December Confessions #3 December 31, 2008
Posted by Ali in analysis, kuwait.Tags: December Confessions, kuwait, Oil, OPEC
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During December the market confessed three important facts. The first is that the Kuwait Investment Authority (KIA) will not provide the optimism needed to restore confidence in the market. The second is that investment banks will fail in succession amid the greatest government intervention since souk almanakh. Finally that oil prices will no longer be controlled by the oil cartel, OPEC.
OPEC Versus Oil
A positive relationship between, long-term oil and the Kuwait Stock Exchange (KSE), has existed for decades. In the 1970’s the KSE rallied with the sharp increase in oil prices. Early in the 1980’s the market crashed when oil prices fell. Later in 1997, the price of oil fell below $10/barrel sending the market spiraling. Thus it should not be surprising to see the KSE collapse in 2008 considering the massive decline in oil prices from $147 to below $40.
Since oil determines Kuwait’s fiscal policy the higher oil prices translate into higher income generated by the government. The higher income results in greater government expenditures thus a bigger fiscal policy.
The drop in oil prices this year will either reduce or delay future projects undertaken by the government. Recently, the plan for the ‘fourth refinery,’ a mega project valued at $10 billion, was cancelled.
It is evident that trade and commerce activities will continue to slow, which will be manifested in the returns by companies trading on the KSE. Given that the listed companies are expected to post lower results in the future, they should trade at prices that reflect return expectations.
Will oil prices reverse the trend?
Unfortunately there is no light at the end of the tunnel. Although OPEC met on December 17th and decided to cut production, oil continued to drop. The market’s reaction to the meeting shocked investors. The price of oil did not even inch upward following the production cut. It seems as though the cartel no longer controlled prices. The repercussions for Kuwait will be devastating if oil prices continue to decline.
In December we realized that this crises is far beyond anyone’s expectations. In the past OPEC was able to manipulate prices, today they could not even stabilize it. Oil prices continue to decline. This is a prime concern for investors since they will not see a bottom in the KSE until oil prices bottom first.
Is this perhaps an indication that there are other ‘forces’ behind the Oil price levels that have controlled them and continues to control them despite OPEC?
Makes sense if we assume the ‘forces’ took precautions/steps/strategies after the Oil crisis during the 70’s to do just that?
nbq, of course, forces of demand and supply.
Technically speaking, oil prices are falling sharply because:
1) Demand is falling
2) Anticipated demand is falling.
3) Human behavior with market and prices is extreme => either extremely optimistic or extremely pessimistic. Now people are extremely pessimistic.
OPEC decision used to affect mostly the Behavior, Psychology, factor mostly. The reaction we saw recently from the market shows us how extremely pessimistic people are.