MENA – Page 2 – eRutledge | Arabian Gulf Economics

Oil prices ‘will stabilise this year’

Current trends indicate demand and supply will increase, says expert

by Mohammad Ezz AL Deen | January 16, 2006

During the Gulf Research Centre’s third annual conference recently, Anas Alhajji, moderator of the Gulf Energy Program-me at the GRC, said he expects oil prices to stabilise in 2006.

Prices will only decline significantly, he said, if the US falls into recession as a result of a decline in government spending. “The soaring price in 2005 was due to the market fundamentals of limited supply and rising demand. Opec members ran out of marketable excess capacity, and non-Opec production was lower than expected, while global demand especially in the US, India and China continued to grow,” Dr. Alhajji said. Current trends estimate that both demand and supply will increase in 2006. However, oil prices will depend on the size of the additional production capacity, he added.

According to experts at the Dubai-based GRC, the Gulf is likely to experience a period of high growth in 2006, a modest decline in oil prices, significant political developments, rising tension, and a slow shift in focus towards Asia in the realm of international relations.

Emilie Rutledge, econ-omist at the GRC, said that high oil prices and the increasing global demand for oil triggered a boom for the GCC economies. The region’s aggregate GDP rose by 5.3 per cent, stock markets grew by 79 per cent and market capitalisation touched $1.1 trillion, an increase of 110 per cent over 2004. The aggregate GCC trade surplus stood at $253 billion in 2005, and imports of good and services rose by 20 per cent, she said. “Regional governments are generally aiming to avoid over-dependence on oil through economic diversification strategies, labour nationalisation policies and the privatisation process,” she said.

Vital issues
GRC Chairman Abdul Aziz Sager highlighted important issues in 2005, including the continuing political reform process that has firmly implanted itself in the region, the effects of the unprecedented increase in oil prices on the GCC economies, as well as the numerous security challenges that confront the region. “Despite the economic and strategic importance it represents, the developments in the Gulf region during 2005 were not reassuring as far as the status of Gulf security is concerned,” Sager added.

The GCC defence budget amounted to $34 billion during 2005, a $4 billion increase over 2004. The budget growth could be related to higher revenues because of oil prices, said Mustafa Alani, Director of the Security and Terrorism Programme at the GRC.

Iran – a threat to the petrodollar?

First published in:
Al Jazeera

Rutledge, E. J. (2005, November 3). Iran – a threat to the petrodollar? Al Jazeera. https://www.aljazeera.com/news/2005/11/3/iran-a-threat-to-the-petrodollar

Iran’s decision to set up an oil and associated derivatives market next year has generated a great deal of interest.

This is primarily because of Iran’s reported intention to invoice energy contracts in euros rather than dollars.

The contention that this could unseat the dollar’s dominance as the de facto currency for oil transactions may be overstated, but this has not stopped many commentators from linking America’s current political disquiet with Iran to the proposed Iranian Oil Bourse (IOB).

The proposal to set up the IOB was first put forward in Iran’s Third Development Plan (2000-2005). Mohammad Javad Assemipour, who heads the project, has said that the exchange will strive to make Iran the main hub for oil deals in the region and that it should be operational by March 2006.

Geographically Iran is ideally located as it is in close proximity to major oil importers such as China, Europe and India.

It is unlikely, in the short term at least, that large numbers of energy traders will decamp and set up shop in Iran; a country which happens to be categorised as a member of the “axis of evil” by the president of the world’s largest oil-importing country; the United States.

But over time, Iran could take some business away from the two incumbent energy exchanges, the International Petroleum Exchange and the New York Mercantile Exchange who both invoice sales solely in dollars.

Economic motives

If successful, the IOB will provide Iran with concrete economic benefits especially if it invoices at least some of its energy contracts in euros.

Iran has around 126 billion barrels of proven oil reserves about 10% of the world’s total, and has the world’s second largest proven natural gas reserves.

From an economic perspective, invoicing oil in euros would be logical for Iran as trade with the euro zone countries accounts for 45% of its total trade. More than a third of Iran’s oil exports are destined for Europe, while oil exports to the United States are non existent.

The IOB could create a new euro denominated crude oil marker, which in turn would enable GCC nations to sell some of their oil for euros. The bourse should lead to greater levels of foreign direct investment in Iran’s hydrocarbon sector and if it facilitates futures trading it will give regional investors an alternative to investing in their somewhat overvalued stock markets.

Euro zone countries alone account for almost a third of Iran’s imports and currently Iran must exchange dollars earned from hydrocarbon exports into euros which involves exchange rate risk and transaction costs.

The decline in the dollar against the euro since 2002 – some 26% to date – has substantially reduced Iran’s purchasing power against its main importing partner.

If the decline continues, more states will increase the percentage of euros vis-à-vis the dollar they hold in reserve and in turn this will increase calls both in Iran and the GCC to invoice at least some of their oil exports in euros.

A move away from the dollar and a strengthening of the euro would further benefit Iran as according to a member of Iran’s Parliament Development Commission, Mohammad Abasspour, more than half of the country’s assets in the Forex Reserve Fund are now euros.

It is primarily the US which stands to lose out from any move away from the petrodollar status quo, it is the world’s largest importer of oil and a move away from invoicing oil in dollars to euros will undoubtedly have a negative effect on its economy.

Fewer nations would be willing to hold the dollar in reserve which would cause a significant devaluation and result in the loss seigniorage revenues. In addition, US energy-related companies stand to lose out as they will be unable to participate in the bourse due to the longstanding American trade embargo on Iran.

Political considerations

In the 1970s, not long after the collapse of the gold standard, the US agreed with Saudi Arabia that Opec oil should be traded in dollars in effect replacing the gold standard with the oil standard.

Since then, consecutive US governments have been able to print dollar bills and treasury bonds in order to paper over huge current account and budgetary deficits, last year’s US current account deficit was $646 billion.

Needless to say, the current petrodollar system greatly benefits the US; it enables it to effectively control the world oil market as the dollar has become the fiat currency for international trade.

In terms of its own oil imports, the US can print dollar bills without exporting commodities or manufactured goods as these can be paid for by issuing yet more dollars and T-bills.

George Perkovich, of the Washington based Carnegie Endowment for International Peace, has argued that Iran’s decision to consider invoicing oil sales in euros is “part of a very intelligent strategy to go on the offense in every way possible and mobilise other actors against the US.”

This viewpoint however, ignores Iran’s economic motives, just because the decision, if eventually taken, displeases the US does not mean that the rationale is purely political.

In light of such sentiments and the US’s current insistence that Iran be referred to the UN Security Council Iran must consider and weigh carefully the economic benefits against the potential political costs.

Although a matter of conjecture, some observers consider Iran’s threat to the petrodollar system so great that it could provoke a US military attack on Iran, most likely under the cover of a preemptive attack on its nuclear facilities, much like the cover of WMD America used against Iraq.

In November 2000, Iraq began selling its oil in euros, its Oil For Food account at the UN was also transferred into euros and later it converted its $10 billion UN held reserve fund into euros.

At the time of the switch many analysts were surprised and saw it as nothing more than a political statement, which in essence it may have been, but the euro has gained roughly 17% over the dollar between then and the 2003 US invasion of Iraq. Perhaps unsurprisingly, since the US led occupation of Iraq its oil sales are once again being invoiced in dollars.

The best policy choice for Iran would be to proceed with the IOB as planned as the economic advantages of such a bourse are clear, but in order to mitigate against the potentially greater political “threat” should provide customers with flexibility.

It would make it much harder for America to object to the new bourse, overtly or covertly, if Iran allows customers to decide for themselves which currency to use when purchasing oil, such an approach would facilitate for euro purchases without explicitly ruling out the dollar.

[As Aljazeera then put it: “Emilie Rutledge is a British economist who is currently based at the Gulf Research Center in Dubai”].

High time for a single GCC currency

First published in:
Al Jazeera

Rutledge, E. J. (2005, October 3). High time for a single GCC currency Al Jazeera. https://www.aljazeera.com/news/2005/10/3/high-time-for-a-single-gcc-currency

There has been a fair amount of scepticism towards the proposed Corporation Council for the Arab states of the Gulf single currency, not just in terms of the likelihood of it actually being launched but also with respect to the economic benefits it is expected to provide.

In terms of appropriateness, as all member states have similar economic structures – export-orientated economies – the single currency should be viable and not be that difficult to implement.

According to monetary theory, key benefits of currency union include the elimination of transaction costs and the generation of greater levels of trade between member states.

With regard to these theoretical benefits, reactionary economists argue that, as all six sovereign currencies are pegged to the US dollar, transaction costs are already effectively non-existent.

They also point out that a single currency would not stimulate much new intra-Gulf Cooperation Council trade as most of the region’s trade involves exporting oil and gas to Asia and Europe, not trading goods with one another.

For currency union to be effective, there will need to be a single independent central bank along with a GCC monetary authority.

Fiscal budgetry

These institutions would need to have the authority to set fiscal budgetary restrictions, and require member states to provide timely and transparent data including national accounts.

Many doubt, when push comes to shove, GCC leaders will actually defer to a supranational institution. A federation of existing central bankers would probably lead to a weak currency and increase the likelihood that it will stick with the dollar peg.

Much of the potential success or otherwise depends on two things: a strong independent central bank and what exchange rate mechanism the region’s policymakers decide to adopt post 2010.

It seems that at present there is little appetite – at least publicly expressed – to move away from the dollar peg, let alone consider invoicing future oil sales in Gulf dinars.

Reasons given for maintaining the status quo include the fact that the dollar is the de facto currency of international trade and that Opec oil sales are invoiced in dollars.

It is also a fact that GCC governments hold vast sums of dollar-denominated assets, such as US Treasury bonds. A move away from the dollar would see more uncertainty as to the value of these assets.

However, the dollar peg is not the optimal choice for the region’s economies.

As GCC economies mature and attempt to diversify away from dependence on hydrocarbons, the utility of the dollar peg needs to be critically examined.

Even if the current arrangement is kept as a convenient convergence tool up until 2010, once launched GCC leaders should seriously consider viable alternatives such as a managed free float or a loose peg to a trade-weighted basket of currencies.

Key problem

One key problem with the dollar peg is that it effectively means that GCC central banks have outsourced their decision-making powers on interest rates to Alan Greenspan of the US Federal Reserve.

Not having independent monetary policy tools can be problematic, particularly in terms of combating inflation and encouraging growth.

As a consequence decisions on whether or not to cut, hold or hike rates are based on economic conditions in the US and these are not always the most appropriate for the GCC.

It is often the case that the US economy will grow robustly when oil prices are low while GCC economies will either experience low levels of growth or stagnation.

Conversely when oil prices are high the pace of US growth eventually slows, and US interest rates have been low for several years now in an attempt to stave off recession.

These low interest rates which the GCC central banks have to track, are now exacerbating inflation in the GCC and leading to the overvaluation of some stock-market and real estate-assets.

There is also increasing concern over the size of America’s federal debt, which is almost $8 trillion. Its budget deficit this year alone is expected to be $600 billion. In recent years the US economy has been characterised by substantial budgetary deficits. It consistently spends more than it earns.

As a result, the US is becoming more and more dependant on foreign countries willing to hold dollars in their reserve accounts and buy its Treasury bonds.

Essentially the US Federal Reserve prints paper – Treasury bonds and dollar bills – and swaps these for commodities such as oil and consumer items such as Chinese household appliances.

The weakening dollar has also resulted in GCC imports from Europe becoming more expensive. When launched in 2002 a Saudi riyal was worth €0.29 euros; today it is worth only €0.21 euros.

This means that it has become 32% more expensive for GCC states to import goods from the eurozone, which happens to be the region’s largest import partner. Unlike the US, the eurozone does not run large trade deficits, and the European Central Bank imposes strict limits on government deficits.

If GCC states were to start shifting some of their dollar-denominated assets into euro-denominated ones prior to currency union, it would provide a good hedge against the expected downward decline in the dollar.

Even more significantly if, post-currency union, the GCC decided to allow the purchase of oil in euros along with the Gulf dinar and other currencies, they would see their euro assets appreciate massively, as a greater number of oil-importing nations would hold higher levels of euros in reserve and therefore increase its value.

Long-term value

Iran’s decision to open an oil and associated derivatives market in March 2006 is interesting, not least because it plans to invoice contracts in euros, not dollars.

It is not likely that many energy traders will leave New York or London and set up shop in Tehran, but Iran’s move does highlight a rising concern over the long-term value of the dollar.

If the dollar continues to decline against the euro, more states will increase the percentage of euros they hold in their reserves because the euro will be a better store of future wealth, and major oil suppliers will prefer to sell at least some of their oil for euros or currencies other than the dollar.

A strong, independent, single GCC currency is likely to attract increased levels of foreign direct investment to the region and facilitate the invoicing of some oil and gas sales in Gulf dinars.

Not only would this provide the region with substantially higher seigniorage revenues but it would also result in the Gulf dinar becoming, albeit a minor, reserve currency with a host of associated benefits, especially for the region’s non-oil financial sectors.

The currency could well be viewed by some Arab and Islamic states as a more “acceptable” reserve currency than that of the US dollar.

The notion that it would be too difficult to set up a market for invoicing oil sales in any currency other than the dollar is quite frankly ridiculous, and is largely being propagated by those with a vested interest in the current petrodollar hegemony.

[As Aljazeera then put it: “Emilie Rutledge is a British economist who is currently based at the Gulf Research Center in Dubai”].