the hardest hit will be the FTSE where a large portion of the commodity stocks are listed.

As shared at the beginning of this writing the Chinese slowdown is ONLY one of the ingredients bound to push the global economy into a bear market. We have strongly believed that we needed just a trigger to call in the bluff of the equity markets and we have gone many potential triggers in place.

I am afraid the China related first trigger have just being pulled.

The financial markets will now begin a long and painful process of deleveraging that will once again point out the fragility of our global financial systems and staggering amount of non serviceable debt accumulated across all markets.

Opportunities for profits available in this environment:
  • Low risk: algorithmic based spread arbitrage on selected commodities and fx pairs across multiple exchanges;
  • Medium risk: transactional funding of agricultural based commodities.

More to it on our next post.

Tuesday, July 21, 2015

Greece: Loose-Loose agreement is now place, additional pain for all parties enduring

The never ending Greek saga is now adding a new chapter to its drama. And dramatic indeed is going to be the situation of the Greek citizen that after yet another round of bailout funds are bracing themselves for yet more of the same failed medicine: austerity measures, cuts to public services, forced privatization, etc.

7 years of austerity measures that didn't work and nobody is thinking about perhaps changing the medicine. It is fascinating to see how an irrational behavior gets perpetrated over and over in spite of the evidence just to be able to preserve special interests, banks and the needs of the powerful Germany industrial apparatus.

So let's analyze the high-level outcome to see how whatever has been agreed so far; mind much more needs to be agreed in the terms of the bailout that needs to come.
  1. the current government of Greece had to swallow an agreement that it didn't believe in. Selve preservation? perhaps... needless to say Mr. Tsipras agreed on punishing measures that are worse than the one offered before the referendum he called. Defeat? Yes. As much as this can be promoted otherwise, his strategy didn't yield any advantage. The only person coming out as a hero out of this is the ex Greek Finance Minister Yanis Varoufakis that called himself out of the deal as soon as the referendum outcome was clear.
  2. The Troika forced terms onto Greece and the general feeling across Europe is that they were forced from the powerful and intransigent Germany, an abuse of power. This is bound to increase an anti European and anti German sentiment across Mediterranean Europe that will be used by anti Euro parties to gain vote at first opportunity. 
  3. The Troika came short of offering any haircut on the debt with the exception of vague allegation of the need of considering one from the IMF. 
So... 1, 2, 3... more of the same bailout in exchange for higher taxes, less social state, rampant cuts to education and health care, privatization of state assets to the benefit of foreign corporation. Mind that this recipe has failed over and over again over the next 7 years, it is therefore ludicrous to think how the new 80B EUR added to the overall Greek debt are even going to be repaid.

In the meantime, a weaker EUR is bound to help German export just for a little bit longer. With the US heading towards a rate increase in fall it is likely to see parity between EUR and USD in a short while.

This last round of negotiation represents a lost opportunity for both parties:
  • For Greece: an opportunity to start re-gaining sovereignty in the face of difficulties. It is clear that difficulties would lie down the road in case of a GrExit but with some proper policing there could also be a light at the end of the tunnel; I am sure that in case of a GreExit there would be new partners in the BRICS very interested in gaining access to the middle of the Mediterranean;
  • For the European leaders: the opportunity to re-evaluate the problem of the Mediterranean countries with a new set of measures. An alternative to austerity will require some debt haircut but it would also give confidence again in the European dream.

As pointed out before: there is no solution to the Euro problems without considering two fundamental steps:
A.  Issuing EuroBonds that would make the debt of European members: EUROPEAN;
B.  A system of significant transfers from richer states to poorer and less competitive states; this has been going on in the USA consistently;
C. A process leading towards a stronger political integration to limit fiscal discrepancies across all countries.

It is essential to point out that the differential in the interest rates applied in each country lies flooded certain less competitive countries with cheaper money from the most competitive one. These transfers in the private sector lead to a dysfunctional situation ONLY when during the fall out of the 2008 crisis we decided to bailout the banks with public money.

Since as it seems A-B-C remain something that is so far removed from the political elites in power in Europe we believe that the whole EURO experiment has failed already and it is just going to impoverish further not only Greece but also Italy, Spain & Portugal to begin with. Eventually the losers will outweigh the "winners" in the EURO game and the experiment will come to an end.

Wednesday, July 8, 2015

The ownership of DEBT in Europe: shifting from private debt of French & German banks to public debt on the shoulder of European Union citizen, saving the banks & the death of the European dream

Debt to be dealt as a main topic all over the news outlet. Although the general rhetoric seems to be rather simplistically dealt with.

It is therefore important for me to speak up against the general statement of: Greeks don't want to repay their debt and therefore they deserve the cuts and austerity?
Mind that the same goes for Italians, Spanish, Portuguese, and let us not forget Islanders and Irish too... 
The only difference with the Islanders has been the recipe applied to solve the debt problem. But we will get to it just a bit later.

Therefore, let's get into a bit of detail to get something straight. Debt comes in many shapes and forms for now we distinguish between Private Debt and Public Debt. (for a definition follow this link)
Credit (& therefore Debt) have been the cornerstone of modern economics, the capitalist version of global development is based upon CREDIT & DEBT.
Simply acknowledge that the most developed countries run a balance deficit and most countries run a positive Debt/GDP ratio: here is a link to a site that calculates it for most countries REAL TIME:

The competitiveness of the credit rate therefore moves capital from one country to another. When in Europe countries started first to run a fixed rate with their local currencies and the EURO and later adopted the EUROs credit opportunities were created by making French & German money available at a cheaper rate in the countries of the south. That is because while the EURO was common the competitiveness of each country was different, the interest rate applied to national bonds were different and therefore Italian, Spanish and Greek bonds were more lucrative thank French & German, that is why money moved from French & German banks to Greece, and Italy, and Spain, etc. etc.

Banks, consumers and individuals in the receiving countries were therefore presented with cheaper money and therefore when presented with a choice they choose the cheaper option. The same natural behavior that takes place EVERYWHERE in the world, not any different than USA, Canada, Korea or Russia. When presented with a more convenient option for similar service people choose the less costly option. 

PRIVATE LENDERS therefore flooded Southern European countries with their money (and also their goods, but that is another story!). Higher yields were convenient to the German and French banks. Nobody complained even if the risk became higher and higher as the competitiveness of the borrowers (southern European countries) was deteriorating. 

At the bursting of the 2008 global crisis the whole game came to an end.

Private money dried up instantly, and the reckless lenders: German, French and Dutch banks for the most part had to be rescued quickly from the toxic waste that they created, and so they were rescued... BUT with public money.

It is ONLY at this point that the PUBLIC debt started to pile up very quickly on the country of Southern Europe, not before. A private debt became a PUBLIC debt issue because Greece and so the other countries started receiving bail-out money that was used to cover the toxic waste of large European Banks. In fact the money of the bailout went directly from the ECB, IMF, etc. directly into the private banks they were saving. 

The rhetoric then became: Greek (or Italians, or Spaniards) don't work hard, over borrowed, etc. 
This argument is simply not credible. The reality is far too complex to believe such an oversimplification.

Southern countries were allowed into the EURO in spite of the fact that they didn't meet the Maastricht requirements (arbitrary requirements nonetheless) because they were useful to keep the value of the EURO low, to allow more competitive countries to develop a new mercantilist strategy and be able to export their goods (and funds and services) to the near shore markets of the south and gain competitiveness abroad.

The imbalances of this strategies have now wrecked any solidarity around the European Union and killed the European dream. Barriers are rising, local nationalist movements are on the rise... sacrificed all in the names of the financial markets, banks and special interests.

I wonder if there will be time for adjusting the system or we have forever deprived the next generation of a united strong and united Europe.

Data: below is a graph (unfortunately in Italian) that shows the debt divided into Bank related Debt in blue (private debt) and State related debt (public debt), you can see the development of the debt from Dec 2009 to Sept 2014, shifting from a private debt into a mostly PUBLIC debt, at that point banks were already saved and the burden of the debt shifted onto European citizen.

Tuesday, July 7, 2015

EURO DOOM: The Greek vote, another significant step towards scrapping or rethinking the EURO as it is

The time has come to shake the fundamental construction of the EURO ZONE.

The Greek government has gambled its existence and won. The technocrats in Europe had stepped up a strong rhetoric in Greece availing themselves of some good connections in the press industry but it wasn't enough.

As we reported before back in 2011 ( the EURO project as it is has failed, and the latest is just the apex of this failure so far but we believe that more is coming, and depending on the tactics used now to handle the Greek situation an anti EURO domino effect could be in play.

Austerity measures have had an adverse effect across the entire set of the southern countries of the Euro zone: Greece, Spain, Portugal and the big elephant in the room: ITALY.
Anti EURO sentiments have been flaring in all countries together with some separatist movements.

In Spain the Podemos movement, in Italy the Lega Nord and the "Movimento 5 Stelle" (M5S) embody the anti euro sentiment growing in the south of Europe.

Austerity measures have brought unemployment, they have NOT reduced the debt/gdp ratio, have impoverished the poor and created further distance from the cast of technocrats and "main" street (Point 6 & 7 below for proof).

It has now come the time to reconsider some of the common well advertised misconception that have been used to ride the austerity measures till now and for simplicity we will use Greece as a base for our discussion, please note that the same reasoning have been applied to Spain, Portugal and Italy.

1.  Greek people retire too early!

Following is a graph visually representing the impact of pension reforms on the average effective retirement age from the labor force:


The graph shows in blue the long term (2060) pensionable age before the pension reform and in red AFTER the pension reforms enacted by the various governments. Pre-Austerity Greece (indicated with the two letters EL) had an average pensionable age set at 61.9 years for male, in line with the rest of Europe.

After the reforms Greek citizen will retire gradually later than Italians and all other Europeans, excluding Cypriots, Danish and Dutch citizen.
IF there are certain privileged segments of the populations that retire earlier (called baby-pensioners) this is true across the entire Western countries and not only for Greece.

2.  In Greece there are too many public servants: FALSE!

The following graph shows the ratio of public servants employed against the total employed population.


The data shows the ration between 1999 and 2007.
In Greece the public servants represent less than 8% of the total employed population. In Germany it is 8%! Greece is right on par with the rest of Europe, bar right from Greece marked as EZ.
In France as a term of comparison public servants almost represent 10% of the total employed population.
As a very important note: with austerity measures no European country has decreased the number of public servants as much as Greece has done to-date. In 2009 public servants were 907,351 and in 2014 they were 651,717. That is 255,634 units less for a total of 25% less! Greece post austerity would find itself at the very right of the graph above.

3.  Public spending is too high: FALSE


In the graph you can appreciate the average public spending value against the total GDP between 1999 and 207. Italy has been put in red as a point of reference. Greece is below the Eurozone average (EZ12 - EU27) and it is distant from the 50% of public spending against total GDP surpassed by France for example. This value has gone from 47% in the year 2000 to 43% in the year 2006.

4.  Greece hasn't implemented any structural reforms: FALSE
Cuts in the public sector and in the pension systems have been rather dramatic. Collective negotiations via trade unions have been overall eliminated all together, although the Tsipras government would like to reinstate them. Furthermore, Greece was in 2010 at the 109th place in the standings of the countries most convenient to open a new company and do business. In 2015 in the same standings Greece is now at the 61th place and has climbed tenths of positions getting close to Italy and all other "advanced" economies. Assuming that a flexible workforce is one of the most sought after criteria for development as per the "ease of doing business" criteria, Greece has made significant relative improvements, most than any other European "partners".


5.  Greek people work little: FALSE


Please don't confuse work time with productivity. It is clear that in spite of the longer hours the productivity of the hours is not at the same level let's say with Germany given the different type of infrastructure and industrial development between the two countries.

6.  Greece's crisis is determined by the high public debt: FALSE
The graph below shows the relationship between Public and Private debt leading to the 2008 world crisis.


Greece public debt remains constant during the entire period at around 115%, lower than the Italian one for example. It is the private debt that starts to run away after the fixed exchange rate is introduced and then the country adopts the EURO.
That is because Greece all of a sudden becomes the target of foreign creditors (mostly French and German) because the interest rates with the EURO become lower and Greece can't devalue its currency to bring the trade balance back to zero. Since export weren't enough, Greece finds itself financing its import with credits to the State and to foreign private institutions. At the unfolding of the world crisis of 2008 foreign credits suddenly stop and Greece is forced to austerity to pay its debt.
THEREFORE: it is a crisis of the PRIVATE debt favored by the EURO set up that strangles Greece and not a crisis generated by the PUBLIC debt as hailed by most.
IF later there is an explosion of the public debt/GDP ratio that now has reached approximately 180% from 125% in 2010 it is because AUSTERITY measures greatly increased unemployment from 7% to 25% and they have greatly reduced tax and vat revenues together with the GDP (-25%).

7.  Greece deserves austerity because doesn't pay back its debits: FALSE
As per the previous point the main debit comes from foreign banks, mostly French and German. These banks have inundated families, companies and Greek banks with money from the establishing of the fixed rate between Dracma and Euro, and even more at full establishment of the EURO till 2007. It is more convenient for Greece (companies, individuals and banks) to borrow from abroad since Greece cannot devalue its currency (and together with it its debts) and interest rates start becoming lower and lower because of the EURO. With the Lehman Brothers crisis of 2008, French and German banks stop any lending and start pretending their debts to paid off. Austerity and European loans to save "Greece" are used to save the credits of French and German banks, not to help the Greek people to stand back on their feet.

The loans of the ESM (European Stability Mechanism) end up for 90% of their value in French and German banks to save them. In parallel the debts of all countries that have participated to the "saving" of a country go UP (In Italy it accounts for 40B EUR) and the Greek public debt reaches 240B EUR of ESM loans. But the debt could be considered not legitimate as it is bore by European and Greek citizen to save private banks that to exploit the EUR lent money without paying attention to the fundamentals of the economies financed.


From 2010 the exposure of French, Dutch and German banks to the Greek debt diminish greatly. The banks have been saved! Now Greece could exit the EURO but the Troika is afraid of the domino effect for the other countries with similar problems and bigger economies, see Spain and Italy.

8. Greece has cheated the numbers to enter the EURO: true, but...
With the help of Goldman Sachs and the supervision of the EU, with governments favored by the European technocrats: Neo Demokratia and Pasok. That is because Greece in the EURO was useful to Northern Europe, especially Germany to keep the value of the EURO low against the Mark. All analysts were aware of the accounting tricks of Greek/Goldman Sachs.
A similar set up has been used for Italy which didn't respect the debt/gdp ratio of the Maastricht Treaty (60%) but that has been welcomed in the EURO zone nonetheless. In fact Italy outside of the EURO zone with its currency and the ability to have its monetary policy would have proven a formidable adversary to the mercantilist policy of Germany.
Please note that even Germany and France didn't keep the 3% deficit/gdp ratio during the first years of 2000 but they have never been sanctioned for it.

Data collected:

Monday, December 15, 2014

Addendum: oil prices, short term - variables at play

This is an addition to the previous post in which we have analysed oil prices based upon fundamentals estimates based on supply & demand. As anticipated in the same post we have warned against large changes in prices due to other variables such as geopolitics.
Since our last post the price of OIL has continued its down spiral and as of today we are sitting at a 5 ½ years low.

We would therefore like to shed some light on the current variables at play and also advise on the non sustainability of such pricing in the long run. These are exceptional times and they should be treated as such.

Variables currently pushing the OIL price down:

  • Policy of containment towards Iran, Syria, Islamic State and Russia adopted by OPEC Gulf States;
  • OPEC members interest in slashing fracking projects profits and delay or contain their production;
  • Weaker than expected Chinese economic performance although we believe that the current statistics with regards to economic performance are not justifying the current price drop;
  • Weaker demand demand than expected from the US side. 
In spite of the large reserves of some OPEC suppliers trapped into their Sovereign Funds, many of these countries have set up their countries expenditures and development against a higher price per barrel. Please be reminded that these countries are tax free regimes and their economic performance and development plans are affected directly by the price of OIL.
Further, a low OIL price and a strong dollar combination is going to hurt significantly all development projects in the Oil & Gas industry that are financed in USD, something clearly undesirable for many powerful US lobbies.
Lastly, while the mainstream media in the USA are hailing the low OIL price as a welcome stimulus to the economy this will not turn into reality. The US is facing a lethargic demand that is not supporting the recovery picture portrayed on the media. Please note that statistically any time that there was an energy tax cut in the US there has been no subsequent sign of positive stimulus afterwards.

ABOOK Dec 2014 Oil Prices Retail Sales

Because of the above listed reasons we believe that the current significant price drop is temporary and far exceed the drop potentially justified by a weak US and partial restatement of Chinese growth.

We would only expect OIL at current price for a protracted period of time in the face of a recession 2009 which could be fought once again by the Feds with a new and improved set of QE cycle.

Wednesday, November 26, 2014

Oil prices - short term considerations & long term perspective

As recent oil news make headlines we have decided to take a closer look at the OIL price and provide a perspective in considerations of few significant industry and geopolitical trends.

Fossil oil is and will play a significant role in satisfying global energy demand. The medium to long-term trend is determined by multiple factors such as among others: the status of the global economy, geopolitical events, technological advances as well as consumer choices. The two main variables impacting supply and demand have been on the one hand a significant increase in the energy demands of developing countries, and on the other hand the emerging of a wider variety of energy supply typologies (i.e. oil sands, fracking technology) altering the traditional energy supply routes and therefore also geopolitical choices.


In 2013 crude oil global consumption grew around 1.3 million b/d (+1.4%), with an average of 90.4 million for year. The Energy Information Administration forecasts an increase of 1.1 million b/d in 2014 and 1.4 million b/d in 2015.
In the medium-term period (2012-2018) Reference Case Demand could increase by an annual average of 0.9 mb/d, reaching 94.4 million b/d in 2018. Europe, Asia and Russian demands are rising very slowly, as illustrated in Table 1 while developing countries demand rise faster, with an increase of 1.1 mb/d every year.
The outlook for the second half of 2014 shows that the oil demand of non OECD countries will be higher compared to the OECD countries.

Table 1 Medium-term oil demand outlook in the Reference Case[1]
Source: World Oil Outlook 2013

In the long-term period (2012-2035) Reference Case Demand could reach an increment of 20 mb/d each year, this value could rise up to 180,5 mb/d in 2035. The biggest share of this forecasted increase should come from developing countries.

Table 2 World oil demand outlook in the Reference Case

Source: World Oil Outlook 2013

Oil and other liquid combustibles global supply is estimated to grow 1.5 mb/d in 2014 and will decrease to 0.9 mb/d in 2015. Nevertheless, Non-Opec countries supply presents an estimated upward trend, with forecasts assessed at around 1.8 mb/d in 2014 and 1.1 mb/d in 2015.

Figure 1 Change in non-OPEC supply, 2012–2018
Source: World Oil Outlook 2013

In the medium-term 2012-2018, as illustrated in Figure 1, total non-Opec supply is expected to constantly rise by 5.7 mb/d. The two main variables impacting these estimates are the supply of “tight oil” and “oil sands”.
These could create additional supply, in particular in Latin America (Brazil and Colombia), in Middle East and Africa, even if in those countries supply may be negatively affected by political instability.

EIA’s data show that crude oil Opec production had an average of 29.9 mb/d in 2013, with a decrease of 1 million with the respect to the year before, due to the oil production outage in Libya, Nigeria and Iraq. This decrease is partially mitigated by a strong growth in non-OPEC country supply.
The EIA outlook indicates that Opec production should decrease of 0.3 mb/d in 2014 and by other 0.2 mb/d in 2015.

In fact, 8 of 12 Opec members, present a negative production in 2013, such as Libya. The other 4 countries try to maintain a stable production, furthermore, Iraq increase its production from 1.75 mb/d to 3.25 mb/d starting from 2005 to 2013. OPEC conservative production allowed to preserve oil price around 100-110 dollars per barrel during the last few years.

The graphic below, reported by Kent Moors, Phd, in Money Morning, shows that demand will continue to grow until 2025, while supply instead is expected to decline. Based upon these estimates it is possible to experience  a shortfall between demand and supply.

Figure 2 World oil demand and supply

Source: Money Morning 2014


Lately crude oil forecasts depend heavily on the oil exporters geopolitical uncertainty. The reduced risk to Iraqi oil exports and the news regarding increasing Libyan oil exports contributed to a drop in the Brent crude oil spot price to an average of $107 per barrel in July2014, $5/bbl lower than the June average, as reported in EIA outlook of August 2014.

The Saudi active intervention in price setting over the past few weeks, coupled with further signs of a weakening of the Chinese economy have both contributed to driving the price to a 4 years low ($80 USD/bbl). Some add that there may be geopolitical interests at play to further weaken Russia by virtue of keeping the price of oil particularly low. Regardless of the geo-political reasons behind this short term oil price low, it is reasonable to expect a medium term increase to a more reasonable price level, especially if the US economy confirms its acceleration as indicated by the latest indicators released by the Federal Reserve.

Based upon recent events oil price forecasts are highly uncertain, and the current values of futures and options contracts suggest that prices could differ significantly from the forecasted levels. Implied volatility averaged 16 %, establishing the lower and upper limits of the 95% confidence interval for the market's expectations of monthly average WTI prices in November 2014 at $84/bbl and $111/bbl, respectively. Last year at this time, WTI for November 2013 delivery averaged $103/bbl and implied volatility averaged 21%. The corresponding lower and upper limits of the 95%confidence interval were $85/bbl and $125/bbl.

Figure 3 Uncertain oil prices are expected to fall
Source: IMF 2014

According to World Oil Outlook (2013), the nominal OPEC Reference Basket price[2] will be remain on an average of $110/bbl until 2020, and then it will increase in both real and nominal terms.
In nominal terms, we suppose that the nominal price will reach $160/bbl within 2035, whereas in real terms it will reach $100/bbl. It represents a slight shift upward than WOO 2012 expected.

Table 3 OPEC Reference Basket price assumptions in the Reference Case
Source: World Oil Outlook 2013


Eventually, oil price is set to rise, influenced by fear and uncertainty from Middle Eastern and North African countries. The new geopolitical instability of the late 2014, continued nowadays in Iraq and in all Middle East, causes oil production shortages that could take oil price back up to $110-120/bbl.
We judge the existing low price as temporary and due to the following conjunction of few geopolitical and economic events: a slow down in Chinese manufacturing output, Saudi oil discounting IS heavily discounted although limited supply. We acknowledge the above as short-term temporary factors.
Although we expect oil prices to rise in the long-term (2014-2035) we forecast that any sustained price above $150 USD maintained for a long period of time is going to accelerate the oil for gas substitution trend. We therefore believe that the probability of high OIL prices for a sustained period of time is be quite low.
Oil price is closely connected to the futures market, that forecasts an increase oil price and it is minor influenced by the production.
As political instability grows in key oil producing areas and extraction technology progresses, oil companies have more incentives to explore and extract oil in international waters away from conflict areas. Thanks to new technologies these new offshore areas are now within reach.


EIA, Short-Term Energy Outlook August 2014, Energy Information Administration, U.S. Department of Energy: Washington, DC.
Kent Moors, Money Morning, August 2014
IMF (2014), Regional Economic Outlook. Update: Middle East and Central Asia Department, International Monetary Fund: Washington, DC.           
OPEC (2013), World Oil Outlook, Organization of the Petroleum Exporting Countries, Publications: Vienna.

Authors: Marta Pezzoni & Luca Gorlero

[1]The Reference Case scenario in the World Oil Outlook 2013 indicates that demand for energy is expected to increase by 52% over the projection period 2010–2035. As for oil, its demand increases by around 20 million barrels a day (mb/d) in the years to 2035, representing the first upward revision in oil demand growth since the WOO was first published.
[2]Introduced on 16 June 2005 from World Oil Outlook, is currently made up of the following: Saharan Blend (Algeria), Girassol (Angola), Oriente (Ecuador), Iran Heavy (Islamic Republic of Iran), Basra Light (Iraq), Kuwait Export (Kuwait), Es Sider (Libya), Bonny Light (Nigeria), Qatar Marine (Qatar), Arab Light (Saudi Arabia), Murban (UAE) and Merey (Venezuela).

Tuesday, June 3, 2014

Caution must be the word of the day

Recent events in Ukraine as well as the long term unresolved situation in Syria have been adding to a complex geopolitical environment that seems to set us back to Cold War times during which the "Western coalition" challenged the influence of the Soviet Union, nowadays Russia. Old memories but truly a completely new scenario thanks to the very assertive political role played by China in the far east.

Further, such events come at the back of a very unusual economic environment whereby we are witnessing the effects of unorthodox (!!!) fiscal policy making: Japan’s monetary policy, Fed’s claimed unwinding of their fiscal stimulus, the Euro ever present crisis and a US bullish stock market that seems to no longer relate to the REAL economy.

Therefore, regardless of our own personal opinions we ought to analyse these events and reconcile their potential effects with the economic decisions that we make today or that we plan to make tomorrow.

CAUTION is the word that comes to my mind when I reconcile geopolitical events in progress with economic indicators coming out of several G7 economies. And therefore CAUTION applies to smaller size economies like the UAE or the GULF that are much dependent on both commodities prices and transit of goods. The recent over-supscription of the Dubai IPO of Marka is a sign that ought to be evaluated carefully.

I would like to therefore motivate my CAUTION advice by pointing out some key facts from around the globe as it is often difficult to cut through the clout of main stream media and the hype generated by the new Dow Jones records. 

Following are therefore some of the sobering or better yet warning signs I collected and that I would like to share:

  • Japan: Abenomics shock economic therapy is generating concerning effects: the plunging yen has crushed the Japenese purchasing power in spite of the growth in the stock market may have given the illusion for someone to get richer. The recent 15% correction may make the illusion disappear, especially if the USD/JPY breaks below 102. At the end all that will be left for the Japanese people is a soaring energy bill and ever increasing food prices. Japanese wages have been falling for 22 straight months with a fall of 0.4% in March only. In the latest news, sony slashes profit outlook by 70% thanks to Abenomics.
  • China: the official Chinese PMI index misses expectations. As a correlated ripple effect: Australian PMI (greatly correlated to China) declined by more than 3 percentage points to its lowest point in nine months (6 consequent months of contraction);
  • USD: while the Dow Jones seems to continue its rally some of the fundamentals of the US economy don’t seem very rosy, signalling once again a strong decoupling between the stock market and the “real” economy. The below data doesn’t give us much confidence in US consumer spending and overall US demand.
    • Consumer spending for durable goods in the USA has dropped 3.23% since last November 2013. 
    • 20% of US families don’t have at least a family member employed;
    • While the US population has kept growing since 2007 there are approximately 1.3 million jobs less (
    • During the “recovery” period 2010-14 employment gains have taken place only in low-wage industries while during the recession employment losses took place mostly in high to mid wage industries (
      • Lower-wage industries constituted 22 percent of recession losses, but 44 percent of recovery growth.
      • Mid-wage industries constituted 37 percent of recession losses, but only 26 percent of recovery growth.
      • Higher-wage industries constituted 41 percent of recession losses, and 30 percent of recovery growth.

    • 90% of the jobs in the USA pay an average of less than 35,000 USD per year (
    • Ukraine: the instability is bound to generate a more rigid contraposition between Russia on one side and the USD & Europe on the other. While sanctions so far have been more formal than substantial the rhetoric is increasing on both sides and there may be instability pass onto the economic system increasing its volatility and impacting energy prices.
    • EU parliamentary elections: while the EU periphery keeps on evidencing clear signs of weakness (Italy, Greece, Spain, Portugal) new elections are looming. Word from the street is that parties against the EURO are gaining significant strength and are bound to acquire a sizeable stake in the new European parliament. If that turns into reality there may be some hard questions put on the plate of the European Union leadership and whether fundamental union regulations are to be readdressed.

Therefore, CAUTION must be the word of the day. In the post 2008 world we have accepted as systemic a much higher volatility index which makes it a bit more difficult to evaluate wider base economic and stock market swings. We just need to analyse the speeches of the heads of the Central Banks to realise that they are leaving for themselves wide arrays of options sometimes at odds with each other. Economic indicators are more difficult to read. In such an environment positions should be short, optimism measured and cash an invaluable asset to give investors the ability to ride with profits both the “bull" and perhaps the “bear" coming our way.