That Was the Decade That Was: the long view

In looking back at the past decade, most commentators have forfeited any meaningful narrative in favor of the proverbial 'better luck next time.' But if the following trends are taken in toto, the past decade in the markets looks downright revolutionary:

-The S&P500 fell 24%, its worst performance since the 1930s, FTSE down 7.3%, DJIA down 9.3%, Nikkei down a massive 44% over the past ten years. Contrast that with the major emerging markets: Russia's Micex index hit the moon with an astounding 802% rise, Brazil's Bovespa jumped 301%, India's Sensex rose 249% and the Shanghai Composite closed 140% higher.

-The benchmark Nymex crude oil contract ended the decade up 210%, but the story in between is among the most volatile in memory. Oil closed out 1999 at $25.60 a barrel, hit $147.27 in July 2008 and ended 2009 at $79.36.

-Spot gold closed the decade up 281%, while copper ended 290% higher.

-Two major stories in the currency markets: the dollar's long decline and the euro's rise to viability. The dollar ended the decade down 23.5% on a trade weighted basis, while the euro gained 43% on the dollar.

So what can we extrapolate from the data above? The 'rise of the rest' is the defining trend of the past decade; loose monetary policy contributed to a great capital flight from developed market equities; the dollar's long relative decline has eroded the US' influence internationally and will shape the coming decade as much as any other trend (politically, financially and economically); emerging market industrialization made commodities a really, really good bet; and precious metals retained their mystical aura in uncertain times.

If you ask people in China, India and Brazil for their impressions of the past decade, I suspect you'll get a more positive consensus than 'good riddance.'

A decade in the markets

The FT has, as usual, fantastic graphs charting the course of different major markets over the past decade.

From the tech bubble to the great credit crunch, this has been a bumpy ride indeed.

The Great Supply Crunch

Take no false comfort, The Economist warns of the coming oil price spike.

I have been arguing since the fall that we are experiencing but a lull; the long term trends and short term pressures contributing to oil's remarkable rise in 2008 remain firmly in place. The Economist lays out the argument in a succinct and comprehensive manner:

The explanation is simple. Oilmen are worried because they believe that many of the factors behind the record-breaking ascent last year remain in place. Much of the world’s “easy” oil has already been extracted, or is in the hands of nationalist governments that will not allow foreigners to exploit it. That leaves firms to hunt for new reserves in ever more inhospitable and inaccessible places, such as the deep waters off Africa or the frozen oceans of the Arctic. Such fields take a long time and a lot of expensive technology to develop. Worse, new discoveries tend to be smaller than in the past and to run dry faster.

So oil firms must work doubly hard to replace declining fields and to increase output. As Francisco Blanch of Merrill Lynch puts it, they must find another Saudi Arabia’s worth of oil every two years just to maintain their production at today’s levels. Yet the oil industry is short of equipment and manpower, thanks to decades of underinvestment in the 1980s and 1990s, when prices were low. That left it struggling to expand despite the strong price signal of recent years, and thus poorly positioned to cater to vast new markets in the developing world, including China and India, where oil consumption has been growing fast. At the height of the boom, with the price repeatedly setting records, production outside OPEC even fell.

As soon as the world economy starts growing again, the theory runs, demand for oil will once again outstrip the industry’s ability to supply it. The seemingly ample cushion of inventories and spare capacity will quickly be exhausted, sending prices soaring. In other words, the global recession has only interrupted the “supercycle” of which many analysts used to speak, during which the normal boom-and-bust cycle of oil and other commodities would give way to a protracted period of high prices, as ever-growing demand from emerging markets swallowed everything the extractive industries could produce. “The commodity supercycle is not over, just resting,” says Mr Blanch.

It is important to note that a number of factors can help mitigate this super-cycle: technological innovation, cap and trade and fuel efficiency standards in the world's largest and emerging economies, a prolonged demand slump in the developed world, the conversion of vehicles and mass transportation systems to natural gas, to name but a few. But the underlying demand, reserve and production trends will sustain oil's steady rise.

The Great Supply Crunch is coming.

Chile's Lesson for Emerging Markets

In a sharp contrast to some of its neighbours, Chile appears to be a model of economic responsibility. Borrowing lessons from Norway, the Chilean government has been stashing away the revenue generated by its abundant natural resources (especially copper) and is now using those stashes to help ride out the recession & commodity bust.

As the article explains, Finance Minister Velasco's policies to save up during the commodity boom were extremely unpopular. Now, as he uses his stored up cash to stimulate the economy and give handouts to impoverished families, he has become one of the most popular ministers in the country. This story is the mirror image of events in countries like Venezuela, which spent its commodity gains during the boom and is now left with little to cushion to economy in the downturn.

But this isn't just a story of "Chile: smart, Venezuela: stupid." Argentina's government tried to tax its commodity growth but was prevented due to popular opposition, so clearly there are political forces at work. I'm ignorant of most things Latin America, so let me ask you readers this: what is it about Chile's political structures/environment that provided the space for policymakers to implement responsible economic policies? And why is the opposite true for its neighbours?

Quote of the day

From Algerian energy minister Chakib Khelil, expressing OPEC's disappointment at Russia's unwillingness to cut supply along with the oil cartel:

“Of course we are disappointed...Wouldn’t you be with your neighbour if you were cleaning in front of your house and he was pouring down dirt.”

Oh, snap!

That Was The Week That Was

Politique
-As the financial crisis rolls on, the next phase of government (re)action is developing: US House approves an $819bn stimulus package (with a certain provision we don't like very much) and the FT reports that Obama will unveil a "Big Bang" package of banking/financial/housing reforms this week (now next), Harper's minority government unveils a federal budget that includes the country's first fiscal deficit in over a decade, Merkel has reportedly settled on a plan to create government-backed "bad bank" vehicles to clean up balance sheets, and Aso unveiled his own stimulus package under considerable opposition (he also pledged $17bn in aid to other Asian nations).

-62% of Bolivian voters approved a new constitution in last Sunday's referendum. The new constitution increases the government's control over strategic industries (including natural resources), strengthens indigenous rights, and furthers land reform. Despite the popular majority, 4 of the country's 9 provinces voted against the changes.

-North Korea voided all political and military agreements with the South this week, as mounting tensions on the Korean peninsula threaten all out military conflict. While Kim's motivation is unclear, a few theories seem plausible: 1) he is pushing his way onto Obama's agenda, 2) he is provoking an international crisis to stem any internal revolt amid his ailing health, 3) he has lost control and hardliners are their authority over foreign policy.

-Social and political instability is spreading across Europe: Iceland's government fell, massive strikes paralyzed France, and British workers walked off the job to protest the use of foreign workers amid rising British unemployment. Nationalism, protectionism, and industrial action are all on the rise.

-Iraqis voted in provincial elections. Despite a lower than hoped turnout, the elections were peaceful.

Economia
-The IMF reduced its global GDP forecast for 2009 to 0.5%, and the global economy shed over 70,000 jobs in one day.

-Sterling had a small recovery this week on a slight confidence jump in UK banks, the Euro slipped amid eurozone economic weakness and lack of faith in the ECB, and the USD and Yen both endured "rollercoaster" weeks.

-Exxon Mobile reported record earnings for the 4th quarter. The Lex column in the FT praised the company for "generating free cash flows as others invested" during the good times, positioning itself to pick off rivals and acquire assets in the bad. This conservatism has acted as a hedge against the rapid fall in prices.

The Rest
-In the Prem, ManU go 2 clear with 1 in hand, Liverpool score 2 late to take all 3 from a 10-man Chelsea, and Arsenal throw up a big 0 at home against West Ham. Elsewhere, Becks scores his second for Milan as speculation mounts over his return to LA.

-In tennis, Nadal beat Federer in 5 for the Australian Open title. Rafa's performance was simply incredible, coming less than 48 hours after his Australian open record 5 hour, 14 minute semifinal match against fellow Spaniard Fernando Verdasco. Many took Federer's uncontrollable tears in the post-match ceremony as a sign that even the Swiss great doubted his ability to ever beat Nadal again in a major final and catch Sampras' record 14 major titles.

-In Olympic swimming, Oops!

-While much of the fashion world has been tailoring collections to reflect our dark economic times, these designers look to color.

-Move over Highlander, meet Turritopsis nutricula: immortal jellyfish.

House passes "Buy America" clause, EC takes notice

On Wednesday I poked fun at the hypocrisy of Vladimir Putin's Davos speech. Despite this, his warning on the dangers of protectionism should be heeded by policymakers, particularly in the US, especially now.

The US House yesterday passed the $819 billion stimulus package, known as the American Recovery and Reinvestment Plan (I love the use of the word "reinvestment", you just know it focus-grouped so much better than "exploding deficit"). The vote was along party lines; not a single Republican voted for the package. The debate over the contents and balance of spending/tax cuts is endless, and I won't wade into those waters here. But I am very troubled by one aspect of the bill: the now notorious "Buy America" clause (which, I must boast, I was all over from the beginning). What at first looked like a shameful attempt at backdoor protectionism, is now officially on the table. It passed.

We know that the House version of the bill is different from the one the President will ultimately sign. It is likely that many of the "pork-lite" programs will be shed to deflect widespread criticism over their relevance to the immediate economic crisis. But in all the partisan back and forth, I have yet to hear a passionate criticism of the "Buy America" clause. The Republicans are more outraged by $335m in funding for sexual health education and prevention programs. The silence on "Buy America" is dangerous and increases the likelihood that the clause remains in the final version. It also provides a fundamental test of Obama's trade policy, whatever that might be. Megan McArdle and Dani Rodrik agree.

Luckily, the European Commission has a bit of a problem with "Buy America" (Canada too). Peter Powers, Commission spokesman, warned, "If a bill is passed which prohibits the sale or purchase of European goods on American territory, that is not something we will stand idly by and ignore." Furthermore, the European Confederation of Iron and Steel Industries (Eurofer), a powerful lobby representing over 370,000 EU workers, has called on the EU to bring it to the WTO, saying, "Our view is that if passed this would be a clear violation of their WTO commitments on government procurement rules", and, "It is a protectionist measure which goes against the commitment made to the G-20 to keep markets open."

Dave was spot on when he said of this rising protectionism, "the real danger is that tariffs/bans on stuffed kittens and fancy cheese are the first snowballs that kick off an avalanche of protectionism that smothers trade and damages geopolitical relations." But what if that avalanche is exactly what we need? Could "Buy America", cheese duties, and stuffed kitten tariffs be the sparks that finally break the DDA deadlock? A rapid deterioration in the trading system could compel leaders to look past the modalities and embrace the central role of trade in saving the global economy.

Maybe. We've learned that a crisis is often necessary to force policymakers out of their comfort zones and stand up to powerful interests. At the very least, a little pressure from the across the Atlantic might bring US policymakers to their senses.

UPDATE: The FT reports that the "Buy America" clause is not present in the current Senate bill, but Senators like Sherrod Brown of Ohio are pushing for its inclusion. I mistakenly assumed it was.

(Photo: funkandjazz)

Figures

- 440%: roughly the amount of debt-to-GDP that the UK would be taking on should they move to nationalize their major banks. This would be in addition to projected deficits of around 10% of GDP. (Maverecon & NYT)

- 6.8%: China's year-on-year growth rates in Q4, compared to 9% in Q3 and the lowest in seven years. How do you say "hard landing" in Mandarin? (RGE Monitor)

- $450 billion: the total value of assets shed by the hedge funds last year, equivalent to 37% of the industry. (Bloomberg)

- 5 million tonnes: the amount of rice that Thailand is considering selling from its stockpile, or 20% of the world's annual trade in rice. Depending upon how it is managed, a sell-off of this size has the potential flood the market and lower the price significantly. Good news for importers of rice, surely; less good for rice farmers. (Financial Times)

- 3: the number of times I've listened to/read Barack Obama's innauguration address. I cannot pick out a better line than the one Rory has chosen below, but two more sections deserve special attention:

"...we reject as false the choice between our safety and our ideals"

"Starting today, we must pick ourselves up, dust ourselves off, and begin again the work of remaking America"

Yes. And the same goes for the rest of us.

Quick hits and pink picks

-David Hale believes the dollar rally is overdone, and argues in the FT that gold, not the euro, will be the short term alternative to the greenback (and inflation hedge of choice) in 2009.

-FP Passport looks at the new American Embassy in Baghdad. Once, US embassies housed cultural centers, English-language libraries and social spaces for the local population. Now, a really high wall and a whole lot of concrete. Architectural historian Jane Loeffler: "If architecture reflects the society that creates it, the new U.S. embassy in Baghdad makes a devastating comment about America’s global outlook."

-Samuel Huntington, giant of political science, died on December 24th at age 81. Huntington's 1993 essay in Foreign Affairs, "The Clash of Civilizations" (later expanded into a book), sparked a global debate on international conflict, religion and the nation-state that still rages today. I have been struck recently by the number of non-IR/IPE people who have not read the essay, especially among those critical of its thesis. It can be found here, and I strongly encourage a (re)reading.

The slippery slope to protectionism or How to create your own depression

The interwar period is a fascinating "topic" in IPE. Scholarship on the period is vast, offering multiple explanations for the trends, events and ideas that contributed to the Great Depression and WWII. Some of the great thinkers in IPE (such as Kindleberger, Eichengreen and some guy named Bernanke) have contributed to the analysis of the period.

The interwar period is studied so closely because it provides lessons on how NOT to respond to economic contraction and financial crisis. If this history is any indication, protectionism should be avoided like the plague. The Smoot-Hawley tariff set off a change reaction of protectionism from 1930 on that plunged the world much deeper into depression. While a global (meaning British and American) consensus on trade was unattainable immediately following the war (see ITO failure), the GATT succeeded largely due to the Anglo-American recognition that tariffs were dangerous to economic recovery, prosperity and peace itself.

Over the next few weeks, the Obama transition team and US Congress would do well to brush up on their interwar history. The US steel industry, after years of benefiting from illegal subsidies, are reportedly lobbying in favor of a massive public works plan that would have a "buy US" provision inserted into every project. This would conceivably require the recipients of federal funds for public works and infrastructure projects to purchase US steel.

The proposal is troubling on a number of levels. For one, it would prove that the TARP was but the tip of an iceberg of government subsidy. Banks, autos, steel...where does it end? Second, it underlines the risks posed by the DDA's failure. WTO and G20 indecision in the face of rising protectionism risks exactly the domino effect that Smoot-Hawley accelerated nearly 80 years ago. Finally, a "buy US" clause would be a dangerous precedent for the President-elect to set. Many are already skeptical of his commitment to a liberal trading system, and early support for such backdoor protectionism would do little to burnish his trade credentials internationally.

Vice-President elect Biden believes that to be credible and effective, the Economic Recovery Plan must be "pork-free". It is equally important that it avoid the kind of backdoor protectionism the US steel industry is lobbying for.

Here we go again...Gazprom to cut gas deliveries to Ukraine

Natural gas negotiations between Russia and Ukraine collapsed Wednesday, with Russia preparing to cut gas deliveries tomorrow. This would be the second time in 3 years that Gazprom has cut deliveries to Ukraine over a price dispute, in turn threatening supplies to the EU. Ukraine is the EU's major transit route for gas deliveries, with over 80% of the bloc's external gas supply traveling over its territory.

The latest Russo-Ukrainian gas row is a reminder that despite the current (low) price levels, energy security remains a major issue, particularly to countries with heavy reliance on external supplies. It may also presage a more aggressive Kremlin in 2009, one that seeks to renegotiate gas contracts (particularly with former Soviet republics paying below market prices) with more frequency and adopts a less compromising position.

As Russia's budget comes under greater pressure, the rouble is devalued further (by as much as 10%, as many economists believe is necessary to account for the loss of petro/gas revenues, a cut the Kremlin has resisted with all of its will) and political unrest rises, the Kremlin will struggle to prop up the Russian economy. It will almost certainly turn to its energy leverage to plug the shortfall and boost spending.

Putin's authoritarian consolidation and economic nationalism have relied on a middle class complacency derived from petro/gas riches. The boom years were financed by the commodity bubble. Over this period the Russian government failed to adequately diversify, liberalize and modernize its economy. This made the Kremlin overly reliant on companies like Gazprom for tax revenues (and spending). Due to excessive state intervention and legal uncertainty, particularly when dealing with foreign investors, Russian industry became overly reliant on the Kremlin for finance and favor. What developed was an economy fundamentally underpined by high commodity prices. This house of cards was always vulnerable to a price collapse. Now that its here, the tight societal weave of Putin's Russia is starting to fray. It is unclear whether Putin/Medvedev are prepared to mend it.

Russia's resurgence has as much to do with oil and gas as it does with Putin. The major question for Russia in 2009 is: how does Putin respond?

That Was The Year That Was: Economia

IPE Journal looks at the economic events that defined our socio-political landscape in 2008, the year of the subprime.

- In The Beginning there was Northern Rock - nationalized in February by the UK government following a good old fashioned bank run. Following heavy losses in the subprime mortgage market, Bear Stearns was next to go: in March, the once-proud investment bank was sold to JP Morgan for pittance. In July, IndyMac Bank went into receivership.

- September Madness. Over the course of a few short weeks, the magnitude of the crisis hit home (so to speak) as financial giants fell like so many martini-and-oyster fuelled dominos. The highlights:

• Freddie and Fannie are taken over by the US federal government
• Merrill Lynch is sold to Bank of America
• The Federal Reserve offered loans to AIG and took an 80% share in the company
• Washington Mutual is seized by the FDIC
• Morgan Stanley and Goldman Sachs become traditional bank holding companies, bringing the era of independent investment banks to a temporary close.
• And Lehman Brothers - in what now appears to have been a hugely significant decision, Lehman Brothers was allowed to fall into bankruptcy and the credit crunch prompty shifted into a higher gear.

- Keynes returns from the wilderness. The collapse in consumer demand has led governments across the globe to initiate fiscal stimulus programs. The sheer rapidity of this about-face in policymaking is breathtaking. We've come to expect such measures from the likes of France and Sweden, but from the UK, US and (gasp!) Germany? Keynes was wrong on many counts and his proclaimed followers even more so, but Keynes' insights on the role of government during economic downturns have gained a new lease on life. For better or worse, the impact of government spending programs and fiscal guarantees will be a defining feature of 2009.

- Price of oil $140 -> $40. A May 5th Goldman Sachs report predicted oil would break $200 within 24 months. Ok, still possible, but six months later the commodity bubble had burst in spectacular fashion and oil was trading under $40 a barrel. The explanations for the remarkable run up in commodity prices of recent years are manifold: historic emerging market growth, global demand, dollar weakness, financial speculation, etc. The price apex was as much about psychology as it was fundamentals, what Donald Rumsfeld would eloquently call the realization of "known unknowns". The "peak oil" moment came in the minds of consumers, politicians and traders across the world, only to be swiftly disregarded as global demand collapsed. Even repeated OPEC production cuts couldn't halt the slide into 2009. Commodity countries from Russia to Mexico are feeling the pressure, with devaluations and political instability on the way.

- Dollar down, up...down? It is awkward to speak of benificiaries of the financial crisis, but the US dollar was exactly that in 2008. By the end of 2007, there was a growing debate over whether the dollar had entered into a sustained relative decline vis-a-vis the Euro, with many concluding the common currency would soon eclipse the greenback's status as primary global reserve currency. The credit crunch had undermined confidence in the US financial system, and hot money ran wild through commodity currencies and emerging markets. But then financial crisis accelerated, and the commodity bubble burst, and investors sprinted to the safety of US dollar. It hit multiyear highs against sterling, the Euro, and a slew of emerging market currencies. Looking ahead, the outlook for dollar appears decidely weaker in 2009. The massive spending plans of Barack Obama and easy money Fed will weigh on the gains of the past year, especially vis-a-vis the Euro and Yen. But the dollar will likely retain its strenght v. emerging market currencies and sterling, as investors continue to find security in the greenback and the UK falls into the abyss.

Notable economic events which could have shaped the course of our year [Update: for the better], but failed: WTO talks & the G20 meeting in November.

***Co-written by Rory Doyle

Quick hits and pink picks

-The FT bids adieu to the commodity super-cycle.

-In lost in translation news- a German science journal, wanting some pretty Chinese characters for its cover, inadvertently publishes an ad for a Macau brothel.

-The Guardian's Andy Beckett looks at London Mayor Boris Johnson's first 6 months in office. His verdict? Bad for Boris. ("Bad for Boris" would be a great band name, like the incredible "Someone Still Loves You Boris Yeltsin". Has there ever been a better name than that?)

-The NY Times charts the "Hidden Travels of the Atomic Bomb".

-Finally, Gordon Brown's Superman complex:

A better way to look at the world

I've been meaning to post this since hearing a piece about Worldmapper on NPR a couple of weeks ago. Worldmapper has created a selection of maps, published in the new book The Atlas of the Real World, that proportion countries according to different demographic and economic categories. The maps are intended to challenge common perceptions of space, size and power. A selection below:

Crude Petroleum Exports, 2002

Internet Users, 2002.

Finance and Insurance Services Exports, 2002

Quick hits and pink picks

-John Thain wants his 2008 bonus, reportedly $10m. Two ways to look at this: 1) his social and political thermometers are broken, or 2) he deserves it. Despite all of his misleading statements on the health of Merrill Lynch and role in its eventual acquisition by Bank of America, he did secure the sale of the firm at $28 a share. Remember what Bear went for? My take: I recognize point 2, but agree with point 1. He's insane for asking, and his compensation committee would be crazier to approve. UPDATE: Apparently, someone told him this whole bonus demand was a bad idea, because he no longer wants it.

-The FT has an interesting article on today's elections in Quebec. The economy trumps sovereignty, a good sign for Liberals.

-The Pulitzer Prizes have expanded to cover online only publications. IPE Journal submits itself for consideration.

-Petroleum Intelligence Weekly has released its influential annual rankings of the world's top oil companies. The report highlights the increasingly marginalized position of the traditional private oil majors, and growing global market dominance of majority state-owned companies. This trend towards nationalization and state control of increasingly scarce resources has a number of powerful implications.

Is the EU finally serious about its energy future?

Find out here...

IEA Report, Russia/China pipeline agreement, and the European Energy Security Plan

A number of important developments in the global energy markets over the past few weeks:

-an IEA report finds that the world's oil output is declining at a rapid pace. The annual rate of decline is projected at 9.1% without a substantial increase in upstream investment. Even after recent investment, output from the world's largest oil fields is falling by over 6%. As my analysis of Russian energy production highlighted, an increase in upstream investment is neither easy nor probable. Falling global demand will only lessen the incentive to invest more in production. With little excess capacity, and OPEC voluntarily cutting production (potentially by millions of barrels of day more in the coming months), the global oil markets risk renewed volatility when demand recovers.

-Russia and China signed a landmark oil pipeline agreement on October 28th. The addition to the East Siberia-Pacific ocean trunk pipeline could ultimately carry up to 15 million tons of Russian oil to China per year. The agreement is significant on two levels: it signals Russia's desire to pursue the "China alternative", and it could portend a greater financial role for China in Russia's energy sector.

-finally, we might look back on October 13th as the beginning of a new era in European energy. The Times of London is reporting that the bloc will announce a European Energy Security Plan. The plan calls for: 1) the construction of a European supergrid, connecting power grids from North Sea wind farms to the Baltics, 2) the construction of two new gas pipelines, connecting Caspian and African gas to the bloc, and 3) a "Community Gas Ring", which would essentially allow for the pooling of European gas supplies in the event of supply disruptions. These measures will directly address import diversification (particularly in natural gas, and specifically away from Russia), security of supply issues, and fragmented national power grids.

This is a highly ambitious plan, and in my opinion, one that has absolutely no chance of being carried out in its entirety. The pipelines just aren't commercially viable yet. Furthermore, the national regulatory and interest-group challenges to EU-wide liberalization in the energy sector are formidable, and to date have blocked any substantive effort towards a single European energy market. The political will simply isn't there in France/Germany/Italy, and national interests always trump regional considerations in European energy. Despite my pessimism, the Plan is an important development, if for only one reason: it coincides with the resumption of talks between the EU and Russia over their economic and energy relationship. It looks like the EU may have finally come around to playing hard ball with Russia, and utilizing its leverage over Russian security of demand. Stay tuned for updates on these discussions over the coming weeks.

That Was The Week That Was

Economia
-Global stock markets crash. For the week: Dow -18.2%, FTSE -21.0%, Nikkei -24.3%, Hang Seng (Hong Kong) -16.3%, Jakarta -21.0%, Moscow -19.0%. Trading was suspended multiple times in emerging markets from Indonesia to Russia.

-Some perspective from the FT: at its low point yesterday, Dow was -23.64% for the week. During the crash of 1929, Dow's lowest weekly point was -23.62%.

-US oil futures fall to lowest level since October 2007. IEA forecasts slowest global demand growth in 15 years. OPEC calls emergency meeting, with oil approaching their perceived price floor of $80 a barrel.

-Extreme volatility in the global currency markets. Flight to safety boosts USD and JPY, commodity currencies like AUSD and NZD plunge. If you own Icelandic krona, buy a furnace.

Politique
-As global markets burn, G8 leaders squirm. Utter lack of coordination, mixed messages, and Berlusconi's insanity compound financial turmoil.

-UK government announces 400bn pound bail-out; effective partial nationalization of entire banking sector marks most decisive action to date by major financial power.

-IMF announces emergency lending facility for emerging market borrowers, first since Asian financial crisis. Proclaims "decoupling" theory rubbish.

-Ukraine's president Viktor Yushchenko dissolves parliament following (final?) collapse of ruling coalition. Power struggle ensues.

The Rest
-Martti Ahtisaari, former president of Finland, wins Nobel Peace Prize "for his important efforts, on several continents and over more than three decades, to resolve international conflicts".

-Major European countries, including France and Germany, call for easing of EU climate targets in light of eurozone recession.

-UEFA president, and epic blowhard, Michel Platini targets England's football clubs over debt and foreign ownership, threatens exclusion from Champion's League. Big-4 clubs laugh, dominate Champions League again.

-As if traders hadn't lost enough, CNBC reporter Rick Santelli finds this on the floor of the Chicago Board of Trade.

-Monkey waiters hit Japan. Japan becomes greatest place on earth, tops Rory's bucket list.

-Latest 2008 US election, Canadian election numbers.

OPEC cuts production...Saudi ignores?

A truly interesting development out of Vienna this evening.

OPEC surprised markets this morning by announcing a 520,000 bpd cut in production. This reflected the concerns of certain members (Iran, Algeria) over the recent decline in commodity prices amid falling demand and the unwinding of financial positions. However, reports are that almost immediately the Saudis (who opposed the cut) were assuring markets that they would not abide by the decision.

This internal split is many years in the making, and reflects the competing interests/viewpoints within the cartel (essentially, Saudi v. all). Because of the Saudi position, markets largely shrugged off the announcement, believing that the kingdom would maintain current production levels.

These developments got me thinking: Does OPEC really matter anymore?

Since the oil shocks of the 1970’s, OPEC has been the dominant actor in the global oil markets. Currently, OPEC produces approximately 40% of global supply, and possesses about two-thirds of the world’s proven reserves. OPEC has also historically provided the spare capacity required to respond to demand spikes and shocks to the global system.

However, in recent years the cartel’s market power and influence has waned. Official statements like the one this morning have failed to calm traders, stabilize record price volatility, or move markets. Two particular measures of OPEC’s influence highlight its declining influence: as a provider of global spare capacity, and as a price setter.

As non-OPEC production growth has failed to keep up with accelerating global demand, OPEC has increased production to cover the shortfall. As a result, the cartel’s spare capacity has diminished. Most OPEC members (with the exception of Saudi Arabia) are now producing at near total capacity. In an environment of heightened political instability in oil producing regions, poor refining capacity, and robust Chinese and Indian demand growth, OPEC lacks the short-term flexibility to stabilize volatile prices. This decreases its authority and influence in the global market.

Like spare capacity, OPEC’s ability to set the price of oil has declined markedly. A number of factors have contributed to this change:

First, rapid demand growth across the developing world has increased supply concerns. The emergence of powerful new consumers in Asia has compounded fears that decades of underinvestment will result in a significant supply shortfall in the coming years. OPEC’s capacity to meet this rising global demand is in doubt.

Second, the growth of both regulated and unregulated over-the-counter exchanges has led to a massive increase in the amount of so-called “paper-barrels” traded. Consequently, financial speculation has become an important driver of the spot price. This diminishes the impact of OPEC production/quota changes on short-term prices. For example, Saudi Arabia’s recent announcement that it was increasing production by 700,000 bpd barely registered on the exchanges.

Finally, political instability in the Middle East has had a significant impact on the price of oil over the past 5 years. Instability in Iraq and Lebanon, the Iranian nuclear issue, and the threat of terrorism have all contributed to record price volatility. OPEC’s inability to ramp up production in response to politically-related price spikes affirms its diminished capacity.

While no longer the market mover it once was, OPEC remains the single most important actor in the global oil market. The fact that the cartel possesses the majority of the world’s proven reserves guarantees its staying power. Non-OPEC production is forecasted to decline rapidly, as alternative fields are geologically complex and difficult to operate. Russia, the world’s second-largest oil producer, last year witnessed its first year-on-year production decline in over a decade. The key challenge OPEC faces in the coming years may be its own internal disagreements, as reportedly playing out today. Despite these differences, the Saudis have always exercised leadership by adjusting their own production disproportionately to accommodate the self-interested actions of other members. As long as the Saudis retain the will to lead, overall unity should prevail.

Thus, while it no longer dictates the global oil market, OPEC remains an important actor whose influence should increase again in the coming years.