Banking & Finance

IPO Watch – Sector Surging

by Executive Staff
written by Executive Staff

The GCC is expected to be the home to over 150 new IPOs during the upcoming two years, according to industry reports. Morgan Stanley predicts that Saudi Arabia alone is set to launch at least 110 initial public offerings over the next two years. In parallel, the number of IPOs in the Levant and North Africa region is expected to increase threefold in the same period.

In 2007 the GCC’s compounded value of funds raised through IPOs was $10.5 billion, up by 40% when compared to 2006. The action was split mostly between the UAE, which came in first place raising $5.1 billion, and Saudi Arabia, where $4.81 billion have been raised. Qatar followed as distant third with $389 million, then Oman with $156 million and Bahrain with $69 million. As such, market observers say that Gulf and foreign investors alike continue to see the region’s IPOs market as a “reliable” and a “safe” place to earn high returns with minimal risk.

The month of March supported that sentiment as it witnessed considerable activities in the IPO market when the UAE-based Ajman Bank, a shariah-compliant concern, was over 85 times oversubscribed when it closed its IPO in the first week of March. Newly established Ajman Bank, whose largest single shareholder is the government of Ajman in the northern UAE, offered 55% of its shares to the public in February, for $.27 each, valuing the bank at $272.3 million.

Offering 55% of equity and shariah-compliance as well was the IPO of new UAE insurer, Takaful Al-Emarat Insurance. UAE-based Al-Buhaira Nation

Insurance Co. or Abnic, and Austrian insurance leader, Uniqa Group, announced their upstart joint venture in mid March and said at the same time that the new firm will conduct an IPO from March 23. The firm will operate out of Sharjah and the target for funds to be raised through the IPO was around $22.5 million.

Saudi Arabia saw a generous number of new IPO announcements in March starting with Muhammad Al-Mojil Group (MMG), a construction services firm, which plans to offer 30% of its shares in an IPO scheduled to be launched on May 3, 2008, and close on May 12. Although the company did not disclose the amount it wants to raise, the IPO is expected to generate a lot of interest since the construction sector is a favorite among Saudi citizens. Another hush-hush IPO announcement came from Medina Cement, which plans to sell portions of its shares in IPO. But the company did not reveal the number of shares that would be offered and the amount it wants to raise. Medina Cement was established in 2005 with a capital of $146.9 million, divided into 55 million shares with a par value of $2.67 each.

In the meantime, three Saudi insurance providers, BUPA Arabia for Cooperative Insurance, United Cooperative Assurance Co, and Saudi Reinsurance Co closed their IPOs on March 15th. The $21.3 million IPO of United Cooperative Assurance was covered 12.56 times with demand. Based on high demand for a wave of Saudi insurance IPOs in 2007, analysts had anticipated over subscription but IPO results for BUPA Arabia’s $42.7 million IPO and Saudi Reinsurance Co’s $106.7 million offering were not in by time of writing this report.

The biggest splash in IPO-related excitement for March was supplied by Zain Saudi Arabia, which debuted March 22 on the Tadawul Exchange with a 110% leap in first-day trading, although the market overall was reeling from negative sentiment. The kingdom’s third mobile phone operator completed the subscription period for its $1.86 billion offer of 50% equity in February.

In the Levant region and specifically in Jordan, Amman-based Sabaek for Investments, a financial services firm, invited subscriptions to an IPO between March 16 and March 30. The company announced in early March that it will offer over 26% of its shares to raise around $5 million to finance operating and investment activities.

It is not difficult to understand the rationale of local and international investors’ interest in the region’s IPO market. Local experts say the recent record oil prices highs in the $110 range will improve liquidity even further and local investors have no choice but to find a new home for their cash. This home, experts agree, will be mostly in regional markets.

Executive spoke to several local experts who gave the indication that the continuing economic spiral in financial markets in the United States and some European countries would encourage the launch of share floats in the region and push investors to park their cash into those companies. This pattern is not unrestrainedly beneficial for the region’s economies, but this is the way it must happen. Oil cash inflows must be put back into the land where the oil came from and the emerging economies of the region must now move on to the final phase of becoming fully developed.
 

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Lebanon

Liquified natural gas – In the pipeline

by Executive Staff
written by Executive Staff

In recent years, Lebanon has been promised supplies of liquefied natural gas (LNG) from Egypt. This cheaper source of energy — a pressing need in light of the oil price spike, towering around $10 a barrel — is to be conveyed to Lebanon through the Pan-Arab Pipeline. At the end of February 2008, the ministers of oil and energy of Syria, Lebanon, Jordan, Egypt and Turkey met in Damascus to discuss the nitty-gritty details of this ambitious project.

The venture, which has been in the proverbial pipelines for some years now, will allow natural gas to be transported from Egypt to the Levant and later on possibly to Europe. When completed, it will have a total length of 1,200 km and carry an estimated cost of around $1 billion. In Lebanon, explained Sarkis Hlaiss, general manager of Lebanon Oil Installations, a subsidiary of the Ministry of Energy and Water, “The pipelines, with a $22 million price tag settled in full by the government, cover a distance of 32 kilometers from the Syrian border. Lebanon’s pipeline has been finished for some time now, but we were still waiting for Syria to finalize its portion of the network, estimated at about $200 million, ending in Deir Ammar in Lebanon.”

Following the Damascus meeting, Syria’s minister of oil and mineral resources Sufyan Allaw announced at a press conference that Syria had reached an agreement with Egypt to start supplying gas via the pipeline starting March 21, 2008, after completing necessary final tests.

In Lebanon, during the initial phase the network will be connected to the Deir Ammar station, which currently meets approximately a quarter of the country’s energy demand. However, Hlaiss added that both the Deir Ammar and the Zahrani power stations boast dual gas-oil and natural gas capacity, one being a replica of the other. The power stations had initially been destined to operate on LNG, with the possibility of temporarily switching to oil, during the cleaning of the turbines.
 

Expanding the gas network

Of course the opposite occurred: power stations are essentially running on gas-oil, which now is not only much more expensive than LNG but also dramatically decreases the life span of turbines, according to a government source. Now that the LNG pipeline is coming, “We are toying with the idea to further expand the current gas network while connecting it to the Zahrani power station,” Hlaiss said.

The pipeline, capable of carrying some 7 billion cubic meters of gas per year, starts in Port Said, on the Suez Canal, and then

Off-shore oil in Lebanon?

In recent months, the topic of possible oil fields off the Lebanese coast has come up in newspaper headlines. But because of the sensitivity of the topic, few facts are known. Speaking to Executive, a Lebanese government source said that up to 25 square kilometers of underwater surface have been surveyed in order to locate oil-bearing deposits, adding that “while preliminary results are excellent, one has to bear in mind that even when geological conditions are at their best, there is only a 15% chance for actual oil deposits.”

According to the source, the possible oil deposits are located at a distance of 32 kilometers away from the Lebanese shore, territorial waters stretching to 80 kilometers.

But for the time being, little more than the initial survey can be done. The exploratory drilling process, which is the only means to confirm the existence of oil deposits, would cost about $300 to $400 million and requires the participation of foreign oil companies. But as the source pointed out, “This participation can only be secured through a bidding process, after the promulgation of oil laws by the parliament, which has been closed for some time.”

runs north through the Aqaba and the Al-Rehab power station in Jordan, before ending in the Syrian city of Homs. The Lebanese government has agreed to buy some 0.6 billion cubic meters per year from Egypt but retains the option to increase the gas input to four times that amount if necessary, according to Hlaiss.

Egypt is also providing 1.7 billion cubic meters of LNG per year to Israel through the Arish-Ashkelon submarine gas pipeline, which was built and operated by the East Mediterranean Gas Company.
 

“Gas is an excellent source of energy, one beyond comparison with fuel, especially from an environmental perspective. Replacing fuel by gas for electricity production will allow the government to cut oil costs yearly by $200 million at the least, in light of the soaring international oil prices,” the manager pointed out. The government is also considering building another power station, in order to increase electrical production. However, the Memorandum of Understanding, which would ensure the transportation of gas from Egypt to Lebanon, remains to be finalized.

Beyond supplying the Levant with LNG, from Syria the Pan-

Arab gas pipeline will further extend to Europe. Originally, slain former prime minister Rafik Hariri, one of the pipelines architects, had envisioned linking Egypt to Europe with Lebanon acting as a platform for the gas pipeline network, a project which was abandoned at a later stage under pressure from other Arab countries. Today, it will be Syria that is the switchboard.

Still years away 

However, sending LNG from Syria to Europe is still years away, as the pipeline going north to Turkish node in Kilis is yet to be put together. “Building of the Homs-Kilis pipeline section will only start in 2009, as the Syrian government is still going through the bidding process,” Hlaiss said.

Addressing rumors that Syria may block the transfer of liquid natural gas to Lebanon, to put political pressure on the Lebanese government in light of the tense relations between the two countries, Hlaiss is sanguine. “I do not believe it is in Syria’s best interest to block or stall the pipeline completion. I highly doubt they will resort to such an alternative.”

 

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Banking & Finance

HSBC – Middle East strategy

by Executive Staff
written by Executive Staff

In early March 2008, HSBC announced that its UAE brokerage arm, HSBC Middle East Securities (HMES), had received a license from the Emirates Securities and Commodities Authority (ESCA) to operate as a broker on the UAE’s bourses and that it would start trading within the same month.

Executive met with Keith Bradley, HSBC’s Regional Head of Commercial Banking, and Charles P. Hall, CEO of the bank’s Lebanon Head Office, to talk about this new step and the HSBC’s strategy.
 

E What value-added does this license as a broker in the UAE bring to HSBC?

Bradley: It gives us presence and allows us to offer a range of services. There is a surge of investment in the GCC and so far trading had to be done through third parties, so we decided to eliminate the middleman and go directly onto the floor.

E Why the UAE? Why not Kuwait or Oman or Saudi Arabia?

Bradley: Most of the business is done in Abu Dhabi and Dubai. Of course, should large volumes develop elsewhere, say in Kuwait, then sometime in the future we might also think of other bourses.

E What do you think of Abu Dhabi having its own Securities Market now? Does the UAE need another one?

Bradley: One of the strengths of the Gulf is innovation. Also there is a keenness for competition, and this in turn will fuel innovation and enhance quality. I did my degree in history, and studied the renaissance period in Italy, where many city states competed with each other and in so doing created a tremendously innovative culture. Today, I see something similar in the Gulf.

E With the advent of the WTO regionally, banks are consolidating and preparing themselves for fierce competition. How do you foresee HSBC’s strategy after lifting foreign bank restrictions and you can be as aggressive as you want to be?

Bradley: Of course, we would like to open faster, and thus after WTO we’ll accelerate development.

Hall: Lebanon is at the forefront of liberalization. Next we want to go into insurance and once we do, we’ll be a major player.

E What type of banking are you looking to develop — corporate, private, retail?

Bradley: We are very committed to a variety of business streams. Corporate and private banking is now so intertwined that it is hard to see them as entirely separate sectors.

E With the liquidity and opportunities in the region, there’s also risk from political developments. How do you perceive the risk and how do you protect yourself? 

Bradley: We’re committed to the region and we’re committed to Lebanon. During the 2006 War in Lebanon the bank stayed open. Even during the Lebanese Civil War we did not close. Like every other financial institution, we have a Business Recovery Plan and a Business Continuity Plan. Because we operate in emerging markets, we have experience with political risk and backup sites.

E Looking at your Lebanon profile, would you say that HSBC is for wealthy people?

Bradley: There is a differentiation of services. Local banks have more branches, larger geographical penetration, and thus are better set up for low-end retail. For historical and risk reasons we do not have the market share. Also, we are not allowed to invest in government eurobonds, and so we cannot subsidize lending. Our split is about 25% corporate and 75% personal banking.
 

Hall: We are very specific in targeting customers. For example, we provide them with an Internet cash-supporting system, where customers who go regional can monitor cash-flow and everything else from abroad.

E Do you have any plans to limit your presence in Lebanon?

Bradley: HSBC is very committed to the Middle East. At the Group level, the Middle East will be a key market for the next ten years. For the first time, accumulated wealth is invested locally. The main developments are in the private sector, and HSBC is traditionally a private sector bank … And at HSBC, we have the best footprint in the region, having been present and involved in the Middle East for over half a century – in Lebanon since 1946 – and thus know the region and have long-lasting and deep relationships.

Hall: I can categorically reassure you that HSBC is staying in Lebanon. Indeed, we are opening a new branch. We are the biggest player in motor finance and one of the biggest in housing.

 

 

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By Invitation

Uncodified knowledge: The Middle East‘s unique innovation opportunity

by Fabrice Saporito
written by Fabrice Saporito

For many years, the developed world had a near monopoly on technical innovation. European, US and Japanese companies conducted high-end R&D in their home markets and then sold the results at home or adapted them for other developed markets. But over the last few decades, the number of companies with innovation centers outside their home market has grown, from 45% in 1975 to more than 65% in recent years, according to a Booz Allen Hamilton study.

Over time, these emerging markets have succeeded mostly by developing particular niches — wide screen television in South Korea, for example, or distributed computing in India. Now, the Middle East is at a stage of development where it too might become a home to innovation. But in a world awash in advanced expertise, which niches remain unclaimed? The answer is a kind of innovation that’s not so easy to put into a box and ship, or to attach to an email. It is a kind of innovation Middle Eastern companies are uniquely suited to developing: uncodified innovation.

Unlike the innovation that is now developed in markets such as India and China, which focuses almost entirely on technical improvements to products and processes, in fields as diverse as the automotive or chemical sectors, uncodified innovation is the kind of innovation that happens as services and products are adapted to the needs and preferences of a new set of customers.
 

Cracking the Code

The growth of globally distributed innovation occurred because companies have grown increasingly good at codifying knowledge. Once codified, each piece of the knowledge that made up a product could be sent to the place where the most cost-effective advances on that product might be made. This reduced the redundancy within the system and in essence avoided the need to replicate R&D centers in each market.

A similar opportunity exists now for uncodified knowledge. In other words, instead of just shipping information about a new product and adapting it to the needs of the market almost as an afterthought, one could ship critical cultural understandings about multiple markets to a single innovation centre. Such a center could ease the cultural adaptation process and indeed the entire customer service experience, whatever the origin of the ultimate customer: essentially, to use a software term, to act as a kind of middleware that translates service offerings between cultures, to help insure, for example, that a hotel chain meets the hospitality needs of its Muslim customers, or that entertainment products are designed to appeal to a Middle Eastern audience.

The Middle East at the Innovation Crossroads

The Middle East is uniquely positioned to take up this challenge. Like the successful Silk Road economy of the 12th to 14th centuries, the new Middle East economy is ideally positioned between West and East. Indeed, it might even be said to be both eastern and western, since places like the UAE are now home to people from a wide range of nationalities, motivated by a set of economic incentives no other economy can provide.

In addition, the demand for new products adapted to the unique cultural and environmental traits of the Middle East is pushing many companies to innovate their products and services. For example, the decision of Time Warner to open a studio in the UAE to develop films and video games in English and Arabic is opening up a new market that was previously untapped.

Whether that means developing video games that respect Islamic cultural values, or developing new financial products to meet the demands of Islamic customers, the core activity involved is creating services that begin by understanding the needs of the customer, not the capabilities of the technology. And that particular process of customer-centered innovation is something the new Middle East could leverage to develop products and services for consumers elsewhere in the world who also have specific cultural sensitivities but are now grossly underserved by one-size-fits all services.

Creating a truly international innovation centre

Although this kind of innovation began with the need to adapt services to Muslim consumers and the specific challenges of developing a world-class business center in just a few short years, the ultimate function of becoming a center for uncodified innovation will be to provide better service to many different peoples all over the world. In this too, the new Middle East will have an advantage, in that it can leverage its identity as a uniquely cosmopolitan region, testing service solutions on local sub-markets and ultimately exporting these to other markets.

Tapping into the unique characteristics of this emerging international innovation lab to create a truly global innovation center will require companies to both apply discipline and yet be flexible. As with any R&D, there is a process of sensing, accessing, and melding knowledge, but the key difference here will be that the essential intellectual capital being created will be not be technology or a technical process, but a knowledge of the people for whom the product or service is designed — knowledge about the customers themselves, whoever and wherever they may be.

Fabrice Saporito is a principal at Booz allen Hamilton,

 

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By Invitation

Orient‘s budding markets beckon equity industry

by Rend Stephan, Ahmed Youssef & Albert Khoury
written by Rend Stephan, Ahmed Youssef & Albert Khoury
 
The private equity (PE) industry in the MENA region (i.e., the Middle East and North Africa) has witnessed significant change over the past five years, evolving from infancy stage to a multi-billion dollar growth market.

In 2003, the MENA private equity market was embryonic, with only 20 firms managing less than $3 billion in capital. In the five years since then the industry has mushroomed to more than 80 firms, with more than ten-fold growth in committed or announced funds. Furthermore, the private equity industry in the MENA region now accounts for a considerable portion of total mergers and acquisition (M&A) activity.

Behind this growth are a number of MENA-based private equity firms, which can be segmented into the following categories:

• Pure-play firms, both regional — such as Abraaj Capital, Amwal Al-Khaleej, and Citadel Capital — and international — such as Carlyle Group — focus solely on private equity and are typically wholly-owned by their general partners to ensure high alignment of incentives.

• Institution-linked firms — such as EFG Hermes Private Equity, NBK Capital Equity Partners, and Shuaa Partners — typically affiliated with regional banks or large conglomerates, can leverage their institutional relationships for fundraising, sourcing deals, issuing debt, and exiting.

• State-backed firms — such as Dubai International Capital — are owned by or linked to regional governments and possess strong networks, often at the government-to-government level, that enable them to source investment opportunities, particularly in regulated sectors.

First-movers such as Abraaj Capital, Amwal Al-Khaleej, and Citadel Capital have made a large number of investments over the last three years and several successful exits to date. First movers have built substantial knowledge, networks, capabilities, and reputations that have well-positioned them to raise greater amounts of capital and have a good view as to where it can be efficiently deployed.

Challenges of MENA private equity

While overall trends bode well for an industry clearly poised for growth, the MENA PE market remains underdeveloped in comparison to other developed and developing markets.

First, compared with other economies, the MENA region’s private equity market is small relative to its gross domestic product (GDP), with the size of the industry in MENA at less than 0.5% of GDP versus 2-3% for developed economies. This indicates significant untapped potential should the necessary investment enablers evolve to facilitate greater PE activity.

Second, PE market growth has been largely driven by a few mega-deals, with limited growth in the number of transactions over the last three years and an increase in deal size, with media transaction size increasing from around $10 million in 2005 to $30-50 million by 2007. The slow growth of transactions could indicate potential pent-up demand or simply difficulty in deal sourcing.

Third, deal sourcing remains highly proprietary, built on closed social and business networks beyond the few privatization or secondary buyout transactions. Many MENA private equity firms who are backed by high-net-worth individuals as their limited partners often source the bulk of their opportunities through their LPs, giving them a competitive advantage over their peer firms.

Finally, and reflecting the industry’s early stage of development, most PE firms have largely focused on “low-hanging fruit” deals — arbitrage, pre-initial public offerings (IPOs), and capital-restructuring plays — as opposed to more complex value creation plays, such as Greenfield investments, roll-ups, and turnarounds. While simple plays have generated returns in excess of 50% to date, this is typical of any young market dominated by first-movers who quickly exploit market inefficiencies.
 

Future outlook for MENA private equity

In order to capture market opportunities, MENA private equity firms will have to capitalize on three major industry trends expected to dominate this sector over the next five years:

First — Continued market growth: Significant investment opportunities in a number of sectors in the MENA region will create many opportunities for MENA private equity firms. This is particularly true in high-growth, capital-constrained markets where private equity can fill funding gaps that exist in the market. In addition, many geographic markets continue to remain “virgin territory” for the private equity industry and are now undergoing significant structural transformations, including trade liberalization, privatization, and capital markets modernization.

Second — Separation of leaders from laggards: The second trend we anticipate is that there will be more differentiation between top quality firms and other “me too” firms. Given the capital excesses and pressures to invest/exit, there may also be some level of consolidation over the coming years. Some less performing firms may end up positioning themselves as co-investors on deals led by top-tier firms, while others will try to compensate through alternative investment classes.

Third — Increased prevalence of more complex value creation plays: In line with the previous trend, top performing PE firms are likely to increase their use of more complex value creation plays, relative to simple plays that depend most on market inefficiencies. This trend is inline with developed markets where leverage and exit multiples play less of a role than operational enhancement in creating value.

Conclusions

Clearly, the MENA private equity industry has made considerable progress over the past five years. However, much territory remains uncharted with significant potential. As firms consume the remaining “low hanging fruit” there will be an increased focus on more complex (and lucrative) value creation plays, such as roll-ups and Greenfield investments, which require greater expertise.

It will, however, continue to be quite competitive and each PE firm will need to carefully think about where and how to play to add value. Each PE firm will need to have its own unique strategy in order to become more differentiated as the MENA PE industry matures.

 

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By Invitation

Which investments have been money-makers in 2008? How to invest in global macro hedge funds and commodities

by Madilean Coen & Christopher Peel
written by Madilean Coen & Christopher Peel
 
With financial markets becoming increasingly more volatile and correlated, investors have found the pursuit of positive returns and capital preservation difficult and are asking the question “Where do I invest in 2008? What sort of investment vehicle can profit from downside and upside market volatility and still provide an investor with liquidity, diversification and accurate pricing?

”The answer year-to-date has been (1) the Global Macro hedge fund strategy (+6.2% through end of February 2008 as measured by the HFRI Macro index) — a strategy that seeks positive returns trading within global financial markets using a multitude of asset classes and financial instruments which includes both long and short directional exposure to stock market indices, currencies, commodities and bond markets; and (2) investments in commodities (+11.23% through the end of February 2008 as measured by the Goldman Sachs Commodity index).

Both of these sectors are arguably best accessed via hedge funds, which have attracted the top investment talent globally over the past several years and have been the natural choice for investors seeking to generate absolute returns from long and short positions rather than long-only passive investing. Historically, hedge funds have been well-equipped to deliver superior risk-adjusted returns and offer a low correlation to more traditional types of investment. However, the huge explosion in the numbers of hedge funds over the last few years has meant investors can sometimes become overwhelmed when trying to navigate the sheer number of choices of trading strategies and funds that comprise the hedge fund industry.

Given the complexity of many hedge fund trading strategies it is no surprise that funds of hedge funds (FOHF) offer a way to invest into this asset class. These specialist money managers offer a perfect vehicle: investment into several actively managed hedge funds in a single portfolio. However, most funds of hedge funds lack a focused strategy and in fact have become more over-weighted towards equities, thus depriving the investor of portfolio diversification when it is most needed.

Data going back to 1992 has shown that the rolling 36-month correlation between the MSCI Europe, Africa and Far East index and the HFRI Fund of Funds index had risen from near zero in 1992 to over 80% by December 2007. This highlights weaknesses in both the style and the bias of many funds of funds. Put simply, many fund of funds managers have increasingly focused on investing in equity trading strategies and therefore returns may be lower in the future given the forecasted slowdown in world growth.

This is a very strong argument for a sector-specific fund of hedge funds when considering this type of investment. Investors should be diversifying away from equities and into hedge fund management styles that have performed best when equities are in a bear market phase. Additionally, they should look for a fund of funds that targets performance over size of assets under management, where the fund of funds has a high level of expertise in their chosen area of investment and can identify the top hedge fund managers and gain access to those hedge funds. For example, the most highly regarded global macro hedge fund managers have long track records (+20 years) and have demonstrated profiting from the 1987 stock market crash, the 1990 Kuwaiti oil Gulf crisis, the 1997 Asian emerging market crisis, the 2002 global stock market correction and, of course, and the volatility demonstrated in 2008 thus far.

The problem is that managers who have successfully realized positive returns in the above environments are often closed to new investment and/or have large minimum investments (often $10M plus). A superior fund of funds can source, perform qualitative and quantitative due diligence, and negotiate capacity into these top hedge funds. It will also pool client assets together so that investors may invest in several of these top single manager hedge funds — thereby mitigating single manager investment risk at a much lower minimum investment amount for the individual investor.
 

Global Macro Fund of Funds

Global macro hedge fund managers are typically known to utilize a top-down, thematic investment approach and pursue directional trading strategies in the world’s financial markets utilizing stocks, bonds, interest rates, currencies and commodities.

In practice, what this means is that the hedge fund manager does not restrict himself to a single market or asset class but trades on an opportunistic basis across many different markets. Successful macro fund managers apply their specialist econometric understanding of the world and allocate risk within this framework. This means that they will be looking for markets to be long or short without having to favor one style or market over another. The upshot of this is that macro funds have been proven to capture both the upside of any equity market rally, but more importantly have shown an excellent history of returns when equities have fallen out favor.

An astute reader might now ask why all hedge funds of funds are not invested in macro strategies?

The answer lies in the fact that most hedge fund of funds managers are not equipped to fully understand macro strategy. They have been wary of macro hedge funds because they are difficult to pigeonhole as equity, fixed income or commodity funds. But a fund of hedge funds that specializes in investing in macro funds can offer an excellent opportunity to gain some exposure to this non-correlated type of hedge fund trading strategy, even if the manager has a proven long-term track record and is closed to new investment.

Commodity Fund of Funds

Commodity hedge fund managers typically utilize a fundamental investment approach that combines both macro economic research and traditional supply/demand analysis to construct directional, commodity trades within energy, metal and agricultural commodity futures and option markets.

As a result of falling global supplies and increased global demand, over the past five years many of the commodity markets, from fuel and energy to agricultural commodities and precious metals have seen an incredible rally. Irrespective of the present state of the equity markets, the rally in commodities will likely continue as demand from emerging economies such as China and India seek to:

1. Improve their diets and standard of living (agricultural commodities: meats, coffee, sugar, cocoa, eggs; as well as energy: crude oil, natural gas, etc).

2. Improve their infrastructure by building new homes, railroads, airports and even cities (base and precious metals). The above will likely replace any fall-off in demand from developed nations.

In addition, commodities have traditionally acted as an excellent hedge against inflation. Commodities will therefore continue to benefit as an asset class as central banks universally relax their focus on fighting inflation as they cut interest rates to promote growth and financial stability.

Finally, the commodity markets are themselves very distinct in nature from the equity markets. They can be constrained by factors such as the supply of land on which to grow crops or the rate of discovery of new mineral deposits, they may be influenced by weather or the cost and availability of transportation. All of these factors add up to make the commodity markets quite independent of equities and an excellent asset class for portfolio diversification. However, most investors are wary of investing directly in commodities, a long-only index or even a single commodity hedge fund manager. Again, for long/short commodity exposure to the top commodity trading talent a fund of hedge funds pool focusing on the commodity sector clearly makes the most sense.

 

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Capitalist Culture

USA – Primary mistakes

by Michael Young
written by Michael Young

As the US primary elections wind down, with some dozen left between April and June, largely absent from the debate has been the matter of democracy in the Middle East.

Even the Bush administration, with democracy as its rhetoric centerpiece, has largely ignored the practical implications of this when dealing with its autocratic Arab allies. Given the rise of Iran in particular, the US has systematically played down human rights abuses and political under-representation, believing now is not the time to embarrass governments whose priority is, like Washington, containment of the Islamic Republic.

Rather than focusing on democracy and how the US can spread its values overseas, the candidates, particularly the Democrats, have started from a premise that American efforts to push its values onto others has harmed America’s image overseas. So, for example, Hillary Clinton argues on her website that “America is stronger when we lead the world through alliances and build our foreign policy on a strong foundation of bipartisan consensus. [I] will lead by the words of the Declaration of Independence, which pledged ‘a decent respect to the opinions of mankind’.”

Barack Obama also supports “bipartisanship” in US foreign policy, but also proposes talking to America’s foes, such as Iran and Syria (unlike the “Bush-Cheney approach to diplomacy that refuses to talk to leaders we don’t like”), and wishes to employ American diplomacy proactively. His campaign website promises, for instance, that he will “stop shuttering consulates and start opening them in the tough and hopeless corners of the world … [Obama] will expand our foreign service, and develop the capacity of our civilian aid workers to work alongside the military.”

There is certainly much to be said about hostility toward the Bush administration around the world. Some of that antagonism may be justified, though one has to wonder whether Iraq factored disproportionately into the thinking of many. After all, Washington has not behaved any more unilaterally than its predecessors when dealing with such crises spots as Lebanon, Afghanistan, North Korea, Iran, Venezuela, Palestine, Kosovo, even Iraq after the initial phase of the war ended.

Indeed, one might argue that when it came to Iraq, but also Afghanistan, Lebanon, and Kosovo, the Bush administration’s willingness to be hard-nosed made all the difference in liberating previously stifled peoples. It is undeniable that the Iraq war could have been managed infinitely better, savings tens of thousands of lives, and that Afghanistan is far from stabilized; but without the US, Saddam Hussein would still be in power, to the chagrin of a majority of Iraqis, and the Taliban would, similarly, be imposing their mad, medieval designs on Afghans. Few are the Lebanese who regret the Syrians’ departure, and it is largely thanks to American backing that Kosovo’s independence has become a reality.

In contrast, those who speak about “improving America’s image in the world” seem less clear about what this means in practical terms. No doubt being hated is a problem for any country, particularly so powerful a country as the United States that needs to build international coalitions to forward its preferred agendas. But is there any sign that “being loved”, or even just being “liked”, makes much difference globally? Not really. Why is it that Americans alone seem so keen to raise this odd question of affection, when most other states pursue their interests without bothering about whether they are liked or disliked?

What the Bush administration has gotten wrong, and its successor will likely get wrong too, is that the only credible benchmark for global influence is respect, therefore success, not popularity. In focusing on affection as the goal in improving America’s image, policy thinkers ignore that no powerful nation is ever truly liked. America’s condition will not improve because Arabs or Asians tell Pew researchers in a year’s time that they admire America more than today. America’s condition will improve when the foundations of its admired capitalist culture are strengthened. These include a defense of open markets and open minds, a rejection of despotism, and a reliance on the soft power of persuasion and example, in addition to a willingness to use hard power when this proves unavoidable.

To expect the US, or any state, to be absolutely consistent in its behavior is asking too much. Politics doesn’t work that way. But to have no guiding principle to base action on can be almost as damaging as appearing to fail in one’s aims. That’s why the Bush administration has paid so heavily for its efforts in Iraq, Afghanistan, and elsewhere. It is seen as a loser, whether this view is fair or not.

All the US candidates should remember this when they issue vapid proclamations about America’s image in the world. To be cliché: there is no success like success, particularly in the defense of liberal values. What all the candidates should be doing now is determining whether their foreign policy options will actually meet this standard.

Michael Young

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By Invitation

A Universe Apart

by John Defterios
written by John Defterios
 
The Great Eastern Hotel near Liverpool Street train station was designed with the City of London financier in mind. Its minimalist interior, clean lines and discrete atmosphere create the right setting for business people to work on a deal or attend a mid-sized forum.

I escaped into the Great Eastern in late March for a few hours at a gathering of Egyptian ministers and business people to discuss the outlook for the region’s most populated country. The talk inside the meeting room was about robust growth of 7%, foreign direct investment hitting a record $11 billion dollars and re-positioning Egypt to capture more than its fair share of Gulf petrol dollars.

On the way over to the meeting, I read my morning paper with headlines reacting to the Federal Reserve’s orchestrated bailout of Bear Sterns and yet another drastic cut in U.S. interest rates to help cushion the blow of the slowdown. This was followed by rampant rumors in London of an imminent collapse of a leading retail bank. The rumors sparked an investigation.

Inside the foyer I took time for a few interviews to sound out my views that we are not living in one global economy right now. “It really does seem like two parallel universes,” said Marwan Elaraby of Citadel Capital the Egyptian investment bank.

“You drive around Dubai or the more frontier emerging economies of the region, you would never guess what is happening in the world economy. What is happening on Wall Street or the City of London seems like a universe away,” added Elaraby.

The dollar continues to tumble; oil continues to surge; prices everywhere for staples are skyrocketing. Despite the rosier economic outlook, protestors in Cairo demanded that President Hosni Mubarak do something about the cost of bread. History buffs know from Roman times that economic growth alone does not deliver votes, but affordable access to bread certainly does.

Finance is Confidence

Middle Eastern players are not ignoring the red-lights of concern flashing on Wall Street, quite to the contrary. They are hoping to minimize the impact. As co-founder of Beltone Financial, Aly El-Tahry noted: “Finance is confidence. As long as you don’t have a catalyst or something that diverts the present expectation from this negative mood, we’ll continue to have uncertainty.”

For Egypt that may translate into a drop of up to 1 percentage point of growth this year according to the country’s Investment Minister Mahmoud Mohieldin. While he acknowledged the challenge, the 42-year-old minister added some bigger picture thoughts on what this might eventually mean.

“I’m much more concerned about the policy formulations in the future because the kind of extreme pragmatism that we’re witnessing today could be justified in the short term by uncertainty, by requirements of having to make and to do some quick actions to fix problems,” said Mohieldin. The Worldcom fiasco led to Sarbanes-Oxley. This severe credit crunch he worries may lead a new White House occupant to move into action to limit trade or the flow of financial investments.

Let’s hope not. We, however, have heard very little from the three remaining presidential candidates on what they would do about the Doha trade round, sovereign wealth funds or the sinking dollar.

Meanwhile, back in the foyer of the Great Eastern, the talk remains on creating new opportunities. Egypt is in the midst of creating a new industrial investment hubs and expanding IT centers. For that to come off the ministers know that skills need to match the demands of companies such as Microsoft or Oracle who already have a presence there.

With this economic boom underway in the region, the players are looking to India and China for inspiration, not Wall Street or the City of London .
 

 

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Closing the doors on oil’s big boys

by Paul Cochrane
written by Paul Cochrane

The halcyon days of cheap energy, pliable governments and a public that didn’t care about pollution or global warming are over for the international oil companies (IOCs). This we all know, or are slowly coming out of a somnambulant state to realize, but recent trends in the oil industry are presenting further concerns for IOCs at the very same time as they report bumper profits on the back of high oil prices.Energy giant ExxonMobil reported a $39.6 billion profit for last year, BP $17.39 billion and Shell $27.6 billion. Such profits were deemed ‘obscene’ in the British popular press, as indeed they might be perceived to be, but what was less noted amid the hullabaloo was that BP saw profits plunge 22% in 2006 — and is now laying off employees — and that Shell is to sink $26 billion of its profits into developing new projects. Likewise, ExxonMobil spent $21 billion in capital expenditure last year, but production increased by less than 1%.

So what is behind this change in fortunes? After all, the IOCs had enjoyed year-on-year record profits for the past five years, demand is still rising and oil looks like it will continue to hover around $100 a barrel.

The problem that IOCs are facing is production and access to energy reserves. The cost of production has surged from $5 a barrel in 2000 to $14 in 2006, largely due to the rising costs of extraction as well as construction of upstream and downstream facilities.

This was evident in the amount Kuwait’s National Petroleum Company (KNPC) had to shell out to build the 615,000 bpd Al-Zour refinery, the world’s largest purpose built facility of its kind.

The original budget was $6.3 billion, but with the cost of raw materials doubling and even tripling in the Gulf, no construction firm would touch the project and the refinery was on the verge of being shelved. But so important is the refinery to the Kuwaitis that the government eventually capitulated last September, earmarking a staggering $14.29 billion to get the job done.

“We are now touching un-chartered territorial waters, the value of contracts in the billions of dollars,” said Ahmed al-Jemaz, KNPC deputy managing director of the Shuaiba refinery.

Such spiraling costs are naturally of concern to IOCs — Shell admitted a 10% annual increase in inflationary costs — but of more pressing concern is the access to energy rich countries.

One by one, doors are being closed to the IOCs as countries re-nationalize resources. Last year, Russia put the screws on BP and Shell to hand over majority stakes in gas operations to the state-run Gazprom, Bolivia nationalized gas and oil fields, Ecuador used military force to take over Occidental Petroleum’s holdings, and Hugo Chavez gave IOCs a choice: handover majority stakes to Venezuela’s national oil company or face complete nationalization of operations in the Orinoco River basin.

In the case of Venezuela, BP and Norway’s Statoil Hydro opted to stay but for ConocoPhillips, which pulled out, the loss of its Orinoco holdings saw the American company’s second quarter earnings plummet by 94%.

The loss of these countries, coupled with growing competition from national oil companies (NOC) around the world — a cursory glance at the countries in which NOCs operate is more than ample to see they are not confined to exploiting their own national resources — is what Jeroen van der Veer, Shell’s chief executive, was quoted as saying is a dangerous trend.

IOCs can be thankful, then, that the MENA region is not part of this re-nationalization phenomenon, but Arab governments are savvy enough to know they don’t have to be taken for a ride.

IOCs are having to face the reality that to access the likes of recently de-nationalized Libya, with proven oil reserves of 41.5 billion barrels and only 30% of the country explored, deals are getting tough.

This was apparent at the last round of bidding in December, where 35 companies were pre-selected to bid for 41 gas blocks, but only 13 companies put in bids and only four blocks were awarded out of 12 licenses.

The lack of interest by IOCs was attributed to ‘uninteresting’ blocks offered by Libya’s NOC, but most notably it was Tripoli hand-

picking companies that would provide the highest share of production, with Gazprom offering 90.2% of any production in finds in western Libya and Shell offering 85% to search for gas.

Such tight restrictions were not there to access Palestine’s recently discovered gas, with only 25% going to the Palestinian Authority, and Iraq’s oil law looks like it will hand over the lion’s share to IOCs, but Libya is not alone in the region with its tough stance.

The only thing that the IOCs have on their side right now is the skills and technology that NOCs don’t — as of yet — have.

All in all, it looks as if 2008 will be another roller-coaster year for the IOCs while NOCs, albeit not necessarily laughing all the way, can at least show some bravado on their way to the (central) bank.
 

PAUL COCHRANE is a freelance journalist based in Beirut. His work has appeared in Britain’s Petroleum Review.

 

 

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Did they ever get it wrong…

by Claude Salhani
written by Claude Salhani

US President George W. Bush and his Secretary of State Condoleezza Rice thought they could solve the Middle East’s core problem — the Palestinian-Israeli dispute — by organizing a peace conference in Annapolis late last year. Having succeeded in bringing together Israelis and Palestinians, as well as Syrians, Saudis and numerous other countries for a meeting that was big in aspect though short in context, the administration bathed in the euphoria of its temporary success. ‘Temporary’ here is the key word because since November of last year, and since Bush’s promise of peace before his mandate expires in January 2009, the Middle East once again finds itself caught in a deadly spiral of increasing violence.

Talk about misreading signals, misjudging reactions and misguided policies.
Since the Annapolis conference Gaza, with its 1.4 million inhabitants besieged by the Israeli military and under Hamas control, sits on the brink of all-out war. As Hamas continues firing Qassam rockets at Israeli population centers and Israel hits back, civilians are caught in the cross-fire on both sides; Jerusalem has been the target of one of the worst terrorist attacks in years when a lone gunman opened fire on yeshiva students, killing eight and wounding another 10; the Lebanese presidential crisis, now in its fourth month, has pitted Syria and its Lebanese allies against the country’s government who enjoys the support of the United States, France and Saudi Arabia. As a result the Saudis have recalled their ambassador to Damascus, while the United States has dispatched three naval gunboats — including the USS Cole — to the eastern Mediterranean in what can only be seen as a revival of gunboat diplomacy. Amidst all this one must not forget Iran, who is believed to be pursuing its nuclear ambitions

So much for peace within the year. Indeed, seen from Washington, the situation in the Middle East looks quite dim, and despite Bush’s misplaced optimism, try as one may, it is hard to see any light at the end of the proverbial tunnel, unless it’s those on Merkava tanks heading for Gaza or for southern Lebanon. Analysts and diplomats have voiced their pessimism regarding the short-term future of the region. As for the long term, no one is really daring enough to venture any thoughts. Suffice to say that events are affecting the region’s economy in a way that, if allowed to continue to deteriorate, may result in drastic — and dangerous — measures.

Many believe that President Bush waited far too long to become actively involved in the Arab-Israeli dispute, and now Washington’s efforts are too little and too late. Additionally, the Bush administration’s policy of refusing to recognize the importance of talking to four major players in the region — Syria, Iran, Hizbullah and Hamas — cannot possibly advance the peace process. Syria, much as Iran, holds great influence on the Lebanese Shiite organization, Hizbullah, and the Palestinian Hamas movement. Much as the White House hates to admit it, the road to peace in the Middle East unavoidably passes through Damascus.

Meanwhile, as one of former President Bill Clinton’s campaign slogans so adequately pointed out, “it’s the economy, stupid.” The dangers of a regional flair-up cannot be ignored as Israel begins to feel the economic crunch of its war with Gaza. Cities such as Sderot, well within Hamas’ range of Qassam rockets, have seen their economy take a turn for the worse. In fact, Israel’s policy regarding Hamas has met with about as much success as Washington’s and the siege of Gaza has backfired. The storming of Gazans across the border into Egypt demonstrated that the policy of trying to contain the Strip has failed to yield the desired results and is having a negative effect on Israel’s economy.

As a result of the continued bombardment, a number of businesses have been obliged to lay off personnel as residents of border localities limit their activities to the most basic and urgent needs. Hoping to incite the people of Gaza to move against Hamas by exerting pressure through the embargo maintained by Israel, ironically, this policy is coming back to bite Israel’s own economy. And herein lies what could be the tipping point. Israel’s Prime Minister Ehud Olmert, already suffering from lack of popularity, a position amplified by the fiasco of the Lebanon War and the ongoing undeclared war with Gaza, may feel obliged to address the situation through military action. As in the past, such short-

sighted policy will only serve to strengthen those opposed to the peace process; a process which can only advance under the guidance of the United States’ influence. But for that to succeed a change of policy is first required. This is unlikely to happen before there is a change in the White House’s Middle East policy, or a change in the White House.

Claude Salhani is editor of the Middle East Times.

 

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