By Andrew Shouler, Editor, Financial Review
Oil prices were already known to contain a risk premium. Now they seem to carry a big speculative premium too. Dr Muhammad-Ali Zainy tells Financial Review that the US's review will probably find some sort of legislative compromise.
There has been a fair amount of talk about the speculative froth in oil prices, and the extent to which this mainstream cost for the importing, substantially OECD or Western, countries has been driven by financial traders. What is your view of that debate? Who are the players in such trading? And does it surprise you that the reaction has not become more political, general and vocal?
The New York Mercantile Exchange (Nymex) is regulated by the Commodity Futures Trading Commission (CFTC), so traders on this exchange cannot follow manipulative practices or excessive speculation since such practices are prohibited by law and regulated by the CFTC. The billions of dollars of the so-called speculators are playing the over-the-counter (OTC) exchanges and the US trading terminals of the London-based Intercontinental Exchange (ICE) trading in West Texas Intermediate (WTI). The OTC and ICE US terminals are unregulated and their dealings are opaque. The players are, therefore, not exactly known to the public, but they include corporate and government pension funds, sovereign wealth funds, large trader banks, hedge funds and other institutional investors.
I believe the reaction to such practices is gathering pace. As the oil price soared, the US airlines, truckers and other shipping companies are calling for a crackdown on financial speculators. It is also becoming more political as the Democrats in the US Congress have proposed legislation to curb speculation in energy trading. The Republicans, however, want to introduce several amendments, including removing the congressional ban on drilling in the US Outer Continental Shelf (OTC); President Bush has already removed the presidential ban on drilling in the OTC. There may also be pressure groups (such as the US pension funds) impeding such legislation.
Before the speculative premium it used to be the risk premium that received most mention, sometimes cited as representing perhaps $20-$30 of the price, even at $100 (Dh 367.3) per barrel. How would you relate that element to the fundamentals of oil pricing currently?
The risk premium would be very little when Opec, the world's swing producer, had ample spare production capacity that would cover any perceived supply disruption. That was the case with the Gulf War in 1991 when Saudi Arabia, more than any other Opec member, had a considerable spare capacity and was able to replace Iraq's exports plus Kuwait's exports when the latter disappeared from the market for a brief period. Tight spare capacity, on the other hand, gives rise to large premiums, which characterises the situation nowadays.
Opec's current spare capacity is barely 2.5 million barrels per day (bpd); about 75 per cent of it rests in one country, that is Saudi Arabia. Given Iran's nuclear issue and the possibility that it might be attacked, Opec's spare capacity cannot replace Iran's present production of over 3.9 million bpd, let alone deal with the potentially disastrous event of closing the Strait of Hormuz through which around 40 per cent of the world's oil trade passes. There is definitely a pronounced risk premium now, which itself partially fuels speculation.
To the extent that it has become part of the political arena, for instance in Congressional hearings in the US and parliamentary scrutiny in the UK. How do you interpret that attention and reaction and where it might lead?
Burning fossil fuels emit carbon dioxide (CO2), which is a greenhouse gas (GHG) that contributes to global warming, although the world is not absolutely clear whether the global warming phenomenon is entirely due to the emission of GHGs or a recurring one in the earth's past history. CO2 emission, however, has to be curbed, whether through the Kyoto Protocol, emissions trading or some other system. To curb the world's dependence on fossil fuel in general, energy conservation should always be pursued and improved, and research has to continue in earnest for the development of economically viable alternative sources of energy. The ongoing efforts in this direction are not too little and it is never too late.
If strong global demand trends for hydrocarbon-based energy is presumed, what trends do you foresee on the supply side, particularly from the Middle East? What price expectations and perception of the strategic dimension do you have in this respect for the medium term?
The onus will fall on Opec supply in case of a strong global oil demand trend. And out of the 12 members of Opec, only Saudi Arabia, Iran and Iraq promise oil supplies that would meet any expected strong demand, given their present proven reserves of 264, 138 and 115 billion barrels respectively. Strategically speaking, there could be a scramble for oil supply security between the rising Asian economic giants: China and India on the one hand and the United States and Europe (to a lesser degree) on the other hand.
Do you agree with the pundits who say that oil prices will now remain high indefinitely? It is not so many years that they dropped into single digits, and for many years they stayed comparatively low, without any expectation of a climb, let alone rocketing ascent. What other themes or factors do you think should be borne in mind about the current situation, and future?
The situation now is different, as there has been a major structural change in the market. The price increases from 2002 and afterwards were, essentially, demand-led. Demand increments, caused by emerging markets (led by China) are still on, albeit with lower volumes. Non-Opec supplies are practically stagnant, and will increase only slowly and modestly as there aren't North Seas or Alaskas anymore. The Arctic potential supplies will need a long time to materialise, and by then world oil demand will have increased too.
Opec will remain with a relatively small spare production capacity, and world refining conversion capacity is currently very tight and may remain comparatively tight even with the addition of new capacity in Asia and the Middle East, given that the marginal Opec supplies are mostly heavy crudes. I have already mentioned above that oil sands, being a marginal supplier, are putting a price floor of $70 per barrel (about Dh257.1). Even if additional non-Opec supplies start pressuring the price downwards, I do not think that Opec will accept a price below the range of $70-$80 per barrel. Opec will move to cut production.
- Interview by Andrew Shouler, Editor, Financial Review.
Last week, King Abdullah of Jordan became the first Arab head of state to travel to Baghdad since the 2003 war. From there, he urged his fellow leaders to re-engage with Iraq, calling it a "source of strength for the Arab nation".
What took him there, five long years after the fall of Saddam Hussein, might have been, in part, Jordan's economic needs: being on good terms with Iraq guarantees a recently agreed deal to provide Amman with discounted Iraqi oil.
But there was more to it. The trip underlined a new diplomatic trend: in recent months several Sunni Arab states, including the United Arab Emirates, Kuwait and Bahrain, have announced the reopening of their embassies in Baghdad and named new ambassadors for the first time since Egypt's envoy was assassinated in 2005.
Sheikh Abdullah bin Zayed al-Nahyan, the UAE foreign minister, became the first top Gulf diplomat to visit Iraq this summer. His trip was followed by the little-noticed arrival of Saad Hariri, head of Lebanon's main Sunni party. He travelled to the Iraqi capital and Najaf, the Shia holy city, where he met Grand Ayatollah Ali al-Sistani, the highest religious authority.
The road from Arab capitals to Baghdad is still slow and bumpy. But, driven by fear that a US withdrawal from Iraq will pave the way to even greater Iranian influence in a leading Arab state, it is a belated recognition of the Shia government in Baghdad and of the need to promote Shia-Sunni reconciliation more vigorously.
Jordan's monarch was the first to warn, in 2004, of the rise of a "Shia crescent", an unfortunate comment that infuriated Iraqi officials. Realising he might have fanned the flames of sectarianism, the king tried to take back his words, sending his aides to deny he uttered them, and to reinterpret their meaning.
But his words stuck for two reasons. They were an expression of the paranoia of Sunni Arab states about Iran's growing role in Iraq, Syria and Lebanon, and a symbol of Arab impotence at the shifting balance of power that the US had created by toppling the Sunni Ba'athist regime.
However, in the time since the king made his remark, Sunni Arab states have reinforced their irrelevance through a misguided diplomatic isolation of Iraq. Although the demise of Saddam Hussein had been a boon to his neighbours, Sunni-dominated Arab regimes have never come to terms with the rise of Iraq's majority Shia, or the fact that Baghdad had become a friend of Iran. They have entertained the fantasy of a return of a Sunni strongman or hoped that a secular Shia would take over, no matter that such a leader could not win an election.
As they have lamented the marginalisation of the Sunni minority, they also increased pressure on the US to ensure the Sunni's reinsertion into Iraqi politics. They ignored Iraqi officials' arguments that embracing the Shia administration was the best way to secure a voice in Iraq and check Iranian influence. Instead, the Arabs backed the Sunni. As Iraq began its slide into civil war the Arab states found themselves threatened with a regional Sunni-Shia struggle.
Fortunately, this attitude is changing. After dismissing Nouri al-Maliki, the Iraqi prime minister, as a puppet of Iran, some Arab officials now praise him for taking on Shia militias. Hinting that the Iraqi government might be more independent than was first assumed, one senior Arab official tells me that he now sees a rare opportunity to bring Iraq's Shia government back into "the Arab fold". Winning back influence in Iraq is more urgent, he says, because Iran has expanded its influence in another Arab sectariar hotspot, Lebanon, where Tehran's ally, the Hizbollah group, has won a greater political role.
But the Arabs' return to Iraq is still hesitant. Mahmoud Ahmadi-Nejad, the Iranian president, went to Baghdad in March in a media blitz. In contrast, the Jordanian king's visit was announced only after he had departed, in a sign of the continued Jordanian concerns about security.
Worryingly, Saudi Arabia has been flagrantly absent from this tentative wave of engagement. The Saudi regime is apparently still holding a grudge against the Maliki government. Yet it is difficult to see how Arab states can be serious about renewing ties with Iraq without the participation of the Saudis.
To contribute to Iraqi stability - and reassure Iraqi Shia that this is indeed the intention - Arab governments' diplomacy has to be more dynamic and convincing. Cancelling all of the debt Iraq owes to its Arab neighbours, for example, is long overdue. Saudi Arabia, for one, has yet to make that move.
Most important, Arab states have to maintain realistic expectations. It would be foolish to expect Iran's influence to dissipate. The Islamic regime - which fought an eight-year war with Iraq in the 1980s - has unparalleled relations with a whole range of Iraqi groups (Kurdish as well as Shia), which it cultivated during decades of Ba'athist oppression.
The aim of embracing Iraq's Shia-led government is to strengthen it so that it can govern the country and stand on its own feet. For that to happen, Iraq needs national reconciliation between its various communities above all. Arab states' contribution should be to encourage dialogue between Iraq and its neighbours as much as between Iraqi parties.