Myths and Mistakes of the Iraq crisis

Global Economy, On the cover, Sin categoría, , , ,

This article was published in El Confidencial on 22/6/2014

“There is no military solution for Iraq” Barack Obama

“Rarely has a U.S. president been so wrong about so much at the expense of so many” Dick Cheney

Getting it wrong is dangerous. Worsening things is lethal. In the case of Iraq , the United States, after spending a billion dollars to remove the regime of Saddam Hussein, has left a global security problem which may be greater than imagined when Obama decided to withdraw the troops . It’s not just about oil. Anyone who lived the Baghdad of Saddam Hussein understood that the regime was a global danger. Similarly, it is essential to understand that the threat was not only Saddam, but the many factions that existed well before the Baath dictatorship, which remained in conflict during the regime and still do so today. Leaving Iraq can become a decision that Obama will regret for a long time.

Why did the U.S. leave Iraq? 

For love and peace? No. Because in 2016 the US will be energy independent -including Canada. The need to defend its interests in the area is today infinitely smaller.

America is already independent in gas and produces 11.3 million barrels a day of oil thanks to the fracking revolution, becoming the largest producer over Saudi Arabia and surpassing the country’s own 1970’s peak.

However, removing the troops leaving behind a timebomb of sunni and shiite factions could end up turning against the United States and the OECD, as it generates an enormous risk of multiple terrorist threats. Energy is not the problem. It is a cultural problem. It is naive to say the least to think that everything will go smoothly leaving Iraq on its own when the country is decimated by clashes of tribes with invasive ambitions. it is the same mistake we have seen in Libya or Egypt after removing a dictatorship regime. The Pandora box of multiple threats opens. I recommend you read ” The Clash of Civilizations “ by Samuel Huntington and “The Lesser Evil”  by Michael Ignatieff. In the West we do not want to understand the culture and customs of these countries, which are very far away from our idea of democracy. Accepting the lesser evil of maintaining a military presence is much more logical than closing our eyes in the hope that the world will move according to our wishes.

Does the Iraq crisis affect its oil exports?

The OECD placed too much trust on the unstable government of al-Maliki. US troops were disappearing and the industry seemed to be recovering. It looked as if everything was on track, but the risk had not gone away, in fact it had increased with the wrong strategic decision to pull U.S. troops from the country without a security contingent.

This week the Iraqi risk rose dramatically after terrorist attacks in the northern part from ISIS (Islamic State Of Iraq and Syria), a jihadist group that even has an annual report of its sinister achievements. See it here (http://azelin.files.wordpress.com/2014/04/al-binc481-magazine-1.pdf ) courtesy of the Financial Times .

When I traveled to Iraq people used to say: “Baghdad is a city covered in gold, but in the south is where the real gold is” (oil).

This map, courtesy of IHS Energy ( press@ihs.com ), shows the location of the main fields and refineries.

Terrorists have taken Mosul, the second largest city in Iraq, Tikrit, Tal Afar, and Dhiluiya Yathrib. However, they have not taken any of the large fields north of the country, especially the giant Kirkuk oil field in the Kurdistan region. the people I knew in the area called this field “the passport of Kurdish independence”. Today it produces 260,000 barrels a day. ISIS terrorists have no ability or desire to attack the Kurdish region.

Most of Iraq’s production, 80%, is exported and more than 77% comes from fields in the South, where terrorist ISIS militants cannot be measured with local forces and private security contingents. There has been no impact as of today in exports, which are made mostly through tankers from the South.

Is it a crisis to regain control of oil from the hands of the multinationals?

Contrary to what has been said in some press, oil in Iraq does not belong to international companies, much less American . All is state-owned fields where international, American, Russian, Italian, Chinese or British companies work with contracts for service , and they are paid to maintain or increase production. That is, the State benefits from international companies’ experience in improving productivity, and therefore has no interest in seeing these companies leaving. This type of productivity contract is what has led to Iraq recovering its pre-war peak production so quickly.

Is it all the fault of Obama or Bush?

The fights and attacks between Sunnis and Shiites are not new. It’s a conflict that has been ongoing for hundreds of years. In the era of Saddam Hussein it was already a challenge to organize security to travel from Baghdad to the border with Kurdistan. In fact, access was banned even for many potential contractors due to constant attacks.

George W. Bush made a mistake thinking that the US would be received as heroes after the invasion, as Wolfowitz expected. The moment that the regime’s repression ceased, the various factions began fighting bitterly. A weak government only reduced the perceived risk. The same mistake has been committed by the OECD in Libya and Egypt.

The Obama administration made a huge mistake by reducing up to three times the number of contingency troops that would support the weak government of al-Maliki. By reducing the promised figure of 50,000 soldiers to 25,000 and then to 3,000, aid became irrelevant, and therefore rejected by the local government.

The lack of involvement of NATO countries in the Middle East problem is part of the disaster. Not only Libya and Egypt have spiralled out of control, but Al-Assad in Syria is now more powerful than ever due to the inaction of the OECD, and Syria has become the launchpad of a strengthened ISIS in North Iraq. Thus, the risk that the area controlled by ISIS becomes a huge camp of international terrorists is not small.

Proposals to divide Iraq into three (Kurdistan, a Sunni North and a Shiite South) would increase the risk of allowing to build a huge training center for global jihadists.

Is the crisis due to peak oil?

Sunnis and Shiites have been fighting for hundreds of years. The problem is not oil … Because in the oil market there is no great risk.

On 11 June, OPEC met in Vienna. Independent analysis (BP Statistical Review) confirmed that there is plenty of oil for decades. Global proven oil reserves have increased to 1,687.9 billion barrels in 2013, sufficient to meet 53.3 years of global production.

Messages from the major oil exporters focused on some aspects that I think are extremely important when assessing the geopolitical risk and not overdo it:

  • The market is adequately supplied and OECD inventories in terms of demand cover are at “comfortable” levels (2,548 million barrels, 55 days, similar to the 55-60 day average level of the past ten years).
  • Spare capacity, ie what OPEC can produce above the established quota of 30 million barrels per day, is today 3.5 million barrels a day.
  • Iraq has reached a production of 3.3 million barrels a day, reaching record highs.

Will Iraq take oil to $ 200 a barrel?

Not likely. The OPEC spare capacity is equal to 100% of total production in Iraq.With the US producing at record levels and non-OPEC production growing by 1.2 million barrels a day in 2014, the market would be adequately supplied even if Iraq fails to export.

Libya, for example, has dropped to almost zero exports from one million barrels per day after the fall of Gaddafi and the oil price has not moved aggressively. The analysis is not “oil has risen to $ 115 per barrel,” but “even after the crisis in Libya, Ukraine and Iraq, oil has only risen to $115 per barrel …” And oil remains in backwardation (the future price is much lower than the spot).

Will the price of oil it create an economic crisis?

Oil does not create crisis. Excess credit and money supply that shoots commodity prices well above the fundamental levels are the ones that create crisis. The price of oil is a consequence, not a cause. In any case, the oil burden of the OECD has not reached 5.5% of GDP, far from levels that are supposed “to trigger a crisis”. The oversupply also helps to mitigate it.

The world has been operating with such crises in producing countries for decades. And the market is always adapting. But linking the Arab problem only with oil is a grave error on the part of all governments.

In the end, as Ignatieff said there is never an ideal solution. To think that the OECD will solve conflicts between Sunnis and Shiites that have been going on for centuries only with military domain is optimistic. Believing that NATO and the United States will be able to opt out of supporting Middle East security without dire consequences for the Western world is suicidal.

Important Disclaimer: All of Daniel Lacalle’s views expressed in his books and this blog are strictly personal and should not be taken as buy or sell recommendations.

The Thatcher Recipe

Global Economy, On the cover, Sin categoría,

(Article published in Spanish in Actualidad Economica magazine, June 2014 supplement: “El Espectador Incorrecto – Una mirada liberal al mundo”)

While Continental Europe is still struggling to recover from the deepest economic crisis since World War II, UK business confidence is reaching historic highs. With an expected GDP growth of 2.7% for 2014 and unemployment trending down towards 7% well earlier than planned by the Bank of England itself, the UK’s economic health is striking. The streets of London are buoyant, with retail sales booming. And importantly such confidence in the future is not limited to London but can also be felt across the country, as confirmed by a recent national survey (Grant Thornton’s UK Business Confidence Monitor – Q1 2014). The roots of such economic success go back to the Margaret Thatcher years.

 

It seems normal to anyone living in Britain today to shop in supermarkets at any time of day or night, to get cash at the bank’s counter or the post office on Saturdays, to switch electricity supplier in a few clicks after being alerted by the incumbent supplier itself that there is a cheaper offer with some competitors, to travel to anywhere in Europe for a fraction of a typical flight ticket, even to start a new business in a day. What a contrast with the UK of the 1970s and early 1980s, which Bank of England was qualifying as “the sick man of Europe”! Britain was paralysed by constant strikes, streets were empty after 6pm with most shops closed by then, Europe was making fun of lazy and lousy Britain. The country’s decline seemed unstoppable and both politicians and the British people seemed resigned to it.

 

Free markets, flexibility in employment laws, tight control of government spending, tax cuts for business and individuals, even for top earners… Such pillars of Ms Thatcher’s economic programme are hardly contested today by either Conservative or Labour leaders, who over the years have, one after the other, admitted being “Thatcherites”. Margaret Thatcher reportedly considered that her biggest victory was to have brought the Labour Party to end-up backing her economic policies. Ms Thatcher’s reforms now appear so obvious and natural that it seems that nobody can contest them anymore.

 

Nevertheless, the intense debate re-ignited at the time of her funeral last year shows that her legacy remains hugely controversial. As if British people were shameful of what they have become: successful and wealthier, but greedy and selfish?

 

While the Iron Lady obviously did not do everything right and too often seemed hermetic to people’s complaints, one has to admit that she has transformed her country to an extent that no other European nation has lived over the past 40 years.

 

Ms Thatcher’s eleven years in power were particularly ground-breaking in three major economic aspects:

 

First of all, government spending was cut dramatically and budget deficits were kept under control for the first time since the War, even turning to a surplus in the late 1980s. Ms Thatcher considered a national humiliation that her country had to request a loan from the IMF in 1976. She decided that the fight against public spending should be the country’s top priority. The only areas intentionally preserved from cuts were police, defence and the National Health Service. After reaching 44.6% of GDP just as Ms Thatcher came to power in 1979, public spending was cut back to 39.2% by the end of her three terms in 1990. This despite having to face two recessions in the meantime. Even more significantly, the control of budget deficits became the new norm so that State spending continued to drop in the 1990s, even under Tony Blair’s New Labour governments, in a clear contrast with most major industrialised economies. At the end of the 1990s, Britain had reduced public spending almost to the level of the US, well below any other large European country. Interestingly, Ms Thatcher managed to reverse the trend of Budget deficits while at the same time drastically cutting taxes. She was convinced that the country was being paralysed by the heavy weight of taxation, which was not only preventing corporates from investing but also was creating an assisted mentality and was killing any entrepreneurial spirit. Taxes had reached levels of up to 83% of income. She capped the marginal tax rate at 60% to start with, then 40%, and cut the common tax rate from 33% to 30%, while raising VAT. And she would refute accusations of favouring the rich, convinced as she was that you need to incentivise those who are ready to take risks, invest and create jobs. The reduction in Budget deficits was financed not only by spending cuts but also by a £50bn privatisation programme. Emblematic companies like Jaguar, British Telecom, BP, British Gas, British Airways, British Aerospace were either sold or privatised. But here again the National Health Service was kept under State ownership and control.

 

Another key aspect of Ms Thatcher’s era is how the stringent reforms underpinned individual wealth, against all odds. Since 1980, GDP per capita has increased more in the UK than in the US, Japan, Germany or France. While the UK’s GDP per capita had been lagging all major industrialised nations in the three previous decades, the situation started to reverse during Ms Thatcher’s terms and Britain took the lead in the 1990s and 2000s. Such statistics are the best answers to those who blame her for having increased the gap between the rich and the poor, as the whole population in fact got significantly wealthier. A good illustration of this is how the most modest segments of the British population gained access to the property market. Through her famous “Right to Buy” scheme, Margaret Thatcher led the State to sell 1.5 million council homes at large discounts so that the poorest could acquire the properties they were living in.  The scheme was clever as it helped restore public finances, generating £18bn over the period. And it made Ms Thatcher hugely popular among popular classes!

 

But if there was one achievement to keep in mind from Margaret Thatcher’s eleven years in power, it is how she has converted Britain to free markets. Her economic principle was to limit the State’s functions to the protection of individuals while the markets would take care of the rest, under the control of strong independent regulators. She profoundly believed in people’s sense of responsibility and therefore in private enterprise. She abolished currency exchange controls and cut State subsidies to industries. She deregulated finance, but also most utilities services, including telecoms, power and gas supply. While largely criticised in its initial stage, notably due to an initial boost in unemployment numbers, the process quickly proved to be a significant incentive to innovation and competition. In her view, economic freedom would lead to growth and job creation, which is pretty much what happened. UK regulators have not been questioned since then and are well respected today for their role to limit free market excesses. They are not only independent from the central government but also careful of interests of both private operators and final users. The British society gradually gave up its assisted mindset to adapt itself to the notion of sound emulation through competition. This has been the source of major progress and growth in the UK economy and still today represents one of the country’s key strengths relative to its peers internationally.

 

So Margaret Thatcher inherited from a stagnant economy, a huge, costly and inefficient public sector, a population discouraged by confiscatory tax levels and structural unemployment. Not so dissimilar to Europe today is it…?  Now we know the recipe to success. But we are running late so let’s not wait, Margaret Thatcher’s era was 25 years ago!

 

Jean-Hugues de Lamaze

Economist and Fund Manager in London

 

Important Disclaimer: All of Daniel Lacalle’s views expressed in his books and this blog are strictly personal and should not be taken as buy or sell recommendations

Chinese Imports discrepancy impacts commodities

Energy, Global Economy, On the cover, Sin categoría,

The discrepancy between Chinese imports continues to drive commodities. As seen below, Chinese copper and coal imports remain weak and trending down while oil imports are rising (see graphs below). Copper is down 1.8% MTD and 9.2% YTD, maybe as a vengeance against Chile for obliterating Spain mercilessly in the World Cup.

chinese copper imports

Oil continues to strengthen with Brent  at $114.074/bbl and WTI at $106.51/bbl despite yesterday’s bearish DOE data. Crude drew 0.58 m Bbls vs. expectations for a 0.58 m Bbl draw. Cushing crude inventories built 0.25 m Bbls on the week and now stand at 21.4 m Bbls.  Gasoline built 0.79 m Bbls vs. expectations for a 0.39 m Bbl draw and distillates built 0.44 m Bbls vs. expectations for a 0.04 m Bbl draw. All products drew 0.35 m Bbls. Refinery utilization was down 0.8% vs. expectations for a 0.7% increase. Refinery utilization stands at 87.1% vs. a 5-year average of 88.2%.

Iraq update: The head of Iraq’s state-run South Oil Company Dhiya Jaffar said on Wednesday that Exxon has carried out a “major evacuation” of their staff and BP had evacuated 20% of its staff. He said ENI, Schlumberger, Weatherford, and Baker Hughes had no plans to evacuate staff from Iraq following the lightning advance of Sunni militants through the country. (Reuters) Comments that the refinery in Baiji had fallen to attackers from the Islamic State in Iraq and Syria have been denied by the Malaki government.

Chinese oil imports have strengthened, driving the products market tighter and Tapis to $118.16/bbl, a premium over Brent.

chinese oil imports

Coal continues to weaken to $79.80/mt driven by weak Chinese imports (see graph below).

chinese coal imports

US gas remains well supported at $4.56/mmbtu. Consensus estimates a 112-Bcf inventory build this week vs. a build of 107-Bcf last week and a build of 91-Bcf last year at this time. Gas demand likely has decreased by 1.8-Bcf/d w/w, mainly driven by a 1.6-Bcf/d drop in power sector consumption.

UK gas continues to weaken, at 40 p/th, down 3.97% this month despite the Ukraine crisis, as Gazprom has reassured European markets will continue to be well supplied, Statoil has promised to increase exports if needed and inventories remain in the upper level of the 5 year average. Recent weak gas production from Norway (down 9% year on year) shows that Europe has not needed to increase its imports and demand remains weak.

Spanish power prices rise 89bps driven by low hydro production and extremely hot weather. Spanish power prices are the best performers this year of all continental power prices, with France down 5.86% YTD, Germany down 5.6% YTD, Nordpool down 9.6%, UK down 16.9% and Spain only down 1.2%

 

Important Disclaimer: All of Daniel Lacalle’s views expressed in his books and this blog are strictly personal and should not be taken as buy or sell recommendations

World Trade Slows Down

Global Economy, On the cover, Sin categoría, ,

comercio mundial

 

Worth noting today the evident slowdown in global trade, massively revised down (30%) from January estimates. Japan posted a 2.7% decline in exports in May, UK was also down 5% in April and Eurozone exports stalled… but at the same time the Baltic Dry Index is down 2.58%v this month (-52.3% this year) driven by ongoing weakness in Chinese overall imports. Overcapacity paints part of the picture, but the other most relevant part is weak trade data, well below the +16% increase expected in January (see graphs below). Merrill Lynch is betting on a BDI rebound helped by seasonality, re-stocking and a rise in seaborne iron ore volumes of +16% in 2014 and +10% in 2015. I fail to be that positive, as the indications from industrial production globally are negative regarding marginal additional growth expectations, as revisions are down 12% from January estimates globally and the backwardation on coal and iron ore has steepened.

If GDP forecasts are correct, the World Trade Organization expects a broad-based but modest upturn in the volume of world trade in 2014 (+4.7%), and further consolidation of this growth in 2015 (+5.3%).

The average ratio of trade growth compared to GDP since the mid-1980s is around 2 to 1 – with trade growing at twice the pace of GDP, according to the WTO. However, in the last two years the ratio was closer to 1 to 1.

To deliver on the expected +4.7% trade growth in 2014, this ratio would have to move to 2.5 to 1 from June to December assuming that global GDP growth expectations are correct (+3.3%)

BDI May

Freight rates for panamax dry bulk vessels are now below opex, and long-term forward rates have fallen below break-even. The main reason for this weakness is in the coal market.

Chinese coal import is the most important trade for panamaxes and chinese imports of thermal coal are expected to be lower in 2014 than in 2013.

Capesize rates have come down 43% YTD and forward rates for Q4 fell 4% this Friday.

Adding to this a 100 milion tonnes of Australian capacity growth, the outlook for both coal prices and the Baltic Dry is not positive. Freight companies are growing the fleet by 4% this year so oversupply is even higher.

Brent at $113.58/bbl, and WTI at $106.87/bbl. The Norwegian Petroleum Directorate has issued its production numbers for May (this aggregates all Norwegian production each month). Oil is down 13% yoy and gas is down 9% yoy.

Worries about disruption to Iraq supply continue to support prices. The IEA in its medium term oil market report published yesterday cut its Iraqi supply forecast by close to 0.5m b/d & now expects it to reach only 4.5m bpd in 2019, commenting that the growth is “increasingly at risk” (this compares to the government’s target of 8.5-9m bpd by 2020).

Coal continues to weaken to $79.45/mt helped by lower Chinese imports and higher Australian exports. Chinese iron ore import prices are down 33.5% YTD.

CO2  at €5.80/mt still driven by backloading. Impact on power prices is inexistent. CO2 is up 13.4% this month and power prices are flat all over Europe.

UK gas is down 1.34% at 40.45p/th with all the gains of the Ukraine crisis erased from the price yet again. Both Europe and Ukraine have ample inventories and alternative supplies to offset disruptions. UK gas is down 40.7% YTD. UK power prices are down 12% YTD due to the weak gas price and poor demand.

 

Important Disclaimer: All of Daniel Lacalle’s views expressed in his books and this blog are strictly personal and should not be taken as buy or sell recommendations