|»5 Minute Wrap Up by Equitymaster|
On This Day - 9 SEPTEMBER 2008
Oil at US$ 300 & more...
In this issue:
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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".
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.
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."
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.
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!).
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.
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.
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.
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.
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