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46 > qatar today > may 2013

Whats keeping oil prices flat? Should the Qatari Riyal abandon its US dollar peg and go it alone? Where will the smart money be invested in the coming weeks and months? Rory Coen caught up with Burkhard Varnholt, Chief Investment Officer at Bank Sarasin, to get some important answers.

hen I interviewed Burkhard Varnholt just over two years ago, he was eager to explain why oil prices would rise to unprecedented levels in the following five years. Sarasin had just published the report Crude Oil: Whats moving oil prices in 2011, and it was very bullish on oils short-term ($120 a barrel in Q1 2012) and medium-term ($200 a barrel in 2015) prices. Varnholt wasnt influenced by the geopolitical tensions in the MENA region at the time, so much as by longer-term factors such as supply and demand. He believed we were in the midst of Peak Oil and prices would very soon reflect this. The low-hanging fruit, or the easily-accessible oil, had all been discovered and explored, which meant it was getting more expensive to extract it; there hadnt been a significant oil field discovered in 30 years. On top of this, OPEC members had an interest in overstating their reserves to achieve higher production allocations, meaning there was probably less oil out there than was estimated. So it was with much eagerness that I reminded him of his earlier estimations. The price of oil had remained relatively stable in the interim and only threatened $110 for

a couple of weeks in February last year before dropping to $80 five months later a far cry from the $37-145 margin in the latter half of 2008. It was trading at $96 in early April, 2013. So what happened? Surely the demand/supply factor coupled with the regional hostilities would drive the price up? The simple reason is the discovery of all those oil reserves in the United States, explained Varnholt, which has just shown us again that some of the most amazing things can happen in these commodity markets when prices reach certain levels. He argued with a trace of facetiousness that oil companies would probably explore the front lawn of the White House for the commodity when prices went above $100 a barrel. The oil discovery in the United States was a big game-changer, he says, and it was something I certainly didnt expect, as I think nobody did. It turned the United States, which was always a net oil importer, into a net oil exporter. It completely changed the equation in the oil market. The US recently discovered vast reserves of shale oil, and the US Energy Information Administration (EIA) forecasts that production will jump to its highest level in 26 years next year. It says US oil imports willfall by a quarter between 2012 and 2014 because of the rising domestic production. It
qatar today > may 2013 > 47

development > listening post

"Its not good policy to remain pegged. Good monetary policy is one not constrained by economic policy and such independence best enables monetary policy to pursue its prime objective: to supply the economy with a stable, fungible medium of exchange"

also forecasts that average global oil prices will be around $99 in 2014. Still bullish Whilst Varnholt had previously predicted that oil prices would hit $200 a barrel in 2015, he was still bullish about the price of oil in the long term. Im still expecting it to reach $200 at some point, but 2015 is now a little too early for this, he says, before qualifying his thesis. What hasnt changed is that the general direction of commodity markets remains upwards, and thats because of factors that I alluded to two years ago, such as demographic growth, economic growth, bottlenecks in supplies, and bottlenecks in infrastructure upstream, in getting the stuff out of the ground; midstream, transporting it; and downstream, getting the biggest bang out of every barrel. These bottlenecks, I predict today, will be big surprises to the markets in the next few years. What I believed back then was that the chances of finding something really big, like the Ghawar field in Saudi Arabia, were negligible that the low-hanging fruit had all been

taken. However, what will continue to contribute to the market are the expensive resources to dig deep or reach far out like they do in Africa or Latin America. The market for liquefied natural gas (LNG) is by no means a matter of the past, either, because of the oil discoveries in the United States. One of the big surprises that the markets havent factored in is the transformation of coal-powered stations across Europe, the United States and China into cleaner power stations using gas instead of coal. China is really suffocated by the exhausts and fumes it produces from burning all this coal. Then again, at some point, there will come a big game-changer in the market for fossil fuels. So the general direction I continue to believe is up and the fundamental trends that I mentioned are, Im afraid, still alive and will only get harsher in the next few years, says Varnholt. Monetary policy The Qatari riyal has been fixed at QR3.64 to the US dollar since June 1980, and this has provided an anchor for macroeconom-

ic policy and a reference point for stability and confidence. Qatar is now approaching a critical time in its history as the drive to diversify by 2030 gathers pace. However, Varnholt feels its not good policy to remain pegged. He claims good monetary policy is one not constrained by economic policy, and such independence best enables monetary policy to pursue its prime objective: to supply the economy with a stable, fungible medium of exchange. But it would have to be an all or nothing break for the GCC economies. It has always been a dangerous act in history, and at this time in particular, says Varnholt, when governments embrace monetary policy and either directly or indirectly use it to fund their deficits. That has never happened well historically, to the best of my knowledge, and I would be surprised if this was the first exception. We have seen a huge shift towards this across the West during the past five years. The best a central bank can do for its economy is to provide price stability and let governments sort out the public funding and the competitive economic policies

Varnholt Counsel
The smart money goes into real assets, into global equities, and it puts an emphasis on the sustainability of the business models it invests with. The smart money is long-term, its cautious and very much value-driven, and there are plenty of opportunities: were in a 10-year equity market boom that started in 2009 and may well last another five years.
48 > qatar today > may 2013


info. crude oil price history at the new york mercantile exchange

none of that is the resort of monetary policy. You will get better economic policy if it cannot rely on a helping hand from the central bank, but thats an inconvenient truth and every policymaker tries to avoid it. And through currency pegs, the unsustainable Western monetary policy is being exported globally, so my suggestion to the Gulf economies would be to let those pegs go and insulate themselves better from what the West is doing. But I guess the GCC economies can only break away from that peg collectively, because if one chooses to break away it would put itself at a competitive disadvantage, as its currency would appreciate and the others would benefit disproportionately from this, and thats why I dont it see happening, but I think it would be the better choice, he adds. With his strong views on mixing economic and monetary policies, it felt natural to ask him about his views on the current European financial mess. Is that a political or an economic issue? Good question, he chuckled, as he thought for a moment. I think, above all, its a political issue, because economically Europe could easily shoulder it if there was the political will. This is not an inescapable dilemma. I mean, to put it into proportion, public debt in Europe is 80% of its GDP. Thats still manageable; its not like Cyprus or Greece. But Europe lacks the political will to save itself, and most of what we hear is rhetoric. Even Germany, which is

"Even Germany, which is usually portrayed in the media as the supporter of austerity, has terrible household figures. For the past several years, including 2012, public expenditure, public debt, and its deficit have all increased."

single year where anything was saved. The only thing that the austerity proponents can claim is that the rate of increase has slowed. Regulation Varnholt contends that the most important regulatory process achieved post-2008 has been in the area of bank equity, with the introduction of the Basel III accord. Banks equity cushions were too thin, and the definition of what qualified as equity capital left too many loopholes open for ever-increasing leveraging of most bank balance sheets. There are two things happening here, says Varnholt. Equity capital is being rediscovered, with interest rates and bond yields being zero-bound, as a better real protector against the loss of purchasing power associated with the Wests ultra-loose monetary policy. Secondly, I am a strong believer that this very old-fashioned Basel III accord, which forces banks to raise equity capital to levels that were last seen a very long time ago, is the right thing, because its the only way to force the banking industry to behave more prudently in the interest of the general public. All this nonsense about risk-adjusted capital ratios it has always worked to the benefits of the banks because they always had the smarter risk managers making their case, and the general public lost out because the regulators couldnt cope with the arguments the banks proposed to them
qatar today > may 2013 > 49

usually portrayed in the media as the supporter of austerity, has terrible household figures. For the past several years, including 2012, public expenditure, public debt, and its deficit have all increased. There wasnt a

($1 = QR3.64)