As various companies go hat in hand to Washington for a bailout, a recurring topic is what guaranty do the taxpayers get that they're not just throwing more money down a hole. Good question. Who wants warrants or preferred shares if the company is doomed anyway? What you're seeing take place are negotiated backstops between the US Government and pools of capital. A couple of examples:
The Big 3 may get a bailout. Financially the US taxpayer will get a stake - in what will surely be radically reshaped companies. Citibank just got a large infusion from Saudi Arabia's Prince al-Waleed bin Talal al-Saud - just days before a US government orchestrated rescue helped rocket the share price. Maybe these are just coincidental moves. Maybe not.
What we're witnessing isn't finance or investment as usual. We're watching a shift to a managed economic structure, where government officials determine who will live and who will die. It's a shift from investments to agreements, where having access to large pools of ready cash is the ultimately persuasive argument. And lacking access means doing whatever you're told.
I've long been encouraging you to read George Friedman's work at Stratfor, but it becomes more important every day. Stratfor is producing a series on Countries in Crisis, and I've enclosed the latest piece which is the exception to the rule, the Gulf Cooperation Council countries. This series is a fascinating look at how those with the gold get to make the rules. Unless you've got your own sovereign wealth fund, you'll probably want to read it...
As you're structuring your own portfolios, understanding the geopolitical drivers behind where the markets are going is now more important than ever. Because these insights are so important, I've arranged a special deal for you on a Stratfor Membership which also includes a free copy of George's new book, The Next 100 Years. Click here to take advantage of this offer today. These are the drivers for the coming year, and I encourage you to factor them in today.
Yours,
John Mauldin
GCC States: Eyeing Opportunities in the Global Financial Crisis
By George Friedman
Editor's Note: This article is part of a series on the geopolitics of the global financial crisis. Here we examine how the global financial crisis will affect the Persian Gulf states.
One of the most influential aspects of the global financial crisis, which has taken many forms around the world, is the shrinking and increasingly risk-averse global capital pool. As investors around the world began to experience heavy losses in the wake of, and partially triggered by, the U.S. subprime crisis, capital around the world began to dry up. At the same time, those who retained access to capital became increasingly risk-averse and have, in effect, begun to hoard capital.
For the time being, this means that risky borrowers or capital-intensive projects around the world are desperately in need of loans that are nowhere to be found. The impact in the short term is that major projects -- such as Brazil's development of its massive offshore oil fields -- will have to be postponed. In the long term, this lack of willing investment will mean a slowdown in growth in the areas of the world that are dependent on foreign capital for the development of infrastructure and industry, such as Latin America, emerging Europe and the Balkans.
A secondary impact of the shortage of capital is the devastating effect it can have on banking sectors. As the capital pool shrinks, liquidity becomes a serious problem for banks as they struggle to meet reserve requirements and avoid contagion. Banks all around the world have been hit by a shortage of credit but nowhere harder than in Europe, where the banking sector is so heavily intertwined with its industrial sectors that the entire underpinning of the economy relies on a highly liquid and supportive (critics would say "too supportive") banking industry. The U.S. market, by comparison, relies primarily on securities markets for external financing needs, and the kind of reciprocal, slightly incestuous relationships between banks and industries that characterize Europe do not exist in the United States. Furthermore, the common monetary policies of the eurozone have left many European states with over-stimulated economic sectors -- such as Spain's real estate sector -- that have been pushed forward by extremely low consumer lending rates (relative to what these countries experienced prior to joining the eurozone) backed by the stability and strength of the euro.
Yet another challenge facing world economies is the global slowdown of growth, which means a decline in demand for goods and a resulting decline in manufacturing. This will mean a slowdown in the Asian countries -- particularly China -- that are home to much of the world's manufacturing. The secondary impact will be on commodity-producing states, which provide the basic materials used in the construction of manufactured goods. These states (including most of Latin America) are facing an export crisis as the markets dry up.
Financial Crisis and the GCC
Fortunately for the Persian Gulf states that constitute the Gulf Cooperation Council (GCC) -- Saudi Arabia, the United Arab Emirates (UAE), Kuwait, Bahrain, Qatar and Oman -- these financial challenges are mitigated, or entirely eliminated, by enormous oil wealth and economies that have been carefully managed.
The GCC states are largely insulated from the global credit crunch because they are the proud owners of some of the world's largest oil deposits. Saudi Arabia alone boasts the largest oil reserves in the world, at well over 250 billion barrels, and all of the GCC states -- with the exception of Bahrain -- are ranked in the top 20 of world oil producers, with Saudi Arabia and the UAE leading the pack. Saudi Arabia alone made $194 billion from oil exports in 2007, and $212 billion (in real dollars) between January and October 2008. The GCC states are so capital-rich that their usual financial management strategy involves attempting to soak up as much liquidity as possible in order to contain inflation.
Indeed, with massive current account surpluses, the six GCC states are creditor nations -- meaning they supply capital to the rest of the world. As net providers of capital, these countries remain much less vulnerable to a shrinking global capital pool than net capital importers, as they can simply let up on the outflows for a bit to recapitalize their systems.
Given that this wealth is controlled for the most part by the GCC monarchies, much of this cash flow goes first into government coffers. This granted every single one of the GCC states a budget surplus, reaching as high as Kuwait's 42 percent of gross domestic product (GDP), in 2007 (this was before the oil price spike of 2008, so while the fall in oil revenue will affect budgets in 2009, the impact will not be as drastic as it would be using 2008 as a baseline). This gives Kuwait a great deal of flexibility in dealing with financial issues as they arise. Qatar, Oman and Bahrain all have surpluses, but they were less than 7 percent of GDP in 2007, so although they do maintain flexibility, they are much more limited than Kuwait.
Despite their budget surpluses and status as net capital exporters, the GCC states do maintain external debt -- used to finance corporate projects and government functions. However, public-sector external debt amounts to less than 30 percent of GDP for most GCC states. The outlying state is Bahrain, which has a public-sector external debt of around 36 percent of GDP. While this is not an insignificant level of debt, it is far outweighed by their sources of wealth. Measures of total external debt paint a different picture, however, and both Bahrain and Qatar have net external debt (which includes both public and private foreign capital borrowing) at between 50 and 60 percent of GDP. Although the UAE does not appear to be in trouble, the Dubai emirate has incurred a massive amount of debt in the process of overheating its real estate sector. The net impact of this high level of borrowing is to put the emirate at a disadvantage when it comes to seeking short-term capital to adjust to the international financial crisis.
Much of this debt has been caused by massive infrastructure and development projects such as Qatar's liquefied natural gas facilities, Dubai's fanciful real estate explosion and Bahrain's attempts to convert itself into a financial mecca. Indeed, the GCC states have used the past several decades of oil wealth to engineer massive development projects and have become, in the process, quite reliant on foreign direct investment (FDI) and the technology and expertise that accompany it. Though Qatar and Kuwait are net exporters of FDI, the other four states are importers of FDI, from Bahrain's modest 0.51 percent of GDP to Oman's more substantial 4.67 percent of GDP.
Offsetting this debt (and just about every other problem they might encounter) are the pools of capital that the GCC states maintain. One of the most important mechanisms for this capital accumulation -- because of its political and financial implications -- is the sovereign wealth fund (SWF). These SWFs are massive investment funds that make strategic investment choices for the GCC states. GCC SWFs maintain holdings that range from Saudi Arabia's relatively modest $5.3 billion to Abu Dhabi's massive $875 billion nest egg (and Abu Dhabi has even more money socked away in other SWFs). These SWFs are invested primarily in the equity markets of developed nations, and some have taken sizable stakes in Western businesses. In addition to the SWFs, the GCC states also maintain large caches of reserves. In Saudi Arabia, the state-owned bank SAMA (in addition to the kingdom's SWF) has $365.2 billion of foreign holdings, and the elite of the al-Saud family has reportedly stashed away somewhere around $1 trillion, though exact figures are difficult to track.
These pools of capital allow the GCC states to exercise great flexibility, especially during credit crunches. Gulf oil is controlled by the monarchies that rule each state, and these strong governments not only can draw on their large reserves but also can run their yearly budgets with substantial built-in surpluses. This gives the governments a great deal of room to intervene in the local markets to compensate for the effects of the financial crisis.
Trouble Spots
There are a couple of notable exceptions to this relatively rosy picture. Saudi Arabia has postponed bids on two major refinery projects until sometime in late 2009. The projects include a $6 billion, 400,000-barrel-per-day (bpd) refinery in the Red Sea port city of Yanbu to be built by Saudi Arabia's state-owned oil company Saudi Arabian Oil Co. (Aramco) and ConocoPhillips and a $12 billion joint venture with French energy company Total for another 400,000-bpd facility in Jubail. But these projects are hardly an issue of economic survival. Instead they are a part of Saudi Arabia's effort to move up the energy supply chain -- from crude production to refined products - - and while these facilities would be nice to have, their delay will not cause any sleepless nights for Saudi Arabia.
A more serious issue for GCC states is that many of them have young banking sectors that have trembled at tightening global liquidity and disappearing capital. Bahrain, an island nation, has capitalized greatly on its location at the heart of the oil-rich Persian Gulf region and has used its proximity to massive capital flows to build a powerful banking sector. This proliferation of banks has been shaken by the financial crisis, but true crisis is not on the horizon because the GCC states have avoided incurring massive amounts of debt.
The impact of the financial crisis on the oil markets is unquestionably a concern for GCC states, and oil prices have fallen to nearly $50 a barrel after reaching highs of over $140 per barrel earlier in 2008. But their cash reserves have given the GCC states a great deal of staying power in the medium term. Saudi Arabia alone raked in more than $1 billion per day when oil prices spiked. With the global slowdown, there will certainly be a decline in the rate of cash flowing in to the GCC states, so they will have to spend what they have wisely. In some respects, this slowdown in cash inflow is a blessing. Until the financial crisis broke, the biggest financial worry for these states was high inflation, and the slowdown in growth will reduce inflationary pressure.
Among the GCC states there are a few with their own unique challenges. In the UAE, for example, there has been a rapid increase in corporate borrowing over the past two years. Most of that borrowing has been to fund massive development projects in the emirate of Dubai. These fantastical projects have included the construction of islands in the shape of palm trees and the continents of the world. Dubai has been planning to build the world's largest suspension bridge across the entire city of Dubai (connecting one suburb to another) that was to be completed in 2012. The real estate sector in Dubai, which sports the world's only seven-star hotel, has reached unprecedented heights of growth.
Its 10-year growth spurt has come to an end, however, as the heavily overheated real estate sector readjusts to something closer to reality and as bank stability is in question, although the UAE has set up a task force to address the problem. According to the head of the task force, Mohammed al-Abbar, state-owned and affiliated companies owe approximately $80 billion in debts, while the government's assets stand at $90 billion, and state-associated companies hold about $260 billion in assets. In addition to across-the-board needs for refinancing, Dubai companies have suffered huge losses in the Dubai Financial Market, which has taken the biggest hit of the GCC-state stock markets so far this year, with losses of up to 66 percent.
Qatari firms have also borrowed some $40 billion over the past two years to finance hydrocarbon projects such as the construction of natural gas liquefaction plants -- though these will certainly pay for themselves as demand for liquefied natural gas rises amid very tight market conditions. A massive outflow of equity investments sent the Doha Securities Market for a spin as it lost 22 percent in the first half of September. Though this serves to tighten Qatar's credit options, it will not have catastrophic consequences.
The massive credit expansion in Qatar and the UAE has put the banking sectors of both countries in a delicate position. Liquidity crises will, as a rule, hit first in the place where commercial banking and lending has exploded the quickest. The relatively young Qatari banking sector has been affected by this phenomenon, and the government intervened in the banking sector by offering a $5.3 billion investment package on Oct. 12. Similarly, the Abu Dhabi Central Bank has intervened with $32.7 billion to ensure the liquidity of UAE banks.
According to reports from Bahrain, the country's Islamic lending facilities appear to be faring better than interest-based lending facilities. The Central Bank of Bahrain is controlling the sector's involvement in the volatile real estate market, as a precaution, and has been adjusting interest rates to maintain liquidity, which appears to be holding. Similar moves have been made in Oman, although the kingdom appears to have weathered the storm with high levels of capitalization.
As these market fluctuations demonstrate, depending on how bad things get, the GCC states may be forced to cut back on programs -- such as Dubai's development projects and Saudi Arabia's refineries. But in the end, the massive reserves they have built up, as well as their relative financial discipline, have made the decline in commodity prices a concern but hardly a crisis. And ongoing hydrocarbon production capacity improvements in Saudi Arabia and other GCC states mean that as soon as the price of oil rises again, these states will once again be positioned to rake in stratospheric levels of oil revenue. In fact, the financial crisis for the GCC states can be viewed as an opportunity for the GCC states to exploit this moment of relative economic power, both internally and on the international stage.
Geopolitical Implications
The strongest player in the region, by far, is Saudi Arabia, and Riyadh uses its massive oil wealth to exert political pressure throughout the region and the world. The kingdom's primary objective in the region is the containment of Iran and Shiite influence as Iran tries to assert dominance over Iraq. The financial crisis has been a huge boon in this endeavor. As a major oil exporter that has failed to achieve the kinds of financial solvency that the GCC states have secured, Iran is staring down the barrel of a gun as oil prices sink. Without a buffer of cash, Iran is very poorly positioned to handle a fall in oil prices.
Though the fall in oil prices threatens Saudi Arabia as well, the Saudi budget is set for an oil price of $45 per barrel, and oil prices have not dropped to levels that would threaten Saudi stability. Saudi Arabia maintains the ability to manipulate oil prices for its own foreign policy objectives and could use them against Iran. (Saudi Arabia is poised to assume an even more powerful position when prices rise again if an ambitious $129 billion project to raise its oil production capacity to 12.5 million bpd comes through as planned in 2009.)
If Saudi Arabia chooses to pursue macro-level adjustments to oil prices in order to target Iran, it will certainly do so cautiously. Though the kingdom has a solid cushion of petrodollars, it still relies on oil for 75 percent of government income. That income is necessary to meet a variety of domestic needs and to counter Iranian moves in the region by bribing political parties and militant groups in places like Iraq and Lebanon.
After Saudi Arabia, Kuwait is perhaps the GCC state best positioned to weather the financial storm. With a SWF of $264 billion, the country is very capital-rich and the government has a huge budget surplus. There has been turmoil in Kuwait's equity markets and banking sector, which has prompted the kingdom to repatriate some $3.66 billion worth of SWF investments, but the government's resources are substantial enough to handily offset these problems. Kuwait stands to gain from the decline of Iranian influence in the region, in terms of limiting both the influence of its own Shiite minorities and Iran's entrenchment in neighboring Iraq. Kuwait's foreign policy goals are thus in line with Saudi Arabia's, and Kuwait will follow the Saudi lead.
Abu Dhabi, the largest emirate of the UAE, is the wealthiest and most tightly run ship in the country. The UAE's problems lie in Dubai and its excessive real estate boom of the past decade. Dubai's financial indiscretions have put it in a position where it will need to be underwritten (to a certain extent) by Abu Dhabi. This presents a strategic opportunity for Abu Dhabi to rein in the political power and excesses of the al-Maktoum family, which rules Dubai and holds the UAE prime ministerial post. Dubai has so far remained staunchly uninterested in Abu Dhabi's offers of aid, declaring that there are no negotiations between the emirates.
Though Qatar has found itself mildly vulnerable to the international financial crisis because of its large debt burden, it is still in a reasonably safe financial position. Qatar's regional and global goals are quite ambitious, as it seeks to increase its holdings overseas and serve as a diplomatic hub for the Middle East. Qatar has already made moves toward acquiring major stakes in companies overseas -- including Citibank -- and these kinds of activities will likely continue. For Qatar, the danger may be in overextending itself in a time of depressed markets and relatively little competition.
For Bahrain and Oman, the smallest of the GCC states, their ability to take advantage of the financial crisis is relatively limited. Bahrain is constrained by domestic political factors as it seeks to balance the needs of active opposition elements with its economic outlook. This will limit Bahrain's ability to use the economic crisis as a stepping-stone toward a larger geopolitical role in the region. Oman, for its part, maintains a very low profile in the region and is very unlikely to make any moves at this time.
For all of the GCC states, the global slowdown offers investment opportunities the world over. On the political stage, the Western states are crying out for capital injections as their economies slow down. In fact, on a tour of the region, Deputy U.S. Treasury Secretary Robert Kimmitt called on the Persian Gulf Arab states to continue investing in the United States to help restore financial stability. This represents an excellent opportunity for GCC states to charge to the rescue -- with hefty expectations for future cooperation, of course.
The United Kingdom has also asked the GCC states to help the International Monetary Fund (IMF) assist countries in desperate need of a bailout. Herein lies an opportunity for the GCC states to engage in long-term financial positioning. By giving money to the IMF, the GCC states could enhance their say in the affairs of the lending institution and, by extension, in the geopolitical arena.
For the moment, however, the GCC states have not responded enthusiastically to these pleas (although Saudi Prince Walid bin Talal did announce that he would boost his stake in Citibank just days before a U.S.-announced government bailout of the company). Countries like Saudi Arabia and Kuwait (which have other options and a variety of needs to balance) see only limited direct political benefit from bailing out the West instead of investing that money at home. This is an outlook that could change once the new U.S. administration is up and running and able to make political deals and security guarantees.
As these openings demonstrate, the GCC states are among few in the world that can view the current crisis and see potential opportunities. While there will certainly be bumps in the road as these relatively young economies settle and shift in the face of a turbulent world economy, responsible management of vast oil wealth has put the GCC states in a position to weather the financial crisis, and weather it well.
