The United States Senate in late June passed a bill that would allow the Justice Department to sue the Organization of Petroleum Exporting Countries (OPEC) for price manipulation and high oil prices, but President George W. Bush has threatened to veto the bill, warning that OPEC members could retaliate by tightening the flow of oil into the US.

The bill, dubbed NOPEC or the “No Oil Producing and Exporting Cartels Act of 2007” would revoke the sovereign immunity OPEC members enjoy from being sued in US courts.

OPEC President Mohammed al-Hamli called the move by US lawmakers a dangerous step and added that decisions taken by OPEC were non-binding and that the organization will fight these attempts.

“It’s a really dangerous step. We will defend ourselves against these attacks,” Hamli told reporters at an oil conference in Turkey in June.

Latest official figures show that Americans are currently paying an average of $3.21 a gallon at the gas pump as oil prices continue to reach record highs. Prior to the Iraq war, Americans paid an average of $1.00 a gallon and blaming OPEC appears to score some points with the public.

“We don’t have to stand by and watch OPEC dictate the price of our gas,” Senator John Conyers, a Democrat from Michigan said. “We can do something about … this anti-competitive, anti-consumer behavior, and we are.”

The pressure’s on

The anti-OPEC bill was sponsored by Senators Herb Kohl, a Democrat of Wisconsin and Arlen Specter, a Republican of Pennsylvania. The House voted 345-72 to pass the bill.

“Price fixing by cartels is the worst violation of antitrust law and the principles of free competition,” Kohl told Executive. “If OPEC nations were private companies, their actions would be plainly illegal under antitrust law,” he added.

He thinks NOPEC would give the US government an important tool in responding to OPEC actions.

Although the White House has threatened to veto the measure, the bill may become law as both the Senate and the House have enough votes to override the veto. “The bill passed both Houses by more than the two-thirds needed to override a veto, 345-72 in the House, and 70-23 in the Senate,” Kohl said. But observers note that even if it became law, the Bush administration’s Justice Department would be the entity that would have to initiate any lawsuit.

But not all Americans support the action against OPEC. Local observers believe the problem with current oil prices is the combined increase in global demand and shortages of refinery capacity in the US. They say that congress is aiming at the wrong target. “It is the US refiners — who have made record profits — who should be called on the carpet and who every year about this time make their annual financial killing,” Robert Prince in Washington said.

“The arrogance this legislation conveys is unbelievable and completely irresponsible. As an American, I’m ashamed,” a US citizen who wished to remain anonymous told Executive. “Oil prices will continue to rise because demand has started to outstrip supply. This is the most basic rule of economics and our leaders don’t seem to appreciate it.”

Republican Senator Pete Domenici of New Mexico warned that the plan would hurt US consumers more than it would OPEC. “OPEC producers could just decide not to sell oil to us any longer,” he told reporters. “They would suffer the loss of some profits but our entire economy could come to a grinding halt.”

Although the official reaction from OPEC to NOPEC was perfunctory, Hamli said OPEC had successfully fought off two prior attempts by US lawmakers against OPEC and will do so again.

But supporters of the bill don’t believe that OPEC will react by cutting or reducing oil supplies to the US. “We would be surprised if OPEC member nations would want to stop selling oil to one of their best customers,” Kohl said.

“We would hope OPEC would respond to this law by ceasing the practice of setting mandatory production quotas designed to drive up the price of crude oil, rather than take the extreme step of cutting off oil supplies,” he added.

OPEC says the high prices are due to geopolitical tensions and refinery bottlenecks in the US rather than any shortage of crude supply. And most analysts do not foresee a decline in prices in the near future. On the contrary, what they predict is an extreme jump in prices by 2009 and 2010.

In late June, the New York-based Bloomberg News quoted Jeffrey Currie, a London commodity analyst at the world’s biggest securities firm, saying that $95 crude is likely in 2007 unless OPEC increases production, and declining inventories are raising the chances for $100 oil. Jeff Rubin at CIBC World Markets predicts $100 a barrel as soon as 2008.

The Kingdom Holding initial public offering in Saudi Arabia last month was the much-anticipated climax of the flotation eagerness that has characterized GCC equity markets since 2004.

IPO lead manager for Samba Financial Group announced that 1.25 million subscribers submitted orders for the 315 million shares which Kingdom Holding put on the market at SR 10.25 ($2.74) per share, a total share offering worth about $860 million. Demand, according to Samba, reached $2.3 billion, representing subscription coverage of 264%.

Kingdom Holding will be the fifth-largest listed company in Saudi Arabia, but the company’s founder and best-known Arab entrepreneur, Prince Al-Waleed bin Talal, will retain over 93% ownership of the holding company with its local and international assets. Although offering merely 5% of Kingdom Holding’s stock for sale — substantially less than the 30% Prince Al-Waleed had talked about earlier — the IPO carried a message of trust in the Saudi Stock Exchange (SSE).

Putting a chunk of equity on the SSE where the mouth of the savvy global businessman Al-Waleed has been for a long time, comes at an important junction. While the primary market in the GCC is far from exhausted, the transmission ratio between the primary and secondary markets has come under scrutiny.

Underpricing has distorted the outlook

Last month, in a working paper for the the International Monetary FundAnalysts studying the IPO market evolution in the GCC between the start of 2001 and 2006 said that the abnormally high first-year returns of 47 IPOs presented a distorted picture. “The average initial abnormal returns of 290% exceed those found in the existing literature for both developed and emerging market IPOs,” the working paper said and related this high ratio to the massive underpricing of GCC IPOs.

Underpriced offerings have been the rule in the GCC and driver of immense oversubscription ratios for a number of reasons, including the practice of state-backed issuers to use the IPO mechanism for a bit of redistribution of oil wealth to retail investors and specific groups in the workforce, e.g. teachers.

This led to huge trading volumes and quick profits in first-day trading of many listed stocks. Latest signs, however, suggested that this phenomenon is waning. 

Low-cost airline Air Arabia, which undertook its IPO on the Dubai Financial Market, was among the region’s newly listed companies that were subjected to a more subdued market sentiment in first-day trading. The Sharjah-headquartered carrier, which saw the second-lowest oversubscription rate (1.5 times) in the DFM’s history in March, ended its first day of trading in July with an 11% gain — low by comparison with other IPOs but still better than what analysts had predicted.

“It will probably go below its AED 1 ($0.27) offer price when it lists,” Shehab Gargash, chief executive officer with Dubai’s Daman Investments had told a conference a week before the listing.

“I still hold to the view that it’s headed below one dirham,” Gargash told Executive after the stock closed its second day of trading flat.

“There are a lot of institutional and high net worth investors carrying more than they bargained for,” he said, referring to those who poured cash into the IPO, likely expecting a typical DFM oversubscription rate at least in the double digits, and wound up with a larger percentage of shares as demand was relatively low.

Air Arabia’s muted performance comes on the heels of the DFM’s former least-oversubscribed, worst-first-day performance title holder Gulf Navigation Holding, which listed in early February. GNH’s 3.5x subscription rate and 20% climb on its debut were a case in point for Amir Halawi, a researcher with UAE-based investment bank, The National Investor.

Halawi recently co-wrote a report predicting that first-day climbs for stocks listed in the UAE hitting the stratosphere were a thing of the past. In his report, he argued that investor behavior in the UAE equity market needs to shift from indiscriminate buying of underpriced IPO shares to acquisition of shares that have the best fundamentals. “We believe that some people have started losing money on some IPOs and this is going to become a structural phenomenon,” he told a local radio show in early July.

No uniform trend

Gargash, on the other hand, denied that there is a uniform trend. “I don’t think a pattern can be generalized,” from the first-day performance of Air Arabia and GNH, Gargash said. “I think the trend is there are two types of IPOs, the star IPO and the…less glowing,” he said, pausing during the telephone interview with Executive to search for the inoffensive put-down.

The differentiation is the perception of investors as to how well-backed by government intervention the companies are and to what extent governments show active support for these companies, Gargash said. GNH is entirely privately held and the emirate of Shajrah only holds a 17% stake in Air Arabia.

Regardless of the fate of first-day gains for UAE first-time floats, the IPO market in the six Gulf Cooperation Council countries has been off to a booming first half of 2007. The number of completed subscription periods of IPOs reached 22 by June 30, up 69% from 13 during the same period in 2006.

A study by Abu Dhabi-based investment bank Gulf Capital said as of July, between 2007 and 2010 there are as many as 76 more IPOs on the way in GCC countries alone, 41 of which already have a lead manager assigned.

The strong expectation for GCC primary markets has resulted in much-increased attention from international investment advisors and researchers. Where sources on IPO activity were limited to one or two local companies in the past — the online information provider Zawya.com leading the field — recent weeks saw a spike in coverage of Middle East IPOs, if not in a dedicated report then at least in a sidebar of global IPO coverage. 

“Middle East IPO growth is driven by high market liquidity, government privatization activities, continued economic prosperity and the massive government budget surplus created primarily by increased oil prices, the main source of the governments’ revenues,” wrote Oman Bitar in a recent report on IPOs by financial services company Ernst & Young, where he is managing partner of Middle East advisory services.

The three researchers, Abdullah Al-Hassan, Fernando Delgado, and Mohammed Omran who looked at the GCC equity markets for the IMF said in their paper that the extremely high positive returns of recent IPOs here come down crashing when the perspective is adjusted to first-year performance. Evaluating IPO returns in the GCC against general indices for the respective bourses, the researchers found that these stocks performed below their benchmarks in the first year of trading when initial returns are excluded.

According to the research, aftermarket performance under a one-year buy-and-hold strategy is positive when seen against the IPO subscription price but negative when first-day returns are taken out of the equation. “A strategy of investing one dollar in IPOs at the end of the first trading day and holding it for one year would have left an investor with only 77% to 50% of the return of each dollar invested in GCC stock exchange general indices,” the academic paper said.

Moving toward realistic values

The consensus of professional market participants, analysts and researchers is that the GCC equity markets are at a junction where the experiences with underpricing, excessive subscription demand, and imbalanced first-day trading have to be mitigated by creation of more professional intermediaries and improved regulatory frameworks along with better information provision.

Recent IPO issues, including the Kingdom Holding offering, indicate that initial pricing — unless mandated differently by regulators as was the case for the Saudi insurance sector — is moving in direction of more realistic valuations.

The fixation on oversubscription is also lessening as IPOs were oversubscribed by an average of 6.5 times during the first half of 2007, about nine times less than the 60-fold demand that was prevalent in average oversubscription rates in GCC countries during the first half of 2006.

Institutional investors are expected to adjust with fair ease to the changed trends and prepare themselves to set their portfolios accordingly. Concerns are stronger that retail investors will face harsher learning curves that require dismissing excessive expectations for first-day rallies and abnormal positive aftermarket returns of IPO stocks.

Four seem confusing, one is asleep, five are quite small, but three are standing tall, doing better than ever — ‘tis not a legend to a treasure map of Captain Jack Sparrow, this; ‘tis the Arab stock markets in the first half of 2007.

From the start of the year until the end of July, the indices of three major Arab equity markets — the Abu Dhabi Securities Market, the Kuwait Stock Exchange, and the Cairo & Alexandria Exchanges — have moved up beyond most expectations, with gains in the range of 20% to 25%.

The KSE and CASE achieved new historic records last month as their rallies drove them above the highs they had achieved in the days of the regional bubble that peaked between autumn of 2005 and February of 2006.

On a two-year performance check, CASE is up nearly 80% when compared with the end of July 2005, KSE is up 40%, ADSM, however, is down by a quarter of its index. Like its twin in Dubai and the neighbor in Doha, the Abu Dhabi bourse had its till now top valuation days in the second half of 2005. The largest of the region’s exchanges, Riyadh’s Saudi Stock Exchange, is down by more than 40% in two-year comparison and — after some gains in July — reduced its losses for the first seven months of this year to less than 5%.

The big black stallion in MENA markets in the first half of 2007 has to be Egypt. Its EFG Hermes Index tested the barrier of 75,000 points in the second half of last month, reaching more than 7% higher than its previous record highs from February 2006. In the way of dark horses, attention possibly deserved by the CASE case was sucked up by the on-going Dubai hype and the fascination of GCC as the main stage in the current Arabian economic miracle.

Credit Suisse favors GCC markets

Swiss wealth maker Credit Suisse (CS) blew its investment horn heavily for the Gulf last month in producing its debut in-depth report on the GCC markets, calling them “the most attractive globally on cash flow and dividend yield metrics.” Besides being very profitable, listed companies in the GCC on average have low debt. For enterprise multiple — the cost of a company expressed as ratio of enterprise value to earnings before interest, tax, depreciation, and amortization — the GCC are currently the cheapest markets worldwide, CS added.

The bank favored the GCC even more on basis of its latest oil price forecast; CS updated its outlook for benchmark crude (West Texas Intermediate) to average $62.5 per barrel through 2010. Its investment advice for GCC portfolio holders is allocation of 40% (market weight) to the SSE, 27% to the UAE (33% overweight), 19% to Kuwait (30% underweight) and 14% to Qatar (27% overweight against its share in the MSCI GCC index).

The weighting reflects that the Kuwaiti market has sped ahead of Saudi Arabia, Qatar, and the UAE in stock price levels. The Bahraini and Omani markets, which also rose to new record highs in recent weeks, do not figure in the hefty CS research and recommendation paper; their combined weight in the MSCI GCC index is only 2%, since they have significant size handicaps against their GCC peers with the exception of the region’s expatriate bourse, DIFC, that has nailed down the role as the world’s largest listing place for Sukuk but still rests in anticipation of its kiss of life for equities. 

With all the enthusiasm about Gulf equity markets, it is an enticing profitability play that a theoretical investor in index-tracking stock on the Egyptian exchange would embark on his 2007 summer holidays with his portfolio value about 120 percentage points ahead versus the Saudi bourse’s Tadawul All Shares Index if he bought and held shares from the end of July 2005 to the end of the same month in 2007. 

Full-month volumes on the Egyptian bourse in June reached 641,911 transactions and exceeded 1 billion traded securities. The value of trades was close to $5.8 billion, of which 4% were over-the-counter trades.

The first-half year rally of CASE was more than many local observers had dared to hope for at the beginning of 2007 when a magazine report in January said all that investors in Egypt could wish for were political stability and another market rally — “but that might be asking for too much.”

Regional investment firms, while taking a positive look on Egypt overall, expressed some polarization in their views on the Nile republic versus the GCC. In its regional outlook published in April, Dubai’s Rasmala Investments was bullish on CASE saying that the capital market is situated for gains because of privatization benefits and infrastructure investments.

Risk sensitivities

Shuaa Capital across town was a bit more kittenish, asserting its positive view on Egypt in the long term but stating the firm had pulled away from the market because of concerns over a valuation parity mismatch with the GCC and fears of Egypt becoming engulfed in a wider emerging markets sell-off.

In the three months since Shuaa published their spring assessment which named the UAE as their first market pick and the Saudi market the second, the Dubai Financial Market and the ADSM have done well with respective index gains of 14% and 16%. But the SSE moved up by barely 5%, and that only thanks an upward push in the second half of July, while CASE’s Hermes Index kept rolling with a three-month rise of over 13%.

As de-facto standalone paladin of the international equity game in North Africa (the much younger bourses of Tunis and Casablanca are no comparable partners at this time) Egypt has concerns over influence of international market swings on its prices, perhaps more so than the GCC where mutual dynamics can play out stronger.

People are getting more sensitive to risk, according to a ruling consensus among analysts who have gauged the credit, equity, and bond developments on large global markets in the past five months. This increased caution also could transmit distant market jitters to bourses in the Middle East in conjunction with the overall growing trend of global interaction of investor sentiments.

Credit Suisse July 2007 Top Stock Picks for the GCC

Coming as a timely reminder of this was Wall Street’s second-worst day of 2007 to that date on July 26 which sent the Dow lower by 311 points. Coming shortly after the New York Stock Exchange set new records, the market quiver radiated into other major markets where Japan’s Nikkei and other Asian bourses went lower the next day.

In their first responses, analysts evaluated the drop in the Dow as significant because of the high volumes of trade involved, which signaled selling by institutional investors. Without attempting any soothsaying about US markets in the remainder of 2007, the fluctuations on Wall Street are noteworthy symptoms of the increasing globalization of major equity markets that also was behind the year’s sharpest drop in the US market index at the end of February.

Back then, it was nervousness on China’s Shanghai market that triggered a wave of slides from the East to the West, ending with a drop on Wall Street. The end-July jitters traveled in the reverse direction, but immediately led experts to speak of a domino effect, raising just the same questions over growing international cross influences of market movements as the February tremor had done.

The Middle Eastern exchanges were not much affected by the February slump and because of the Islamic weekend had a time insulation benefit from the late-July drop which fell on a Thursday/Friday. However, intensification of global market developments and their influences on regional markets can be expected.

Accessibility to foreign investors needed

Looking at it from another angle, the accessibility of the region’s equity markets to foreign investors is worth wondering about in the positive sense. CASE statistics, in June, said foreign investors supplied 31% of the exchange’s total market value traded. An important factor in Egypt’s rally has been the economy’s platform of reform, privatization and improving of attractiveness to international players.

The announced intention to sell 80% Banque du Caire by the Egyptian government last month was a major case in point, leading — despite an outpouring of local concerns over selling out to foreigners — to immediate reports of international interest in buying the bank.

On the other hand, most of the top stock picks which CS presented in its review of the GCC markets had the drawback of not being open to foreign investors. Some blue chip stocks in the GCC that have been given mouth-watering upsides of well over 50% by local and international analysts are not available to non-GCC buyers.

In light of the performance differences between the privatization and diversification driven uptrend of CASE and the heavily oil-dependent path of the restrictive Saudi market, it is worth asking if GCC equity markets in 2007 have sacrificed significant valuation gain potentials through their access policies which barred sophisticated international investors from making moves on what they identified as the end of the correction phase that followed the initial Gulf equities bubble.   

Also an open question is to how much the Middle East can be knitted into a sufficiently coherent fabric of equity markets, trade and services. Over half a century of political proclamations of Arab free trade have not panned out, today’s private sector web of financial firms and investment relations is the intriguing show. To give just one small example for this integration, UAE investment firm Abraaj Capital owns 20% in Egypt’s EFG Hermes which owns 25% in Lebanon’s Banque Audi.

What is still missing is the joint platform of a true regional bourse — but with a load of political agreements needed and the ratio of magnanimous announcements to concrete steps in that direction waking musings on the actual international willingness to acknowledge the Palestinian state, all short-term bets on the joint Arab bourse option should be in Monopoly money.