IMF Managing Director Dominique Strauss-Kahn said the tense talks at the G-20 meeting over the weekend in Paris reflected the resurgence of national interests in the wake of the crisis, while undermining the G-20 two years after it helped broker a deal to pull the world economic back from the brink.
He said: “What I was worried about, I’m sorry to say, materialized, which is that it's more difficult than before to have people agree … Our task to reach this consensus was not even that difficult.”
France's attempts to gradually draw China into talks on its currency met with “scant” success. Central Bank PBOC Governor Zhou Xiaochuan told the Oriental Morning Post: “We rely mostly on our own judgment in making adjustments to the value of the yuan (CNY) …. We've never paid special attention to outside pressure.”
Anyway, the indicators to gauge global economic imbalances on which the G-20 have agreed on don't have any targets attached to them. Yes, there will be quantitative analysis of the indicators, but there won't be any specific target values for any single indicator a country has to reach. Strange kind of solution, isn’t it?
At the same time, the Chinese newspaper Xinhua reported that at a meeting attended by top Communist Party leaders in Beijing on Saturday, President Hu Jintao described China's growth as remarkable but said its development was “unbalanced, uncoordinated and unsustainable.” Investors should remember that.
Now, violence and unrest that has swept the Middle East and North Africa has now gripped Libya’s capital Tripoli. Libya is an OPEC member which produces 1.6 million barrels per day, which is about 1.8 percent of global oil production. There are rumors that he Al-Zuwayya tribe in eastern Libya is threatening to cut off oil exports unless authorities stop what they called the “oppression of protesters.”
Output at the Nafoora oilfield in Libya has also stopped because workers are striking. AFP quotes witnesses as saying that protesters in Tripoli sacked the headquarters of state television overnight and set ablaze offices of the People's Committees. Reuters also reports that the central government building in Tripoli is on fire. In the meantime we have Brent crude oil prices above $104 a barrel, which is a 2½-year high, and West Texas Intermediate (WTI) above $89.
No doubt, all this creates renewed insecurity. We should remember that Libya, Bahrain, Algeria and Yemen together account for slightly less than 5 percent of global oil production. Libya and Algeria represent the vast majority of that 5 percent while the Ghawar field, which is the largest conventional oil field in the world that represents an estimated 6.25 percent of global production, lies only about 70 miles away from the end of the King Fahd Causeway leading out of Bahrain.
Although so far, it doesn’t look like the unrest in Bahrain is spilling over into other states in the region, it seems reasonable to suppose that the ongoing events will lead to an increasingly significant risk premium that will be included in future oil prices.
Try to consider for a moment the potential impact such a new “North African/Middle East” oil shock could have on the U.S. dollar.
In order to have an idea of what could be ahead us, we should look back at what happened during the last three great Middle East oil shocks.
The “1973 Oil Embargo” took place from October 12, 1973, until March 17, 1974, began on October 6 when Egypt and Syria attacked Israeli occupied lands in Sinai and Golan Heights. President Richard Nixon authorized on October 12 the “Operation Nickel Grass” to deliver weapons and supplies to Israel, after the Soviet Union had begun sending arms to Syria and Egypt.
OPEC announced on October 16-17 they had decided to raise the oil price of oil by 17 percent to $3.65 a barrel while they would further cut production by 5 percent from September's output, and would continue to cut their production in 5 percent increments until their economic and political objectives were met.
On October 19, President Richard Nixon asked Congress for $2.2 billion in emergency aid to Israel. On October 20, Libya announced it would embargo all oil shipments to the United States and the other OPEC states followed suit. The U.S. had become the initial target of the embargo. On January 18, 1974, Secretary of State Henry Kissinger obtained an Israeli troop withdrawal from parts of the Sinai. On March 17, the Arab oil ministers, with the exception of Libya, announced the end of the oil embargo against the United States.
During that period, and between October 1973 and March 1974, the oil price rose from $3 a barrel to $12/bbl.
Remarkably, the dollar remained steady until the week ending January 27, which was the week after Kissinger negotiated an Israeli troop withdrawal, the Dollar Index surged an impressive 15.2 percent, at which levels it stabilized until the week ending March 17, when the embargo ended, before weakening slightly. In November, the dollar started to trend lower again.
Then we have the Iranian revolution from December 1978 until September 1980. It all started on December 10 and 11 when millions of anti-Shah demonstrators marched throughout Iran. On January 16, 1979, the Shah left Iran. On January 20, Saudi Arabia announced a cut in first-quarter production and imposed a 9.5 million barrel per day ceiling that in fact never was achieved. On February 1, the Ayatollah Khomeini returned to Iran.
On March 26, OPEC announced a 14.5 percent price increase for 1979 that became effective on April 1 that resulted with crude rising to $14.56 per barrel. Thereafter, on June 26–28, OPEC raised prices again by an average of 15 percent effective July 1st. On November 4, 66 Americans are taken hostage in Tehran and on November 12, President Jimmy Carter ordered cessation of Iranian imports. On November 15, Iran canceled all contracts with U.S. oil companies. Then, on December 13, Saudi Arabia raised the crude marker price to $24/bbl. In May, once again, Saudi Arabia raised its marker crude price to $28 per barrel, which was retroactive to April 1. On September 17, Iraq proclaimed sovereignty over the Shatt al-Arab waterway. Finally, on September 22, 1980, Iraq invaded Iran.
During that period, oil prices more than doubled between January 1979 and the first major fighting of the Iran-Iraq War. In the period between the end of October 1978 and the end of November 1978, the dollar surged by around 8 percent before weakening slightly through to the end of December, following the anti-Shah demonstrations in cities in Iran.
It’s interesting to take notice that notwithstanding the change of leadership in Iran early in 1979, the dollar in fact moved up, albeit gradually, over the next five months to reach a new high during the last week of May 1979. Then, the dollar began to lose ground through June, coincidently following continued price hikes by OPEC, and continued on its downward path until the beginning of January 1980 while remaining above the December 1978 low that occurred following the Russian invasion of Afghanistan.
The next four months saw the dollar performing a sharp rally that brought it 13 percent above its October 1978 low. However, these gains were reversed in the 2 months that followed the failed hostage rescue attempt in April 1980. Nevertheless, in December of that year, when oil prices were at more than double where they were at the end of 1978, the dollar had begun its major five-year uptrend.
Overall, the period of the Iranian revolution and the subsequent energy crisis of 1979/1980 represented the point at which the dollar finally began to stabilize after eight years of sustained losses. It’s interesting to note that the moments when dollar losses occurred tended to be related to U.S. specific issues such as the taking of the Tehran hostages and “Operation Eagle Claw” rather that oil price issues per se.
On August 2, 1990, Iraq invaded Kuwait, a conflict that would stretch until February 1991. On August 3, the U.N. Security Council passed “Resolution 660” condemning the Iraqi invasion of Kuwait and demanding it unconditionally to withdraw all forces. Thereafter, on November 29, the U.N. passed Security Council “Resolution 678” which gave Iraq until January 15, 1991, to withdraw from Kuwait. The U.N. empowered states to use “all necessary means” to force Iraq out of Kuwait after the January 15 deadline. On January 17, 1991, the aerial bombardment of Iraqi forces began and on February 23 the ground assault against Iraqi forces began. On February 28, 1991, the ceasefire is announced.
During that period, between the invasion of Kuwait on August 2, 1990, and the start of Desert Strom, the price of oil jumped from below $20 a barrel to above $30/bbl. Over the same period, the dollar lost about 8 percent between the invasion of Kuwait and the start of Desert Storm.
During the four months following the expulsion of Iraq from Kuwait, the dollar gained close to 20 percent in value.
So what does this tells us? It’s difficult to come to any definitive conclusion on how the dollar tends to react to Middle East oil price shocks. We note that the reaction of the dollar to the events in the 1973 “Oil Embargo” was remarkably different to that seen during the invasion of Kuwait in 1990.
Nevertheless, we can see that it is not immediately obvious that an oil price shock should necessarily be dollar negative. In 1973 and early 1974 investors actually sought out the dollar as a safe haven during the height of the crisis. Also in 1979, the dollar remained surprisingly stable. It was only when the U.S. became directly involved with the hostage crisis and the failed rescue mission that the dollar reached a new high before falling afterward.
Interestingly, this latter observation finds an echo in 1990 when the dollar came under pressure ahead of the start of Desert Storm but staged a sharp rally once it became clear once the conflict was over and oil prices finally came down.
In my opinion, what’s happening now with the dollar is not all that different from that we have seen before. Over the course of the past few weeks, investors have typically sold the dollar in reaction to heightened political uncertainty in North Africa and the Middle East. The general perception has been so far that the developing crises would feed through into further dollar weakness.
However, when we review the post Middle East oil crisis, the oil price shocks have taught us this need not necessarily be the case. Indeed, there is solid evidence that suggests unless the U.S. is caught up in events on the ground, the dollar could even represent a safe haven.
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