Adamant: Hardest metal

Fed sees debt, inflation vexing Iraqis

From the Business & Economics Desk Published 5/6/2003 11:11 AM

SAN FRANCISCO, May 5 (<a href=www.upi.com>UPI) -- Iraq's next government will face a daunting economic challenge from past debt and the anticipated cost of rebuilding despite its wealth of oil reserves, the Federal Reserve Bank has said.

Oil will no doubt continue to be the keystone of Iraq's fledging economy once a new regime takes over in Baghdad, however an analysis Monday from the Federal Reserve's San Francisco bank warned that Iraq will return to the oil market saddled with heavy debt and a vulnerability to rampant inflation with even a possibility of total economic collapse down the road.

"The post-war Iraqi situation appears to be one of a heavily indebted oil-exporting country, more similar to Venezuela than to Saudi Arabia or Kuwait," the report from Fed analyst Mark M. Spiegel concluded. "Moreover, the cost of rebuilding Iraq after the war is likely to place further burdens on its public finance."

A decade of war and economic sanctions took a crushing toll on Iraq's infrastructure while at the same time Saddam's Hussein government ran up international debt that the Fed said, citing numerous economists, has been calculated as high as $300 billion.

Although Iraq has the world's second-largest proven crude reserves, the outstanding debt alone could take 35 years to pay off even if half of Iraq's oil revenues were dedicated to the arrears.

The Fed noted that the 50-percent figure would be three times the rate of export income that Germany was obligated to pay in reparations during the disastrous post-World War I period that ended with Adolf Hitler's ascension to power.

"While there has been discussion of possibly reducing this debt burden through moratoria and outright forgiveness, servicing its outstanding debt burden is likely to be a major feature of Iraqi public finance going forward," Spiegel said in his report.

The stage appears set for Iraq's new leadership to be faced with managing a shaky economy over an extended period while at the same time being pressured by the ups and downs of the oil market in a potentially volatile political atmosphere. Many economists see such situations as a recipe for disaster if politics begin to interfere with sound monetary policy.

"The fear that a nation's central bank will give in to pressure and devalue its currency can lead to a loss of confidence...and an increase in a nation's cost of borrowing," the report warned. "This can further exacerbate the government's budgetary problems and lead to an inflationary spiral ending in a collapse of the exchange rate peg."

Iraq's exchange rate indeed will likely be pegged to the dollar, the Euro or a combination of the two, the Fed predicted. The dollar is the currency used in the vast majority of international oil transactions; however, it would also expose Iraq to the perils of currency speculation and a spike in Baghdad's cost of borrowing.

"At worst, the peg could collapse dramatically, leading to financial turmoil," the report said. "Because of the exposure to these difficulties, it would be imperative that a managed exchange rate peg regime be tailored to limit concerns about Iraqi monetary policy."

The United States has developed a comprehensive economic plan for Iraq that includes an unspecified overhaul of Iraq's central bank and stock market. Thus far, the plan appears primarily focused on creating a market-based economy that opens the door to direct foreign investment and the privatization of Iraq state-run industries.

Spiegel said all was not lost in Iraq since the incoming Iraqi government would basically be able to start from scratch and build a monetary system that will best suit Iraq's specific economic needs and keep inflation in check rather than having to adapt an existing system that is no longer effective.

"A critical issue is the determination and management of the country's outstanding liabilities and the costs of financing the rebuilding of the nation," Spiegel said in his report. "No less important is the need to institute a monetary regime that promotes price stability, and the most positive environment in which to meet these other challenges."

(Reported by Hil Anderson in Los Angeles)

Are We Headed for Another Recession? Small Companies Bracing Themselves

entrepreneur.com May 05, 2003 By Joshua Kurlantzick

Economic indicators aren't too optimistic, particularly for small companies. But if the past few years have taught us anything, it's that the news isn't all bad.

In March, as the U.S. military began its invasion of Iraq, many American businesses feared the impact of the battle on commerce. Yet they hoped a quick victory would provide a post-war boost to the economy. An end to the war, they hoped, would prompt exuberant and relieved consumers to open their wallets, depress the price of oil, lead to increased spending on domestic travel, and allow companies to more easily make plans for capital spending.

Unfortunately, it does not appear that a post-war boom is likely. In fact, many economists and businesspeople now worry that America actually is headed for another recession--one that could prove the final blow to many small companies already struggling from more than two years of economic weakness.

The signs are not good. A well-known index of economic indicators, the Conference Board report, fell in March; meanwhile, March's index by the Institute of Supply Management, the nation's leading forecaster of manufacturing activity, dropped below 50, signifying that the manufacturing sector is contracting, and employers eliminated more than 100,000 jobs in March, after slashing nearly 300,000 the month before. Overall, companies are hiring at their slowest pace in more than a year. "It does appear increasingly likely that we're headed for another recession," says Robert E. Scott, an economist at the Economic Policy Institute, a Washington, DC, think tank.

"It's one of the most difficult periods I've ever seen," concurs Al T. Lubrano, president of Technical Materials Inc., a Lincoln, Rhode Island, company that manufactures specialty metal products. "Where's the hope on the other end?"

Unlike in the past, economists say, this war has not--and will not--provide much stimulus for U.S. economic growth. "Despite the defense spending for the Iraq war, the amount of spending this time is still quite small, proportionally, compared to previous conflicts," says John Nye, an associate professor of economic history at Washington University in St. Louis, Missouri.

What's more, the end of the war in Iraq has not significantly reduced the uncertainty felt by many Americans--an uncertainty that keeps consumers from spending as much as possible and prevents businesses from making long-term plans. Although the price of oil has dropped, America still remains dependent on potentially unstable nations--Nigeria, Venezuela--for a considerable percentage of its petroleum.

Many U.S. businesses and consumers remain unconvinced that another war is not on the horizon. "The victory in Iraq hasn't resolved this uncertainty, because we don't know it will be the last conflict," says Joel Marks, executive director of the American Small Business Alliance, a Washington, DC, trade group. "Given the fact that we're continuing to fight against terrorism, we don't know that we won't have a conflict soon with Syria, or Iran, or North Korea."

Numbers Don't Lie Indeed, the Federal Reserve's weekly assessment of lending to businesses dropped throughout April, suggesting that most companies are holding off on new investments. As Craig Thomas, an economist at West Chester, Pennsylvania, forecasting organization Economy.com, notes: "Why would anyone want to invest in equipment [right now]? I just don't see it."

Meanwhile, housing construction fell in March, suggesting that American consumers, who are carrying higher levels of personal debt than they did during the 1991 Gulf War, also are becoming more cautious. In the past, the government was able to stimulate spending and growth by slashing interest rates, but the Federal Reserve has cut rates 12 times since 2000, to its current rate of 1.25 percent.

The arrival of SARS in North America has further heightened uncertainty. Already, Stephen Roach, chief economist at Morgan Stanley, has predicted that the world will fall into recession this year, in part because of SARS. "Right now, SARS is in Toronto, and we've seen how it's decimated the economy of that economically powerful city," says Marks. "Tomorrow it could be in Des Moines."

SARS, the possibility of future conflict and the continuing threat of terrorism also are complicating shipping logistics, cutting into companies' profits. For example, over the past six months, freight rates have risen by more than 30 percent for companies shipping through the Middle East, as marine insurance companies raised rates on shippers since the Iraq war by as much as 50 percent. In fact, according to marine insurance companies, shipping rates have been pushed to their highest level in years.

More expensive logistics, along with increased tension between Europe and the United States due to friction over the Iraq war, is putting a damper on global trade. "The pace of free trade expansion has slowed drastically," says Scott. "If we engage in more conflicts in the Middle East, that could further alienate Europe, which is already hurting economically, and damage trade." Indeed, unlike in the wake of the 1991 Gulf War, when Europe and Asia were growing and helped pull the American economy out of recession, today Europe and Japan are struggling on the verge of their own recessions.

America's burgeoning deficits--its national deficit and trade deficit with other nations--also are constraining the economy. The federal government will run a 2003 deficit of at least $200 billion, and states also are facing their biggest deficits in ages. Many states are taking almost laughably drastic measures: In Missouri, the governor has ordered every third lightbulb unscrewed in state buildings. At the same time, as the American trade deficit has grown, the U.S. has become increasingly dependent on foreign capital to finance growth. If that capital pulls out, it could shave as much as 10 percent of U.S. growth and drastically weaken the dollar, Scott says.

Small Companies Bracing Themselves As all these signs of economic weakness build, small companies have the most to lose. Thus far, small firms have largely been shut out of contracts for post-war reconstruction in Iraq, though the Bush administration has promised to share the wealth. And according to Marks, many small companies do not possess the kind of cash reserves to deal with another prolonged period of economic downturn, since banks have become more willing to turn away small clients than they have larger companies. "Small companies have spent down much of their cash already, in the previous recession, and they didn't have time to build it up again," Marks says. "There's numbness out there in the small-business community, wondering whether they can hold on to the cash they have and numbed by each economic shock."

Lubrano agrees. "I look at competitors in the field, and I see many of them are going bankrupt," he says.

Meanwhile, small companies rarely have the capital needed to create the redundant, alternative supply chain networks that can allow goods to bypass world hotspots and generally avoid logistical problems. And owners of small companies often are ill-prepared to deal with the effects of continued anxiety and uncertainty on their workers, since few have the kind of dedicated in-house counseling services large companies employ.

Small companies also usually are more reliant on obtaining business from other entrepreneurs. "Unlike bigger companies, small firms usually depend on getting paid by a large number of small clients, many of whom can't pay now," says Marks. "Small companies can't extend them the kind of credit they need to last until an upturn that big corporations could."

Always a Silver Lining But not all signs of the economic future are negative. In the immediate aftermath of American troops arriving in Baghdad, stock markets, which can be leading indicators of economic expansion, posted stronger gains than they had since September 11. What's more, since the beginning of the Iraq war, the price of oil has fallen by more than 25 percent. A decrease in the value of the dollar actually could help American entrepreneurs, as it would make them more competitive with companies from the developing world.

And despite high levels of debt, American consumers often prove willing to keep shopping. Corporate credit became slightly easier to obtain in March. The fact that companies have spent so little over the past three years ultimately will leave them with no option other than to increase business spending. Last week, Federal Reserve Board Chairman Alan Greenspan told Congress the economy is poised for growth even without further tax cuts--though the Bush administration continues to push for a $550 billion, 10-year tax-cut plan that may or may not stimulate the economy. (In February, a group of 10 Nobel Prize-winning economists concluded that the tax cuts would not have a significant short-term stimulus effect--some leading economists worry that further tax cuts could exacerbate federal and state deficits.)

Perhaps most important, small companies have internalized lessons from the 2000-2001 recession to prepare themselves for more economic turbulence. "Small companies that are around now are leaner than they were two years ago, and they've learned how to cut fat or adjust in other ways--merging with competitors, going into niche markets, renegotiating their contracts, conserving cash," says Marks. "Three years ago, two guys and an idea could raise capital; today those guys are living in their parents' basements."

"If you haven't already prepared for economic tough times, either by cutting all extraneous things or moving into niche markets where you can survive a downturn," says Lubrano, "after all we've been through the last few years, you have yourself to blame."

Forging Ahead Nothing's certain in today's economy, but it appears business owners aren't letting a potential recession stop them from seizing opportunities for growth, according to an OPEN Small Business Network 2003 Monitor from American Express. While the number of small businesses reporting that they foresaw growth opportunities for their companies in the next six months fell to 56 percent, down from 64 percent last fall, growth remains their number-one priority.

These business also plan to add jobs--35 percent of those surveyed indicated they would hire full- or part-time staff within the next six months. The reasons for the additional new-hires are varied, with 48 percent saying it's to help drive business volume increases; 34 percent, for new business ventures; and 10 percent, to fill a vacancy that's been open for a long time.

And there's more good news: While these companies position themselves for growth, they're also cutting costs, with 30 percent cutting back on expenses and 24 percent cutting back on personal spending. Fewer businesses (57 percent) are reporting cash-flow woes than they were in the fall (63 percent).

With an enterprise value of over $1 billion, MISC's acquisition of AET from NOL sets a new record. The largest Malaysia-Singapore M&A ever?

financeasia.com By Steven Irvine 30 April 2003

It is the largest transportation M&A globally in 2003 and bankers suspect it is the biggest ever M&A between Malaysia and Singapore - two countries that are not known for selling assets to each other. Petronas-controlled MISC has paid Singapore's NOL $445 million for American Eagle Tankers (AET), an asset that will fuel MISC's global shipping pretensions.

The size of the deal goes above $1 billion if you include debt assumed and measure the strict enterprise value. Bankers close to deal are ecstatic that such a deal could get done in the midst of SARS and such turbulent markets.

"In these challenging markets it's good to see that companies are still taking steps to address strategic issues," says Richard Seow, Citigroup's head of Southeast Asian investment banking, and whose firm advised MISC.

"This is definitely a win-win deal for both companies," acknowledges Todd Marin, head of M&A at JPMorgan.

His firm was appointed by NOL to dispose of AET in the fourth quarter of last year. NOL has actually been trying to dispose of AET for some time.

In July 2001 it tried selling 30% of the company in a US IPO with Singapore Depositary Receipts attached. This $130 million deal - which valued the company at $433 million - however was pulled due to turbulent market conditions by then lead manager, Salomon Smith Barney.

In spite of two Asian companies being involved, however, this is less of an Asian asset than one might assume. Indeed, it is really a US company.

American Eagle Tankers has three main operations: lightering, voyage chartering and long-term chartering. The first involves the transfer of crude oil from long-range large tankers to smaller tankers capable of entering shallow water ports.

Voyage chartering involves the transportation of oil from loading port to discharging port, and long-term chartering involves leasing company's tankers on a pay per-day basis. American Eagle gets 69% of its revenues from the Atlantic basin but had recently signed the so-called Bitor contracts with Venezuela which saw the firm transporting oil from the Gulf of Mexico to Asia.

The deal will provide MISC with 29 Aframax tankers and two very large crude carriers. With the acquisition the Malaysian company will have the second largest combined Aframax fleet in the world. It will also have the youngest Aframax fleet with an average age of 7.5 years.

Analysts explain that the main benefit of having such a young fleet lies in the premium rates oil companies are willing to pay to avoid the embarrassment of environmentally damaging oil spills. MISC will be transformed to become one of the leading tanker operators globally.

MISC is paying 1.45 times book value for the company, but will allow NOL to keep a $75 million dividend from this year and will also allow NOL to share some upside via an earn-out structure based on actual cargo rates versus projected cargo rates for the next two years.

From Citigroup's perspective, this is the second M&A deal closed for Petronas group companies in as many weeks. It also recently closed the $1.7 billion sale of Edison's Egyptian oil assets to Petronas.

Infusion of oil from Iraq a wild card in U.S. economy

[ The Atlanta Journal-Constitution: 4/27/03 ] By MICHAEL E. KANELL

The war with Iraq is over, but the uncertainty is not. And one of the biggest unknowns is how much impact the return of Iraqi oil to the market will have on the wobbly U.S. economy -- and how soon.

A lot is riding on the answer. Optimists say Iraqi oil holds the promise of keeping global energy prices down, limiting the influence of the Organization of Petroleum Exporting Countries and offering relief to beleaguered American consumers and companies.

"I think the war changed things in a big way," said economist Ujjayant Chakravorty of Emory University.

Few oil wells were torched by Iraqi troops. No missiles hit Saudi oil fields. No suicide bombers blocked oil ports. As those fears evaporated, the price for oil came down dramatically.

From a prewar flirtation with $40 a barrel, oil prices fell into the mid-$20s.

For a struggling U.S. economy that stumbled again in recent months, the higher prices had threatened a renewed recession, said Rajeev Dhawan, director of the economic forecasting center at Georgia State University

"We definitely dodged the oil bullet," he said.

Still, the ripple from the halt of Iraqi oil production when the war started has yet to even reach U.S. shores.

Oil from Iraq, which had been the fifth-largest supplier to the United States, stopped flowing shortly after the bombs started falling on March 19. Since it takes more than a month for oil to wend its way from the Middle East to the United States, it is too early to assess the effects of the shutdown, said Matt Simmons, chairman and chief executive of Simmons & Company International, a Houston-based energy investment bank.

Oil production in Nigeria has also been disrupted, by political violence.

If the cutbacks in those countries are going to mean higher prices, we should start to see them in the coming days, he said.

Most analysts expect a slow return of Iraqi production and relatively stable oil prices for a few months. And as the flow of Iraqi oil swells, that added supply should nudge prices down.

But there are other possibilities. Many analysts expect the Bush administration to dismantle Iraq's state-run economy in favor of a free market.

Privatization would be a tremendous shock and might delay full production, said Lewis Snider, professor of political science at Claremont University in California, who has lived in the Middle East.

"The politics of this could get really nasty," he said.

The issue is important because timing matters. America's need for gasoline peaks in midsummer.

With most of the world's producers pumping near capacity and the stream from Iraq slowly resuming, gas this year will be available at surprisingly reasonable prices, Snider predicted.

"I don't see too much reason to be anxious about the tightness of supply this summer," he said.

Still, inventories are at historically low levels. With so much oil coming from unreliable places, and with OPEC planning to cut production about 7 percent, an increase in energy needs will leave precious little room between supply and demand, said Jay Hakes, former administrator of the Energy Information Administration.

"I still think we are in the tightest market since the Persian Gulf War. Saudi Arabia helped, but it hasn't offset the oil lost from Iraq."

And other losses are possible.

Balance shifts

Crunch time is from Memorial Day to Labor Day. If all goes right, which includes Iraq starting to export oil and Venezuela and Nigeria staying placid, then there will be enough modestly priced gas for Americans.

Unfortunately, that means depending on a lot of coins to come up heads, Simmons said. "The odds are really low that we will have an easy time."

"This market is very vulnerable to any little disruption," Hakes said. "I think OPEC may be misreading the world market. There is not a good supply of oil out there. That could make for fireworks in the next few months. If gas goes to $2 a gallon, that has an impact on the economy."

Short-term questions aside, the war has shifted the balance of oil power.

Iraq's oil reserves are second only to those in Saudi Arabia. While Iraq's decaying industry struggled in recent months to pump 2 million barrels a day, its capacity could be three times that.

As some war-backers argued, a U.S.-friendly Iraq would erode Saudi Arabia's power to shape prices.

The 2001 Cheney Report on energy argued that America must diversify sources for oil and make sure those sources are dependable. "The policy-makers want to move away from the Middle East -- to the Caspian Sea, to West Africa and Latin America," said Daphne Wyshan, a fellow at the Institute for Policy Studies.

A pro-U.S. Iraq would provide one more dependable source. But significant production needs to be resumed first.

Vice President Dick Cheney recently predicted that Iraq will be pumping 2.5 million to 3 million barrels of crude a day by year's end -- better than its production has been for years.

The experts are split on that projection.

First is the problem of legality: Will the United States win United Nations approval to sell Iraqi oil? Would the United States go ahead without an OK?

Niceties of international law aside, dilapidated equipment and transportation bottlenecks could throttle a return to full production, Simmons said. "But it's like a patient who needs an MRI and CAT scan. We just don't know yet."

Even the much-touted estimates of Iraqi reserves are unreliable, he said. "How much oil is there? Nobody has any idea."

Politics plays a role

Iraqi oil's impact may depend more on politics than engineering, said Ken Miller, vice president of Purvin & Gertz, an international energy consulting company in Houston.

With the world's large economies weak, Miller said the supply will overwhelm demand and prices will come down.

For American drivers, the idea of cheaper gasoline sounds delightful. But that could spell political disaster.

Middle East oil producers have built economies around oil dollars. When the price plunges, it can savage the standard of living and undermine the compact between people and rulers.

Some analysts scoff at worries about revolution. Still, the danger is obvious from the numbers, Simmons argued. Saudi Arabia has a burgeoning population and a large royal family that has its own kind of welfare. The nation's income has fallen from about $26,000 per person to $6,500 in less than two decades.

"Do the numbers -- unless they are willing to produce another cash crop, they need an average of 10 million barrels a day at $50 a barrel," Simmons said.

Oil prices didn't get to $50 a barrel last year. But during the winter, higher energy costs were seen as a drain on the finances of consumer and company alike.

Price increases are not as costly to the economy as three decades ago, but America cannot run without oil. When the price goes up, we pay. Only if it stays high for a long time do consumers shift their habits and purchases.

That makes the short-run effect of oil prices potentially painful. So, if OPEC's cut forces oil prices up rapidly, that could put a nasty hole in hopes for a recovery.

The price equation

High oil prices have been a factor in -- or the cause of -- most of the U.S. recessions since World War II. On the other side of the coin, low prices have added fuel to several booms.

While the fall from prewar levels is welcome, oil prices are still far higher than in late 2001 and early 2002. Back then, gas prices in metro Atlanta were below $1 a gallon. Still, if prices don't climb again, that is a very modest kind of good news.

With the U.S. economy struggling -- job losses up and business orders down -- oil prices are not helping, said John Silvia, chief economist of Wachovia Securities. "But it won't hold us back -- we're already stuck in the mud."

Hopes for renewed growth have been pegged to a resurgence in business spending. But companies have been unsure about the future and hesitant to spend, just like consumers. Higher-than-average oil prices only add to uncertainty, said Dwight Allen, a partner at Deloitte Research.

"At least we know we are not in for a dire, acute situation," Allen said. "But the future is as cloudy as it was before."

Allen is telling his corporate clients to come up with several backup plans, to consider various scenarios and to hedge their bets. This is not a time for gambling, big spending or padding payrolls.

"For the next 12 months, you make only a limited commitment," Allen said.

Battered Germany is a lesson for Brown • OECD predicts American-led bounce

<a href=www.opinion.telegraph.co.uk>telegraph.co.uk

Whether or not the Iraq war was about oil, the post-war prospects depend on it. The price of the world's most precious commodity topped $30 a barrel at the start of last month, and pretty painful it felt, too, to those who use it, which means just about everyone.

Part of the rise was due to Sod's Law, the one that says that if one thing goes wrong, others will follow. Increased demand from the US military coincided with production shut-downs in Nigeria, civil unrest in Venezuela and (obviously) the disruption of production from Iraq.

The price surge produced hysterical headlines but (as was predicted here) the $30 barrel was a bear market waiting to happen, and now the forces that pushed up the price have gone into reverse. Yesterday Opec, the cartel which still tries to control the price, announced that $25 was fine by them, and they'd try and hold it there.

It looks a forlorn hope. The price is coming down, probably below $20, and perhaps well below. The boost this will give to the world economy underpins yesterday's relatively cheerful forecast from Jean-Philippe Cotis, chief economist at the OECD.

Is he right? Perhaps. After two years of stagnation and contraction, companies are mending their balance sheets and much of the surplus investment is being worked off, especially in the US. A recovery in business investment and world trade will follow, next year if not this.

For all its fine Paris premises, international reputation and pompous title, the Organisation for Economic Co-operation and Development is just another forecaster, but it comes nearer than most to agreeing with Gordon Brown's rosy view of prospects.

Our economy, it says, should grow by 2.6pc next year, too slow to prevent a further deterioration in the public finances, but fast enough to make us look good against our competitors. We will look positively racy when compared with the eurozone, where the OECD has chopped its forecast to just 1pc growth. In Germany, growth has almost stopped and thanks to the strength of the euro, prospects are getting worse.

A manufacturing economy in stagnation needs devaluation, not revaluation, but there's nothing the Bundesbank can do. Should Mr Brown need further convincing that his famous five tests to join the euro have not been passed, Germany provides a grim lesson. The single currency has been a thoroughly miserable experience for what was once Europe's most successful economy.

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