Gavin's Blog

I liked this quote:

One arguments holds that the market is essential to individual freedom or to respecting people’s self-ownership. Forced redistribution of resources away from the outcome resulting from individual exchange violates people’s freedom to do what they like with what is theirs. Another, quite distinct, argument claims that the market gives people what they deserve. Talented, hardworking people deserve more than untalented feckless ones, and the market makes sure they get it. These justifications may coincide, in particular cases, but defenders of the market shouldn’t slide from one to the other without being aware that they may not.

Political Philosophy, Adam Swift, page 39.

I tend to agree.

If you have been following the travels of former Esat BT/Esat Digifone owner Denis O’Brien you will be aware that he has been investing heavily in the Caribbean. It seems that Digicel is causing something of a problem on some of the islands:

Historically, C&W has had a virtual monopoly in Britain’s former Caribbean colonies – a monopoly that has been suffering erosion since 2001, when Irish businessman Denis O’Brien, the man behind Digicel, entered the Jamaican market with the country’s first GSM mobile phone service.

Digicel quickly became the market leader in Jamaica and now has operations in 15 countries in the region, including Barbados, Grenada, Antigua and Barbuda, St Vincent and the Grenadines, Haiti and St Lucia.

“We generally overtake the incumbents within the first 12 months or quicker,” Mr O’Brien says.

But C&W has been prepared to fight Digicel every step of the way, as the West Indies Cricket Board discovered to their cost last year.

C&W had sponsored the West Indies team until 2004, when the board signed a five-year deal worth $20m (£11.4m) with Digicel instead – a move described in some quarters as being tantamount to replacing Coke with Pepsi.

In the meantime, C&W had signed individual sponsorship deals with seven West Indies players, including Trinidad-born captain Brian Lara and big-hitting Jamaican batsman Chris Gayle.

The resulting conflict led to the seven being dropped from last year’s opening West Indies Test match against South Africa in Guyana, although the weakened home team still held the visitors to a draw.

And so desperate was the incumbent to hold on to customers that they offered a buy-one-get-one-free phone deal to customers, causing riots.

I like this quote from Ann Mettler of the Lisbon Council, concerning France’s economic policies:

“France has not internalized a very important transition that is happening in Europe right now, which is the shift from the industrial economy to the knowledge and services economy,” said Ann Mettler of the Lisbon Council, a market-oriented research group based in Brussels. “Its interest groups, which are very strong, are still trying to preserve the industrial age.”

Sums it up pretty nicely.

Foreign Policy poses seven questions to Matthew Simmons, a chief proponent of the idea of peak oil. Some of the juicier ones:

FP: You’ve written that Saudi Arabia relies on old and overproduced oil fields that are likely to start declining in output. How has Riyadh responded to your analysis?

MS: They’ve said “trust me, we have no problems.�? Petroleum Minister Ali Naimi said that they could pump up to 15 million barrels per day for as many as 100 more years. The likelihood of that is as remote as me being on the moon 10 years from now. They dismiss requests for any field-by-field data as preposterous, and simply say that they’ve been a reliable supplier of oil for 70 years. My view is that it’s just good supply chain management to ask a key vendor for details about their capacity. Plus, they are shopping the market so hard for drilling rigs right now. If they can produce 15 million barrels per day for another 50 to 100 years, why do they need new rigs?

FP: Which countries are best positioned to deal with a decline in oil production?

MS: Papua New Guinea. Unfortunately, that’s an honest answer. The countries that haven’t yet built a society that needs an exponential amount of oil are in the best shape. Around 30 years ago, around half the world didn’t really use oil. And now look, cities like Hanoi have millions of motorcycles they didn’t have five years ago. We’ve built the global economy based on the false assumptions that oil is just another commodity, that the Middle East has basically unlimited amounts of oil, technology will improve, and that the price of oil would get progressively cheaper.

The more I’ve gotten into this, the more similar it is to what we do in our own minds with ignoring people’s getting old. When do you take your parents’ car keys away? It’s so painful that you go into denial that they’re getting really old.

Interesting figures:

China has overtaken Japan: it now has the world’s largest foreign-exchange reserves. The combined reserves of the People’s Bank of China and the Hong Kong Monetary Authority stood at $833 billion at the end of June. By now, given their recent rate of growth, they could be nudging $870 billion-worth, most of this in dollars—well ahead of the $830 billion in Japan’s coffers at the end of last month. Asia as a whole now has a stash of more than $2.5 trillion, two-thirds of the world total, up from $1 trillion in 2000.

Ultimately the Economist blames Americans not saving for its current account deficit, not Asian governments.

These kind of rises could really eat into any growth forecasts for the rest of the year, how high can it go?

In Wednesday trading in New York, a barrel of US light crude temporarily hit a fresh high of $65.00 before ending the day’s trading at $64.90. London Brent saw similar gains, jumping $2.08 to a new peak of $64.06 a barrel, before settling at $63.99.

The Economist has oil as its cover story this week, a subject oft-covered on this blog. Vijay Vaitheeswaran is writing this story in the Economist. Here’s a nice graph:

Vijay notes, and I will highlight the bits I like:

More worryingly, Mr Morse believes the problem extends well beyond just spare production capacity. He points to the tightness in markets for oil rigs, tankers, petroleum engineers, refinery capacity and various other bits of the oil value chain, and concludes that the problem is systemic: “The illusion that oil is in perennial oversupply has led to two decades of underinvestment in the oil industry. The world has been living off the legacy spare capacity built up many years ago.�?

Given today’s high prices, surely the market will soon enough provide the necessary new infrastructure? Probably not, for two reasons. The first is that the world seems to be coping rather well with today’s shockingly high prices, so perhaps they have to persist for longer or rise higher still before investors are stirred into action. The second reason is the bitter memory of oil at $10 a barrel.

OPEC countries are unlikely to rush to build lots of spare capacity because they are worried that another price collapse may follow. PFC Energy observes that when the oil price hit $55 late last year, spare capacity was less than 15% of the 8.7m bpd peak reached in 1985, and notes: “OPEC national interests do not lie in creating large capacity surpluses that have existed for most of the history of oil.�?

But as always in the style of Economist articles – on the other hand…

Still, the crunch may ease if the Saudis rebuild their buffer. It may be in their interest to do so. For most of the OPEC countries, it makes sense to try to maximise prices in the short term because their reserves of oil are relatively small. The Saudis, by contrast, are sitting atop at least 260 billion barrels of proven oil reserves, far more than Libya, Venezuela, Indonesia and Nigeria combined. Even at current production levels of around 10m bpd, which make them the world’s top exporters, they have enough oil to pump for most of this century. They will not want prices to stay too high for too long, or else investors will put money into non-OPEC oil or alternative fuels.

The desert kingdom’s rulers also remember the lessons of the 1970s oil shocks, when the biggest losers were not consuming economies (which eventually adapted to higher prices) but the petro-economies of OPEC. Ali Naimi, the Saudi oil minister, rejects the idea that his country wants prices to rise ever higher: “We are misunderstood: we thrive on the economic growth of others, which is concomitant with energy demand.�? That is why the Saudis have long acted as the voice of moderation within OPEC, resisting calls from price hawks such as Libya, Iran and, since the rise of Mr Chavez, Venezuela to squeeze consumers.

Indeed, at the most recent formal OPEC meeting, held in Iran on March 16th, the Saudis in effect bullied reluctant cartel members into trying to calm prices down. They won agreement for a rise in oil production quotas to boost global oil inventories that looked like a reversal of the cartel’s established policy of keeping OECD inventories tight and prices high.

Developments within Saudi Arabia seem to confirm that the buffer is being rebuilt. Saudi Aramco, the state-run oil giant (and the world’s largest oil company), has recently launched its biggest expansion programme in many years. Outside contractors report a surge in rig counts and drilling activity as the country increases spare capacity to its stated goal of 1.5m-2m bpd. But even if Saudi Arabia is willing to re-establish an adequate buffer, this could take years. Will prices stay high until then?

Well will they? In short, yes. But there is a ‘but’ attached. Here’s why.

OPEC ministers and Wall Street analysts talk of a new “price paradigm�?. At first sight, there seems to be something in that. In the past, contracts for delivery of crude months or years ahead (what Alan Greenspan, the chairman of the Federal Reserve, has poetically called “distant futures�?) usually stayed low and stable even if the spot price shot up because of some short-term disruption. But for the past couple of years the distant futures have tended to shoot up too. The markets clearly expect that higher prices are here to stay.

Political scientists point to the bloated welfare states in most OPEC countries which will require higher oil prices to balance budgets and avoid social unrest. Some industry analysts see a new “floor�? price of $30-40, if only to persuade oil firms to splash out on necessary investments upstream. Matt Simmons, a prominent energy investment banker, thinks that in view of rising input costs (for such things as oil rigs, steel pipes, tankers and so on) the oil price “needs to go way, way up�?.

But…(and what was Bush saying about China’s demand for oil recently?)

One factor is potential weakness in demand. There is much talk about Chinese demand changing all the rules, but that is just plain wrong. China’s share of world oil consumption is still under 8%, far smaller than America’s at 25%. Goldman Sachs, an investment bank, estimates that even assuming robust growth, China will remain a smaller oil consumer than America for decades to come.

And the growth in China’s oil demand of nearly 16% last year is unsustainable. For one thing, there are simply not enough cars in all of China to guzzle that much oil. Much of the 2004 rise was related to the country’s overheating economy and is unlikely to be repeated. For example, shortages of cheap coal led to the use of pricey fuel oil or dirty diesel for electricity generation; as bottlenecks in the coal system ease, that oil use will disappear. Over the past two years, as the country has developed its oil infrastructure, it has needed to fill pipelines, storage tanks and the like, but these were one-off purchases. The International Energy Agency (IEA) says that in January and February 2005, Chinese oil demand rose by only 5.4% on the same period in 2004, less than a quarter of the rate a year earlier. And if China’s banking sector or its overall economy takes a knock, oil consumption is bound to be hit too.

And to conclude:

Aramco’s boss [Saudi's and indeed the world's largest oil company] Abdallah Jumah, sums it up: “Where the oil price goes, nobody knows.�? He wishes it were otherwise. “The key is stability so we can plan. Oil investments take a long time to come to fruition.�? His boss, Mr Naimi, argues that “oil is simply too vital a commodity to be left to the vagaries of the marketplace.�? But even Saudi Arabia cannot guarantee oil-market stability, especially with its buffer so depleted. Indeed, the only sensible thing anyone can say about oil prices today is that they are unlikely to remain stable.

Dan Drezner has a lenghty post concerning a debate he’s having with Matthew Yglesias and Brad DeLong. It surrounds the US request for China to “immediately introduce a flexible currency” which the FT reports is “a marked shift in tactics after several years of patient diplomacy aimed at nudging China towards allowing the renminbi to float”.

Drezner notes:

Brad’s assertion is that political scientists think that “getting serious” about something is dispatching an ambassador — as opposed to the economists who want to fix the problem. Actually, to a political scientist — more specifically, one who studies international relations — you “get serious” about an issue like the currency when you engage in tactical issue linkage to change other government’s policies in such a way as to change the balance of returns and risks facing those buying and selling in foreign exchange markets. If one can arrange for other countries to bear a greater portion of the costs of adjustment from the current set of macroeconomic imbalances, then political scientists will predict that governments will prefer this policy option ten times out of ten — even if the long-term economic picture would be improved by listening to economists. [Yes, but doesn't this still leave the U.S. with some long-term macroeconomic problems?--ed. I believe it was an economist who pointed out what happens in the long run.]

This leads to Matthew’s appropriate question about leverage — what does the U.S. have to offer? What is the tactical issue linkage that could be put in play here?

The Economist presents a pretty stark view of the world economy with such gems as:

Unemployment in the euro area is 8.9%; in Germany, France and Spain it is in double digits. Manufacturing in the single-currency zone has stalled. In its latest World Economic Outlook, published this week, the IMF, like other forecasters before it, slashed its forecast for euro-area GDP growth this year, to 1.6%. The world economy’s other weak link, Japan, faltered half-way through 2004 and despite the odd spark has not yet sputtered into life again. Rising oil prices have helped neither of these giant weaklings.

Even in America, where the strength of the expansion has consistently surprised economists, there are nascent signs of slowdown and worries about oil. With job growth scarcely topping 100,000, the March employment report was much weaker than expected. Retail sales grew by only 0.3% (month-on-month) in March, less than half of what analysts had expected, suggesting that record petrol prices were wearing holes in consumers’ pockets.

Or even:

According to statistics released on April 12th, America’s monthly trade deficit reached a record $61 billion in February (see chart). The climb in oil prices may mean another record in March—although much of February’s increase reflected sharp growth in non-oil imports, which were 16% higher than in February 2004.

Brad Setser, a former Treasury official who is now at Roubini Global Economics, an economic-analysis firm, reckons that if non-oil import growth continues at its recent pace and the oil price stays over $50 a barrel, America’s annual trade deficit would reach nearly $800 billion by the end of the year. That said, the figure may not get that high, because $50 oil ought to dampen American consumer demand and hence import growth.

But they conclude:

It is possible to be sanguine about America’s ever more colossal deficits, just as it is about oil. Certainly, the doomsday scenarios of a dollar crash or a hard landing for the American economy are not in sight. America has had little trouble attracting the necessary capital to fund its soaring deficits. Though Asia’s central banks are still big purchasers, they are not the only ones. Thanks to soaring prices, oil exporters have been building up their surpluses. Russia’s foreign-exchange reserves, for instance, are now over $130 billion. Many of these oil exporters are choosing dollar assets. The dollar has strengthened since the beginning of 2005 and long-term interest rates remain remarkably low.

This calm may explain why the world’s finance ministers have done so little to wean themselves off their addiction to American-led growth and why they will spend most of their time in Washington fretting about oil. That is a pity, for while the oil price seems to be the most imminent risk, the size and rate of growth of the global imbalances are the real reason to worry. If the world economy continues on autopilot, those imbalances are set to increase. And you do not need to be a Cassandra to predict that, eventually, they will create a nasty problem.

I guess we will have to see how things pan out in the coming months.