Oil at US$ 300 & more...

Sep 9, 2008

In this issue:
» The problems of the Gulf
» Japan is making strides in pharma
» Saudis don't need oil
» EU's borrowed wealth
» ...and more!

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  Gulf is in a dilemma
While markets across the world are breathing a sigh of relief at the fall in crude prices, the OPEC is not necessarily gung-ho about these developments. Oil prices have fallen considerably after the high of US$ 147 a barrel reached in July and are expected to fall below the psychological US$ 100 barrel for the first time since March. Fall in consumption is one of the major factors contributing to this decline. An economic slowdown is weighing heavy on the Americans, who are cutting back on their fuel consumption and given that US is the largest consumer of oil, a slowdown in this country is certainly contributing to the meltdown in crude prices.

Oil producers are in a quandary. Some of them do not want prices to drop below US$ 100 a barrel, as it would greatly undermine their revenues. If they cut production to support the high prices, they stand the risk of being perceived as profiteers. At the same time, leaving production unchanged may trigger the decline in prices at a time when oil demand is slowing. The International Herald Tribune states, "Venezuela and Iran, the leading price hawks within the group, said they did not want oil to fall below US$ 100 a barrel, a price Iran's oil minister recently said was a minimum level. Both countries signaled that members of the OPEC needed to reduce their output to prevent prices from dropping further. Other OPEC members, like Algeria or Kuwait, fear that high-energy costs could jeopardize their exports as the global economy slows down and consumers reduce their consumption. Saudi Arabia, the world's top oil exporter, has not said what would be a fair price, although King Abdullah has said that US$ 100 was too high".

  Oil to reach US$ 300 a barrel...
...by 2015, that is! This is according to Weeden & Co's energy analyst Charles Maxwell; his main rationale for this estimate being the uniqueness of oil. He has stated, "When it begins to disappear, there really aren't any good substitutes, while there are for so many other commodities. It's that lack of substitutes that forces the pricing mechanism to balance supply and demand".

While there has been a lot of brouhaha about developing alternate sources of energy namely coal and nuclear energy, he does not perceive them as viable replacements. This is because there is a lack of technology to burn coal more cleanly and development of nuclear energy has become entangled in various political issues. Further, the discovery of new oil fields looks more likely in remote locations, the accessibility of which will entail huge costs. Besides geopolitical issues worldwide, resource nationalism will continue to stop oil-rich nations from opening up their reserves.

  Saudis don't need oil
Natural resource rich nations really have it easy. All they have to do is dig more wells or blast up a few more mountains and they are ready to live off the income generated from selling these resources for decades to come. However, one look at the history of most resource rich nations and this perception is likely to vanish in thin air. During boom times, the mind is so overcome by greed that the harsh reality of a downturn is unlikely to sink in. Inevitably, a pattern of spending binge and sharp cut backs during busts repeats itself several times.

However, if the recent years are any indication, most of the nations seemed to have learnt from their mistakes as they have gone about building what are known as the Sovereign Wealth Funds that aim to save money for the rainy day. As per the Economist, these funds at the end of 2007 were worth a mind boggling US$ 2.5 trillion and the use that they were put to differed across different nations. While countries like Norway poured money from sale of natural resources into pension funds, nations like Chile are hoping to smoothen the economic cycle by accumulating funds when a commodity boom is underway and distributing the same when prices fall. Despite these measures, it remains to be seen whether these countries are indeed able to break the curse this time around. What is of course needed is a leadership that is transparent and has the common good of the people at large in mind. Otherwise, one is likely to hear people of resource rich nations like Saudi Arabia lament, "We do not need that oil because it is doing us no good."

  Japan making strides in pharma
The Japanese pharmaceutical industry is witnessing a flurry of activity especially in the merger space. After acquisitions made by Eisai and Daiichi Sankyo, the latest entrant in the M&A club is Shionogi, a strong player in the antibiotics space, who has acquired the US based company Sciele Pharma for US$ 1.1 bn. This is the fourth big overseas deal in nine months by Japanese drug makers. Infact, already in the year so far, overseas acquisitions from Japan have totaled US$ 42 bn, which is nearly double the figure for all of 2007. Japan, in recent times, is also being afflicted by the challenges facing other developed nations, namely rise in the aged population, increasing healthcare costs and pressure on the government to reduce these costs. Given the fact that the R&D pipelines of major global innovators including the Japanese companies are drying up, many of them are looking to augment their product portfolios by either acquiring small innovators or generic companies.

In recent times, the Japanese government has been laying increased stress on reducing the healthcare burden and has started introducing some healthcare reforms, which have been pro-generic. This is a huge step for a nation, where generic penetration was very low, despite being the second largest pharma market in the world, as generics were perceived to be 'inferior'. Indian companies have also been making some progress in the Japanese pharma market. While the Ranbaxy-Daiichi combine will strengthen the former's presence in the Japanese market, players like Lupin and Cadila have also identified Japan as in important market to bolster revenues from generics.

  • Also read - The Japanese market is waiting to be tapped...

      US' 'broken' financial system
    "This bright new system, this practice in the United States, this practice in the United Kingdom and elsewhere, has broken down," says the former Federal Reserve Chairman Paul Volcker on the sorry state of developed world's financial system. He has in fact pointed out that the system, dependent upon securitisation rather than traditional bank loans, is broken and may contribute to the weakest expansion since the 1930s.

    Volcker further predicts, "Growth in the economy in this decade will be the slowest of any decade since the Great Depression, right in the middle of all this financial innovation." These are ominous words from the man who sailed the US through one of the country's worst economic times in the 1980s, when inflation touched 15% pushing Volcker to raise interest rates to as high as 20%.

    While this move from Volcker drove the US into its deepest recession since the 1930's Great Depression, it ended the stagflation crisis (something that is talked about these days as well) by limiting the growth of the money supply, abandoning the previous policy of targeting interest rates. Inflation, which peaked at 13.5% in 1981, was successfully lowered to 3.2% by 1983. Volcker's moves also brought some sanity to the US dollar that had reached the brink where it looked like a worthless currency (some say it looks the same these days as well!).

  • Also read - Wise thoughts in unwise times

    Volcker's latest comments have come after a US government report showed the country's unemployment rate rose to a five-year high as the economy lost more jobs than forecast in August.

      In the meanwhile...
    After the rally seen on the bourses yesterday in both the Asian and the European markets bolstered by the US government's decision to bailout troubled mortgage giants Freddie Mac and Fannie Mae, the Asian indices were at the receiving end today as shipping and financial stocks bore the brunt of the investors' ire. Not surprisingly, concerns with respect to the slowdown in the global economy once again took centrestage. However, European indices gained on account of lower crude prices. Commodities also faced the heat with gold, silver, copper and oil registering declines. Mirroring the trends in the global markets, the benchmark BSE-Sensex closed marginally lower today.

    As per reports on Bloomberg, China's trade surplus fell by 6.4% in August due to faltering demand in the US and Europe. The Baltic Dry Index, a measure of shipping costs for commodities, fell 3% finishing at the lowest level since June 2007 on concerns that Chinese demand for iron ore is weakening.

      What's with the rupee?
    Influenced by the rising strength of the dollar, the Indian rupee has been on a depreciating trend since the start of the year. Infact, the rupee fell to 44.88 a dollar, the lowest level in almost 21 months on speculation that oil importers were buying dollars as crude fell toward US$ 100 a barrel. Also contributing to the Indian currency's decline has been the weakness in the stockmarket, as foreign investors choose to exit from the same on concerns of a global meltdown. India's worsening current account position has also played a rose in the rupee's fall. India imports around 70% of the oil that it consumes and hence the import of oil plays a dominant role in determining the current account position. According to Bloomberg, India's average oil import costs increased to US$ 8.2 bn a month this year, from US$ $5.5 bn in 2007.

    Interestingly, as per reports in a leading business daily, exporters who were trying to sell dollars at 40/US$ have chosen to stay on the sidelines when the rupee is just a hair's breadth away from breaching the 45/US$ mark. The RBI, which actively intervenes in the forex market, has been subdued so far. Unless the fundamentals, which have led to a weakening rupee, drastically change, the RBI is unlikely to favour a stronger rupee.

      EU's borrowed wealth
    While the world is busy criticizing the US for its subprime misadventure, the European Central Bank and the Federal Reserve have unraveled a shocking truth. Europe's non-financial companies are currently burdened with Euro 5.3 trillion or US$ 7.5 trillion of debt, equal to about 57% of the Euro-zone economy. This figure is up 48% since 2001 and comparable with 46% in the US. A decade of investing more than they have earned has loaded companies in the 15-nation Euro area with debt, leaving them thinner cushions of cash to fall back on than their US and Japanese counterparts. Companies in this region are now under pressure to curtail hiring and capital spending to meet rising interest payments, as lower growth has already impacted their profitability.

    Even as the US and Japanese companies were already taking measures in terms of getting rid of idle factories and excess workers and repaying their debt since the early part of this decade, European companies, on the other hand, took advantage of easy credit to increase borrowing, allowing them to make acquisitions and bolster investment for 20 straight quarters. Companies across sectors in Europe have reportedly accelerated their borrowing in the period 2005-2007, adding Euro 1.8 trillion to their debt. However, the German companies, having burnt their fingers in the technology bubble of the 1990s, have tread off the beaten track and reduced spending in the same period, leaving them better off than their other European counterparts.

      Today's investing mantra
    "Why not invest your assets in the companies you really like? As Mae West said, "Too much of a good thing can be wonderful". - Warren Buffett

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