February 25, 2011

JP Morgan on Middle East: Long-Term Oil Volatility Likely; Yemen Next to Fall

JP Morgan sponsored a conference call today on the current situation in the Middle East. The call was in four parts by four different speakers. Key takeaways include:

  • Crude oil volatility may last months, not days, as the threat of contagion events in the region persists.
  • Saudis are pumping extra crude to make up for the lack of supply from Libya.
  • Most major economies are much more concerned about growth than inflation, and will likely not tighten even with the threat of higher prices.

I recommend staying the course in client portfolios, and continue to view the pullback as a buying opportunity unless/until conditions deteriorate.

Full notes follow (thanks to Nathan Dutzmann for being on the call).

Part 1. Joyce Chang, financial specialist

  • Too early to change procyclical forecast of 4.0% global GDP growth.
  • Emerging market policymakers are focused on growth and social stability rather than inflation, and will only tighten very cautiously.
  • EM fixed income indices are not much affected by the geopolitical crises.
    • JPM still thinks 5-8% EM fixed income gains are possible this year.
  • U.S. high-grade and high-yield credit not much affected by the crisis
    • Inflows have been strong, even this week.

Part 2. Brahim Razgallah, MENA geopolitical specialist

  • Next likely regime overthrow candidate is Yemen.
    • Situation similar to Libya in terms of overall oppression, high unemployment, and violent response to protesters.
    • If Yemen’s regime falls, a political vacuum is likely, which could add instability to the region.
  • Low probability of regime change in Bahrain, but high odds of negotiation with opposition parties leading to substantive changes.
  • UAE and Qatar are unlikely to have crises, but some financing contagion risk exists.
    • Financing contagion would be a big deal for Dubai, which has and needs tons of debt financing.

Part 3. Matthew Levitt, terrorism expert

  • Arguably, the events of the past few weeks help delegitimize terrorist groups.
    • Accomplished regime overhaul in a few days, when terrorists couldn’t do so through years of activity.
  • Typical pattern: Unity of opposition during overthrow; sharp splits during government formation.
  • Oil supply concerns go beyond days and weeks; could be months or years of disruption in some cases.
  • Saudis could send forces into Bahrain if they perceive a risk of Bahrain being pulled into Iran’s orbit.
    • Appears to be low risk at present.
    • Still, Saudis were disappointed that Bahrain pulled back from violently putting down the protests.
  • The Saudi government is talented at buying stability.
    • The only risky region for them is the oil-rich, Shia-dominated east.    
  • The United States has limited leverage in this situation.
    • No-fly zone in Libya may be on the table.
    • If we don’t respond when Qaddafi is strafing protesters with gunfire from helicopters, it’s hard to imagine a level of oppression that would be sufficient for us to respond.
  • International financial response has been strong, preventing former officials from stealing money from Egypt, Tunisia, etc.

Part 4. Lawrence Eagles, oil expert

  • Oil market late to wake up to risks, but now very volatile.
    • Recent low volatility was unrealistic given the geopolitical situation.
    • Conversely, sudden extremes may be an overreaction.
    • There is a need to take stock of actual risks, and probabilities of various outcomes.
  • Libya oil outage likely to last months, but the loss is finite.
    • Saudis are selling oil from storage, offsetting losses.
  • We may not see another contagion event.
    • Moderating risk plus new supply would lead oil prices down.
    • Initial dip would meet resistance from nervous buyers.
    • Longer-term lack of contagion could lead to lower prices much closer to recent historical levels.
  • The OECD will be very concerned about higher energy prices’ effect on global growth.
    • Very worried about return to recession.
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