Saudi Aramco Oil Facility

Some may have seen recent news reports of Saudi Arabia targeting $100 oil. TradeFlow21 has tweeted (Jan 18th: “Saudi Arabia is not targeting $100 oil.“) a very helpful article on just the subject. Complementing the article, TF21 adds that triple-digit oil prices are not exactly in the Saudi’s or any oil exporting country’s best interest. Reason being is that often times when oil prices are high, they are accompanied by higher prices almost across the board. In volatile times like now, at home in the U.S. and in countries around the world, wages paid to employees that have not kept up with inflation are partially to blame for discontent. Thus, $100-plus oil is not helpful to Saudi Arabia if it in turn must pay higher prices for materials (and services) for the tens and hundreds of billions of dollars of real investments it’s making.

This paper examines the cyclicality of fiscal behavior in 28 developing oil-producing countries (OPCs) during 1990-2009. After testing five fiscal measures – government expenditure, consumption, investment, non-oil revenue, and non-oil primary balance – and correcting for reverse causality between non-oil output and fiscal variables, the results suggest that all of the five fiscal variables are strongly procyclical in the full sample. Also, the results are not uniform across income groups: expenditure is procyclical in the low and middle-income countries, while it is countercyclical in the high-income countries. Fiscal policy tends to be affected by the external financing constraints in the middle- and high-income groups. However, the quality of institutions and political structure appear to be more significant for the low-income group.

Among the conclusions:

The results confirm that political and institutional factors, as well as financing constraints, play a role in the cyclicality of fiscal policies in the OPCs. Most of the variables on the quality of institutions and the political structure appear to be significant for the low- income group. Two of the variables are significant for the middle-income countries: the composite institution index and checks and balances. None of the institutional variables turns out to be significant for the high-income countries.21 Domestic financing constraints seem to matter for the low-income group. But fiscal policy is affected more by the external financing constraint in the middle- and high-income groups, as they may be more integrated into the global financial system than the low-income countries.

Despite their many differences, all the OPCs face volatile and unpredictable oil revenues, a situation that makes fiscal management challenging. For this reason, it is imperative for them to formulate effective countercyclical fiscal policies by which they can smooth government expenditure, decouple it from the volatile oil revenues, and prevent boom-and-bust cycles. Breaking away from a procyclical fiscal policy will enable them to sustain long-term growth and keep the safety net that the poor need. Sound fiscal policies and discipline require strong institutions, a higher-level bureaucracy, and more transparency. Strong institutions and transparency would also help reduce the ―voracity effect,‖ which, in turn, would facilitate the accumulation of financial assets and build up confidence among investors to raise funds when needed.

More data here.

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We present evidence on one facet of energy security in OECD economies – the extent of diversification in sources of oil and natural gas supplies. Viewed from the perspective of the energy-importing countries as a whole, there has not been much change in diversification in oil supplies over the last decade, but diversification in sources of natural gas supplies has increased steadily. We document the cross-country heterogeneity in the extent of diversification. We also show how the extent of diversification changes if account is taken of the political risk attached to suppliers; the size of the importing country; and transportation risk.

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The expected announcement of Iraq’s new government marks the culmination of a remarkable process. The former bully-boy of the Arab neighborhood has become its only functional democracy. What may be the world’s richest resource economy, once the closed shop of a murderous clique, is today wide open for business.

Driven by what many geologists consider the world’s largest oil reserves, Iraq will probably be the world’s biggest crude oil producer within a decade. The country currently ranks second to Saudi Arabia in official reserves, with 143 billion barrels. With much of Iraq’s exploration still to come after a three-decade hiatus, and with Saudi Arabia’s reserves substantially inflated and already in decline, Iraq could take the mantle as No. 1 in fairly short order.

Iraq last year signed 12 oil contracts that promise to take output from under two million barrels per day currently—less than Algeria—to over 12 million by 2016. This timeline is probably optimistic, but the contracts will likely see Iraq surpass Saudi Arabia’s 10 million to 11 million barrels per day within a decade. And these figures include no contributions from Iraqi Kurdistan, from natural gas reserves, or from new oil fields, with which the lightly-explored country is replete.

The Saudi comparison suggests that as Iraq’s oil production rises, its economy could grow approximately six-fold over the coming decade—gross domestic product is currently $66 billion—and add a mind-boggling $300 billion in annual GDP. This means one of the largest economic reconstruction and development booms in history.

The entire Iraqi economy is being rebuilt. The government’s electricity program has a $50 billion price tag. Baghdad has awarded the reconstruction of Sadr City to six Turkish companies at a cost of $11 billion. Nationwide, thousands of police stations, schools and clinics will be built. Airports, bridges, dams, railways and roads are being planned. The $20 billion Al Faw port project will create the leading port in the Persian Gulf. A modern army, air force and navy will be trained and armed. The investment programs of last year’s 12 oil deals alone add up to well more than $200 billion.

The holy cities of Najaf and Karbala currently receive more annual visitors than Mecca but have almost no hotel space or modern residential facilities. Iraq’s real-estate sector generally is warming up, with Abu Dhabi companies alone committing over $65 billion in the last year. New refineries, cement plants and steel mills are being financed across the country.

Iraq’s greatest resource is its famously resourceful, tough, educated and enterprising people. Whereas the capitals of the Gulf oil monarchies did not have paved streets a generation or two ago, Baghdad and Basra are ancient capitals of commerce, ideas and global finance.

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The Daily Star of Beirut, reports today that “the improvement in oil prices and projections that they could increase further would largely benefit Gulf crude producers, however, they carry risks of return of high inflation to the region,” according to National Commercial Bank (NCB). What’s highly interesting here is that the Gulf producers obviously want to earn as much per barrel as possible, however, after a certain (sustained) level, say $100/bbl, problems arise due to the weaker dollar (remember oil is priced in dollars), since most of the Gulf Cooperation Council members peg their currencies to the dollar, and thus they will face the challenge of rising domestic inflation from the massive dollar inflows subjected to higher import prices.  Therefore, the producers must somehow achieve a desirable level, say between $80 and $85/bbl (remember their respective national budgets are based on levels as low as $40/bbl), and thus, with an already weak dollar and an abundance of global economic uncertainty, they will utilize their excess production capacity to cap the upside in hopes of maintaining the said lucrative price range.

TradeFlow21 is not keen on collusion, but it turns out that should the dollar’s value erode further due to a rightfully perceived multi-front deficit death spiral in the face of quantitative easing, and if crude continues to climb over the wall of economic worry turbocharged by the same quantitative easing, then a little cooperation among the GCC is good thing if it keeps a lid on oil prices. It’s a win-win, for now and near-term, since oil at where it trades now means hard cash for the producers (with some purchasing power to boot), and in the U.S. it means averting a repeat of the oil price spike of 2008. Such circumstances suggest the possibility of a real recovery, as the GCC is able to continue to both make oil-related investments and diversify their respective economies and financial investments; and the U.S. can keep the price of a key input under some sort of control.

So oil at $80 is not necessarily a bad thing, since it could be much higher, or on the flip side, it could even flirt with $30 again, in either case effectively reintroducing “it’s the end of global trade” scares again.

The message from oil analysts and capital market participants is mixed. On one side, the picture is bleak, as unemployment and economic contraction loom, while so-called oil “fundamentals” are weak (weak demand and strong supply). These all suggest that the oil rally may have run its course for the time being. However, the bullish camp points to the now rhetorical “green shoots of recovery” theory, reports of stockpiling by China, short (seller) covering in futures markets,  and higher risk appetite among investors and traders — with all the aforementioned accompanied by a weakening dollar, which has an inverse relationship with oil and many other commodities.

Therefore, it truly is a mixed bag. For consumers and domestic U.S. manufacturers, an economic recovery at home and more broadly around the world has huge implications, but higher oil nibbles away at the purse and at margins, respectively. At the same time, as a weak dollar typically suggests a more favorable climate for U.S. exports, there is pressure on the input (or materials) side from rising commodities. Nevertheless, at current price levels, higher growth for higher oil is a bargain! For oil producers, higher oil is almost always welcome, although refining operations can cap the upside. Also, higher oil means more likelihood for investment and exploration, which eventually may lead to more revenues, and supply, but ultimately, perhaps somewhat of a damper on prices.

That being said, TradeFlow21 remains enthusiastic about the sustained growth prospects in the Middle East. In some cases, oil now accounts for a lower portion of GDP than in years past as Gulf economies seek economic diversification, but in terms of a source of foreign reserves, oil overwhelmingly remains the source of liquidity. In our opinion, the higher oil prices of late are not necessarily worrisome from the U.S. viewpoint. Reason being is that OPEC, and the Gulf producers in general, are sensitive. A recent guest on Bloomberg Radio made the point that the Gulf producers don’t want to be blamed for a prolonged global recession, and therefore, are willing to sacrifice near-term profits and even some budgetary shortfalls. Oil producing companies have a relatively low break-even price, perhaps as low as $30 or less, but oil producing nations that went on a spending spree in recent years tend to have budgets based on break-even oil in the $40-$60 range, with outliers such as Abu Dhabi in the low $30s and Bahrain in the $70s (Fitch Ratings). No doubt sovereign budgets have been, and will be further adjusted, but in order to sustain growth, significant amounts of money will continue to be spent within the region. For Connecticut manufacturers and exporters, the Gulf represents real opportunity (from everyday consumer products to building materials and beyond), and TradeFlow21 is here to help make the region more accessible to you.