03-04-04

Unexpectedly high demand for energy from such rapidly growing regions as China and India, combined with supply side constraints, means that the global energy market is about to face a "huge structural change" of tremendous importance, according to leading economic expert Dr Woody Brock, president and founder of US financial consulting group Strategic Economic Decisions.
Brock provides specialist advice on the applications of the modern "Economics of Uncertainty" to forecasting and risk assessment to leading investment banks and institutions around the world, and in South Africa to niche financial services group Brait, among others.

Addressing participants at a briefing in Cape Town by invitation from Brait Specialised Funds, Brock pointed out that energy, in all its forms, still plays a significant role in the global economy despite the dominance of the services sector in developed countries.

"Energy still matters, and to more people than ever before," he noted. "And energy demand is growing faster than predicted-there has been a drastic underestimation of 'Chindian' demand, which represents the approximately 700 mm successful people in China and India whose incomes are growing rapidly -- from around $ 4,000 to $ 30,000 per year over the next 20 years."

That demand had been growing faster than supply was evidenced by the "strange" doubling in international oil prices over the past five years, in the face of slow global growth, stated Brock. This rise was not attributable to the powers of OPEC, he said, as the cartel now only controlled around 35 % or less of global oil production, down from about 72 % previously.

"The cartel's ability to manipulate prices has largely collapsed," he observed. "The cartel is not setting oil prices."

Rather, highly inelastic and rising demand for traditional sources of energy had helped push up the price of oil in the face of supplies that were looking more precarious than ever. On the supply side, it was a concern that the huge excess reserves previously estimated in Saudi Arabia had been overestimated, he noted, and production at the largest and most well established oil fields was peaking more rapidly than expected, with sharper subsequent falls in production levels.
The "technological miracles" emphasised by many in the oil industry -- stemming from advances such as horizontal wells, water injection and the like -- had also not been as successful as forecast.

Although there were new fields being discovered and exploited, these did not have the "huge" reserves required to replace existing ones, he cautioned.

"Former Federal Reserve Chairman Paul Volcker has said that that the most important price is that of energy, because it drives interest rates," noted Brock. "The energy market is therefore a very important story, with huge implications for investment markets, economies, everything."

Meanwhile, Brock pointed to fundamental asymmetric microeconomic policies in place in the world's largest economies as the reasons behind the four current major imbalances in the global economy -- asymmetrical growth; domestic fiscal imbalances; savings rate imbalances; and current account imbalances.

"How can the country that is the world's most productive and innovative have such a huge trade deficit?" he asked. "It is because of microeconomic policies (in terms of regulations and laws), such as the wide misallocation of capital in Japan and the inflexibility of labour and product markets in Europe. These asymmetric policies are the culprit underlying all four imbalances -- and this fundamentally changes the issue of who is to blame for the imbalances."

Brock said the US was the only nation to have largely conformed to the basic microeconomic principles of allowing for mostly free markets in labour, capital and products. As a result, it had accumulated huge trade and fiscal deficits through its relatively more rapid economic growth, fundamentally higher propensity to spend, lower savings rate, freely floating exchange rate and its open commercial policy.

In addition, world economic growth had been much slower due to improper microeconomic policies elsewhere -- global growth was a relatively high 4.1 % in the 1970s "stagflation" period, compared to an average of 3 % in the 1980s and only 2.5 % in the 1990s, what he referred to as the "growth paradox".

"The fiscal red ink in Europe and Japan is due to poor micro policies that misallocate capital and labour," he observed. "The US has a capital efficiency that is double that of Germany and 3.5 times that of Japan, yet the US trade deficit has built up to a net $ 3.5 tn per year -- a very serious level. But had other countries grown properly, these imbalances would not exist."
Brock downplayed the risk of an impending "dollar crisis", saying he believed the US dollar had not experienced an "overshooting" in its depreciation against other major currencies because of a lack of suitable alternatives for investors.

"The dollar hasn't fallen more because there are no alternatives -- theyen and yuan aren't safe, and they don't trust the euro. This is why gold has been relatively attractive in recent times, but people can't diversify their holdings much beyond gold and the euro."

At the same time, it was impossible for foreigners to refuse to finance the US trade deficit, as this was tantamount to refusing to be paid for what they were already owed, he added.

US risk premiums, in the form of yields, had not risen because where some investors had opted to sell their US assets, there were always others to buy those assets and continue to finance the trade deficit. While the massive US trade and fiscal deficits were of serious concern, noted Brock, he was optimistic that the country's phenomenal productivity would "carry it through" the current difficult period.

"The fiscal deficit is half that of Japan, and most of the country has experienced no housing bubble whatsoever. US capital spending is coming back, inventories are being rebuilt and productivity growth is strong -- the greatest scientific revolution in history," he concluded.

Source: Business Day