FINANCIAL ANALYSIS
by Chris Weafer
Asia's markets and most commodities are tracking higher this morning as investors wait in hope that the US Fed may announce some new measure to try and boost economic growth when it holds its annual meeting at Jackson Hole, Wyoming starting Thursday. Sentiment remains very fragile and while investors will try to extend those gains across other markets today, any disappointing data point will reverse that trend.
The initial knee-jerk reaction to the news of the surprisingly quick advance of opposition forces into Tripoli yesterday was a $2 /bbl fall in the price of Brent as traders started to factor in a quick return for Libyan oil to the export market. A more sober reflection suggests that while a quick return of 300-500,000 bbl/d is possible, it may take anything up to 18 months for full recovery. (See more detailed note below). The price action of the past 24-hours supports the bullish case for oil and reflects the net long position in then Futures market. This is a very positive backdrop for the Russia investment case once the rest of the world settles.
Brent crude for one-month delivery is trading at $108.79 p/bbl in Asia currently and that is now higher than Friday's close. WTI is at $85.03 p/bbl.
The dollar-euro rate is at $1.4372, i.e. almost unchanged in 24 hours as traders wait for fresh news from either the EU or the Fed on Friday. Gold is again at a record high, last trading at $1,906.4 per ounce. Silver is up another 1.1% after gaining 3.3% yesterday. Copper is 0.5% better.
Today. While investors are now firmly focused on the US Fed’s annual meeting at Jackson Hole, and Bernanke’s speech on Friday in particular, there are two important data points scheduled for today that may have an impact on equity and currency market sentiment. In Europe, Germany updates manufacturing and service trends and the UK will publish an indicator of industrial trends. In the US, the main number is the July new home sales report. Against the current negative global backdrop, investors are much more sensitive than usual to almost all indicators.
Corporate. There are several corporate reports in Russia today; Hong Kong listed IRC (1029:HK) has just published good numbers and the stock is trading 5.3% better in HK at mid session. Veropharm (VFRM RX) is expected to publish 2nd Qtr operating results and TNK-BP (TNBP RU) will publish consolidated 1st half US GAAP numbers.
Politics: Ruling party support recovering
Matviyenko victory. Russian media reports that St. Petersburg governor, Valentina Matviyenko, has secured more than 90% of the votes in two city district elections at the weekend. Once she takes one of those seats, she will be eligible to be appointed speaker of the Federation Council, the country’s third most powerful position after President and Prime Minister. Matviyenko will replace (as speaker) Sergei Mironov, who is also head of the A Just Russia party, currently the fourth most popular with voters.
Some recovery in UR support. An opinion poll published by the Public Opinion Foundation, shows some recovery in the popularity of the United Russia party. The survey found that 43% of people intend voting for United Russia (up from 40% two weeks earlier), 10% intend voting for the Communist Party and 9% for the Liberal Democrats. As it stands now, only these three parties would take seats in the next Duma as the cut-off for taking a proportionate share of seats is 7% of the vote. Parties that get between 6% and 6.99% of the vote will be eligible to take two seats and parties achieving between 5% and 5.99% can take one seat. Parties polling below 5% get no seats.
Prokhorov’s party will improve. A Just Russia can expect to take only 4% of the vote according to the Public Opinion Foundation while Just Cause, the party founded in 2009 and now headed by Mikhail Prokhorov, has no major showing yet. That is, however, expected to change significantly in the months leading to the December 4th election. In the December 2007 Duma election, United Russia polled 64.3%, the Communists took 11.6%, LDPR had 8.1% and A Just Russia achieved a 7.7% share of the vote.
Voters are cynical. The biggest problem may be voter apathy, albeit there is no minimum voter turnout requirement for a valid election. A survey published by the Center for Political Technologies showed that 55% of people believe that the so-called ruling elites (politicians and bureaucrats) are only interested in “material and personal wellbeing” rather than the national interest. That is up from 33% in mid 2010.
Oil: The Libya Factor
The price of Brent eased 28 cents p/bbl lower yesterday as Libyan opposition forces were, surprisingly, reported to have met little resistance as they entered Tripoli. That modest closing loss contrasted with a drop of over $2.0 p/bbl at the start of trade - and a loss of $1.32 p/bbl as Moscow's bourses closed - because the initial market reaction focused on prospect for a quick end to the civil war and an early resumption of oil production/exports. By the close of the day's session there was a more sober assessment of just how difficult that may be to achieve. Over the nest few days and weeks there is likely to be a great deal more volatility in the oil market as traders and politicians inevitably speculate on how much, and how quickly, Libyan oil production can be restored.
Although the relatively better performance of Brent crude since the start of August (down 7.0% from August 1st to last Friday’s close) did not prevent the RTS and MICEX (down 11.0% and 14.8% respectively in the same period) from falling just as fast as the MSCI EM Index (-14.7%) and S&P (-13.1%) as investors bolted from traditional risk assets, volatility in the price of Brent will continue to impact sentiment towards Russian equities and the ruble over the short-term.
The reality is that, even with the end of the Qaddafi regime, it will take a long time before the country can restore previous production levels.
The major questions are:
How quickly can Libyan oil production and exports be restored?
What will be the reaction of Saudi Arabia?
Is the Mid East “fear factor” now done?
What will be the effect on the WTI-Brent spread?
Libyan recovery. Libya produced an average 1.59 million barrels per day in January. That fell to a reported 100,000 barrels average in July. Saudi Arabia covered most if that short-fall by adding almost 1.5 million barrels to its daily production since January.
Unlike in Iraq, there has been relatively little damage done to Libya’s oil infrastructure. Some damage for sure but nothing on the scale seen in Iraq where wells were deliberately blown up. In theory, therefore, production can be restored quite quickly. Also, unlike in Venezuela or Russia twenty years ago, Libyan oil production is relatively easier so there should be no major geological reasons to slow the resumption.
That said the international oil companies have removed almost all of their personnel from the oil sites and will likely be cautious about returning them. The aftermath of any civil war is always very unpredictable and security concerns will remain for some time. There is also a big question mark over the efficiency of the administration and the expected new government structures. Recriminations, vendettas, and even tribal infighting are very likely in the coming weeks and will slow the return to normal working. Even then, the new administration will want to renegotiate many of the oil deals concluded with the previous regime and that also will take time.
It is reasonable to assume that some restoration work will begin within weeks and that the country may rebuild average daily production up to 300,000 – 500,000 barrels by the end of this year. Those are the quick-fix wells. Moving beyond that will be slower and more challenging so that, a return to the previous production levels may take until the end of 2012. But, until the damage is assessed and the security situation seen to have improved, recovery will be slow and any timelines merely speculative.
Saudi reaction. Saudi Arabia is reported to have increased its average daily oil production by almost close to 1.5 million barrels, i.e. from an average of 8.4 million barrels in January to approximately 9.8 million barrels in July. That compares with its agreed production quota of 8.05 million barrels. Most OPEC member countries, especially the price hawks led by Libya and Algeria, will press Riyadh to cut its current production in line with Libyan recovery. The new Libyan government will also press for that reduction as it tries to boost revenues for rebuilding.
Saudi faces a dilemma, actually three dilemmas.
Governments in the importing countries (US, EU, Japan, China, etc) will press Saudi to maintain supply in order to drop the price of crude as low as possible. Their priority is to try and stimulate the global economy with cheap energy.
Saudi is keen to re-establish control its political dominance within OPEC. It suffered a defeat at the last OPEC minister’s meeting when it tried to raise the official quotas and has clearly been brooding over that since. Maintaining its current production for longer, i.e. even as the price of Brent falls, would allow Riyadh to very clearly demonstrate to the price hawks that it calls the shots.
However, balanced against those political factors is Riyadh’s budget requirement. One of the consequences of the Arab-Spring is that the Saudi government has had to raise social spending considerably as it tries to appease one of the largest – and fast growing - unemployed young male populations in the Arab world. What that means is that while the budget balanced with (approximately) $75 p/bbl Brent in 2010, today it needs close to $100 p/bbl (Brent), rising to $110 p/bbl in 2012 according to various reports. The year to date average is above $110 p/bbl so Saudi can live with a sub-$100 p/bbl price for Brent for a few months but not through the winter.
Egypt-Israel. Syria, Yemen and Sudan are not issues for the oil market. Israel and Egypt “may be”. The issue is the November elections in Egypt. The military have control currently and will likely listen to US calls for maintenance of stable relations with Israel. The wild card is whether other political groups will try to cause an increase in cross-border tensions, i.e. as a domestic populist measure, ahead of the November polls. If that were to happen then the oil market (Brent) would be much more sensitive to events than it is to Syria, e.g.
WTI-Brent spread. The loss of Libyan oil certainly led to the record high spread between the two contracts ($26.21 p/bbl on Friday) but the spread was widening anyway and will remain wide for the foreseeable future. The problem is that the WTI contract settles in Cushing, Oklahoma, and capacity at that facility is quite limited. As new oil is produced in US mid-west states, it is piped to Cushing and driving the price lower because of the supply glut. New pipes, to take the oil beyond Cushing to the refineries in the Gulf coast, are under construction, but will only be available later next year. Meantime, truckers taking Cushing oil to the refineries are reported to be making a lot of money. But, the physical infrastructure around Cushing will, more than the mid east supply threats, keep the premium high for the rest of this year, albeit not as high as the recent record.
Trading – Moscow: Moscow’s bourses again followed the international trend yesterday, albeit the weakness in the price of Brent proving to be a restraining factor. The indices closed the session off the day’s high with a 20 basis point gain for the RTS, at 1,578.5, and a 36 basis point rise for MICEX (to 1,443.9). Polymetal was the best of the big stocks as the price again moved with the gain in gold and silver and also on the back of a media report that the company is pushing ahead with plans for a primary London listing later this year.. Rostelecom was also a big mover, closing 5.1% better after it was announced that the government will announce the review of 4G licenses on September 8th. Investors believe that the newest state commercial enterprise is well positioned. VTB bank, one of the biggest losers in the August markets slump, rallied 1.8% while Sberbank ended its MICEX session almost flat.
Trading – London: The London IOB Index of GDRs fared better because of its higher content of high-beta steel names. The Index added 60m basis points with Evraz and Severstal both adding close to 3,5%, albeit with low volume. Polymetal was the star performer with a gain of 6.9%. Partly because of the rising silver price but also because of a report in the media that the company is pushing ahead with plans for a primary London listing later this year. Novorossiisk Seaports had a rare good session, closing 5.3% at least partly in response to the news that one of its major shareholders plans a major investment in Rotterdam.
Trading – New York: US equities opened strongly yesterday on the back of optimism that the Fed may initiate a 3rd QE programme and because lower Brent may act as a growth stimulus for the global economy. But, as the session progressed the fragility of confidence was again exposed and prices slid into the close. The S&P, which was up almost 2.0% at the opening and which was showing a gain of 0.7% as Moscow closed, finally ended the session with only a 3 basis point gain. That reversal was also seen in the Russian ADRs, e.g. Yandex closed off 3.15 and Mechel, which was up more then 2.0% as Moscow closed, ended the day up only 0.5%.
Ruble: The ruble mainly moved with the dollar-euro market. As the dollar edged lower, i.e. with prospects of QE 3, the ruble gained 8 basis points to close the MICEX session at 29.153. Against the euro the ruble lost 13 basis points to close at 41.995.
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