What could be expected from reduced Chinese banks’ reserve requirements?

Liquidity shortage in China will be reduced by cutting banks’ reserve requirements. Authority’s decision announced in November, 2011 will come into effect on Friday, February 24, Reuters reported on February 20. The same day Bloomberg noticed that the proportion of cash Chinese banks must set aside will drop half a percentage point and more capital will be available for loans. This announcement was made by the central bank on its website on the 18th of February. The amount of additional capital, according to Australia & New Zealand Banking Group’s estimation, may reach 400 billion yuan ($64 billion). Economy stimulation policies define further stakeholders’ actions, so what could be expected?


According to the Statistical Communiqué of the People's Republic of China on the 2011 National Economic and Social Development published by National Bureau of Statistics of China on February 22, 2012 [1], the completed investment in fixed assets (excluding rural households) of the country in 2011 was 30,193.3 billion yuan, up by 23.8 percent over the previous year. Detailed information about fixed assets investment and its growth by sector is available in table 1. [1]

The actually utilized foreign capital increased by 9.7 percent and amounted 116.0 billion US dollars in 2011. The value of direct investment in non-financial sectors and the growth rates in 2011 is provided in table 2.[1] 

The other important aspect is China’s international trade. According to the statistical data imports comprised 1.743,5 billion yuan, exports amounted 1.898,6  billion yuan. The main trade regions and growth rates in 2011 are provided in table 3.[1] 

More information about the main export and import commodities is available in the table 4 and table 5[1] 

 

So, it is likely that the message about the reduced Chinese banks’ reserve requirements will stimulate trade; however, the additionally released capital of 400 billion yuan ($64 billion) comprises only 1.3 percentage of total investment in fixed assets made in 2011. Additionally, according to the above information, China’s trade surplus  amounts 155,1 billion yuan in 2011 and presents 0.5 percentage of total investment in fixed assets. Moreover, isn’t the shortage of liquidity a sign of financial risk?

[1] Statistical Communiqué of the People's Republic of China on the 2011 National Economic and Social Development, National Bureau of Statistics of China, February 22, 2012, http://www.stats.gov.cn/english/newsandcomingevents/t20120222_402786587.htm



How much does oil cost?

Financial crisis, recession, deterioration of assets... Alongside that, an assumption regarding Iran’s pursued nuclear programme and evoked protest. Geopolitical sanctions against Iran involve oil embargo which may disturb oil supply and push higher crude oil prices. So, could we add the energy crisis beside the issues that burden recovery?

In general, market prices of crude oil are forecasted by the consumption demand of oil and the capacity to supply oil that meets the economy growth. However, I would rather start from the available world oil reserves. According to the Annual Statistic Bulletin (2010/2011 edition) of the Organization of the Petroleum Exporting Countries, OPEC share of proven world crude oil reserves comprised 1193 bn. barrels id. est. 81.33% of total proven crude oil reserves and Non-OPEC countries possessed 274 bn. barrels of crude oil reserves that amounted 18.67% of total proven crude oil reserves. Statistical data represented at the OPEC website shows that Iran is the third largest oil reserves country in the world with the 151.17 bn. barrels of proven crude oil. Hence, the rest of the world strongly depends on oil produced by the OPEC unless we compare proven oil reserves versus recoverable and unconventional world oil reserves.

According to the U.S. Geological Survey World Petroleum Assessment 2000 which was cited in 2003 by Bill Kovarik, Ph.D formerly a journalist and editor of publications such as Energy Resources and Technology and Latin American Energy Report (Professor of Communication at Radford University, Virginia Tech and the University of Western Ontario), identified total world reserves comprised 1103.2 bn barrels and recoverable reserves presented additionally 2272.5 bn barrels. The more accurate pictures of proven versus recoverable an unconventional world oil reserve are available below.



Picture 1. Proven oil reserves [1]



Picture 2. Additional Figures from the US Geological Survey those represent recoverable and unconventional oil reserves. [2]

Even though it is difficult to estimate the conventional oil reserves they are proven as following. Petroleum engineers estimate the costs of drilling and connecting new wells into a reservoir as well as calculate operating expenses per well and cost per barrel extracted. The initial daily output of oil declines and the cost of extraction rises. When the costs become equal to the market value of output, production reaches its “economic limit” and extraction stops. The estimated aggregated output of the new wells over time is known as the “proved reserves added” or “reserves booked”.

However, beside conventional reserves, petroleum may be refined from Heavy Oil reserves, Tar Sands or Oil Shale. Consequently, dependence on oil supply from the Middle East may be reduced. Moreover, the head of the world's largest oil company, Saudi Aramco, in 2006 acknowledged:

“We are looking at more than four and a half trillion barrels of potentially recoverable oil. That number translates into 140 years of oil at current rates of consumption, or to put it another way, the world has only consumed about 18 percent of its conventional oil potential. That fact alone should discredit the argument that peak oil is imminent and put our minds at ease concerning future petrol supplies.”
 
Considering the cost of oil production which was obtained from traders and industry analysts and published by Reuters in July 28, 2009, Saudi Arabian crude oil is cheapest because of its location near the surface and the size of fields, which allow economies of scale. The operating cost (excluding capital expenditures) of extracting a barrel was estimated around $1-2 and the total cost including capital expenditures comprised $4-6 per barrel. Similar total costs of oil extraction are estimated in Iraq and United Arab Emirates. Oil Extraction from mature and deep water offshore fields is more expensive. It was estimated that production in ultra-deep water fields in Nigeria reached $30 a barrel compared with onshore costs of around $15. The other comparison by the region: operating and capital costs in Algeria, Iran, Libya, Oman and Qatar were estimated around $10-15 per barrel, in Kazakhstan around $10-18, in Venezuela, where fields tend to be mature and small, costs reached $20-30, in the mature British North Sea, where the remaining oil is difficult to access, the costs could be around $30-50.

According the International Energy Agency World Energy Outlook 2008 the statistical data of estimated production costs were the following:

So, if estimated recoverable and unconventional world oil reserves are twice as large as proven oil reserves and if it is possible to extract oil under the $60 per barrel how much consumer should pay for the crude oil? According to the World Oil Outlook 2011, prepared by the OPEC, it is assumed that prices will stay in the range of $85-95 per barrel for the next decade and will reach $133 per barrel by 2035. Different world events may significantly affect the crude oil prices as it is showed in the picture 3. However, high oil price volatility also depends on the futures speculation.




Picture 3. World Events and Crude Oil Prices 2007 - May 20, 2011Recessions and Oil Prices [4]

Notes:
[1] Peak Oil is wrong. THE OIL RESERVE FALLACY Proven reserves are not a measure of future supply By Bill Koyarik http://www.radford.edu/~wkovarik/oil/


[2] Peak Oil is wrong. THE OIL RESERVE FALLACY Proven reserves are not a measure of future supply By Bill Koyarik http://www.radford.edu/~wkovarik/oil/

[3] "The Impact of Upstream Technological Advances on Future Oil Supply" - Mr. Abdallah S. Jum'ah, President & Chief Executive Officer, Saudi Aramco, address to OPEC, Vienna, Austria, Sept. 13, 2006

[4] Oil Price History and Analysis  http://www.wtrg.com/prices.htm

How far unsolved repayment of Greece's debt lead? Straight to the abyss

A joint EU’s and IMF’s financial support similarly imposed even higher burden to Greece. A €110 billion EU/IMF bail-out package approved in May, 2010 followed by the Eurozone’s €12 billion bail-out package in June, 2011 and extra €109 billion support in July, 2011 were agreed in exchange of accepted severe austerity measures those involved spending cuts, tax increases and privatization of public assets. Passed proposed measures without taking a recovery plan into consideration shrank Greece's economy into deeper recession.


According to the remarks mentioned at the IMF’s conference called on Greece in December 13, 2011, the representatives of the mission revised the Greece’s GDP growth down to -6% in 2011, and -3% in 2012. So, could anything worse be expected than deteriorated Greece's economy and increased Greek default probability?

Credit Default Swaps were invented by Wall Street as credit insurance to reduce risks and facilitate issuance of debt securities. However, it may appear that banks, investment banks or hedge funds those issued the Greek Treasury CDS do not have enough collateral to compensate the insured for his loss if Greece default on its debt. If the above is possible then a voluntary private sector involvement in 50% nominal haircut proposed in October 2011 may also be treated as an agreement designed to avoid the collapse of insurers. It is expected that voluntary accepted write-down of Greek debt will not trigger CDS compensation and at the same time will reduce the Greece's sovereign debt by €100 billion. An extra €100 billion support to Greece could reduce its debt to 120 % of GDP till 2020.

However, the success of such agreement which is aimed to minimize losses depends on the proportion of Greek bonds holdings and issued CDS. According to the information published at the New York Times in January 10, 2012, it was estimated that a few months ago about €200 billion of Greek bonds were held at large European banks. But as talks have dragged on, many big holders in France and Germany sold their holdings to London Hedge Funds and other independent investors. Hence, a voluntary private sector agreement to accept a 50% haircut may be harder to achieve if an entity which possess Greek bonds is not an issuer of the CDS.
On the other hand, if an agreement of a voluntary 50% haircut is available then what a purpose and a future of the credit default swaps? According to the BIS quarterly review issued in December, 2011, a notional amount of outstanding credit default swaps was $32.4 trillion in June, 2011 with a gross market value of $1.35 trillion.

What bilateral agreements do markets accept?

Germany sold 4.06 billion euros of the bonds on the 4th of January with the average yield of 1.93% on 10 year government bonds. France sold 7.9 billion euros of bonds on the 5th of January with the average yield of 3.29% on 10 year government bonds. It is supposed that Italy’s and Spain’s borrowing in the markets this week could be facilitated as well due to the ECB’s injected liquidity through 3-year refinancing operation worth of 500 billion euros and expectations that the ECB’s Governing Council will cut interest rates on the January 12 meeting. However, despite the European sovereign debt crisis and broken markets’ confidence, China, Japan and South Korea move forward to closer financial cooperation.


After the Asian financial crisis in 1997-98, the leaders of East Asian Countries agreed to promote the Chiang Mai Initiative (CMI) which aimed to create a network of bilateral swap arrangements (BSAs) among ASEAN+3 countries to tackle short-term liquidity issues and to supplement the existing international financial arrangements.

Under the above mentioned initiative, the $120 billion crisis fund was established. In 2001 Finance ministers of ASEAN+3 agreed to exchange data on capital flows bilaterally on a voluntary basis in order the effective policy dialogue was facilitated and in 2005 Finance ministers agreed to enhance the effectiveness of the CMI by (1) integrating and enhancing the ASEAN+3 economic surveillance into the CMI framework, (2) clearly defining the swap activation process and the adoption of a collective decision-making mechanism, (3) significantly increasing the size of swaps, and (4) improving the drawdown mechanism. Moreover, developed bond markets under the same initiative reduced the dependence on short-term foreign currency-denominated financing and helped to mitigate the vulnerability caused by the currency and maturity mismatches aroused due to the volatile short term capital movements.

Japanese Prime Minister Yoshihiko Noda visited the Chinese Premier Wen Jiobao on the 25th of December in 2011 and discussed a bilateral package of financial agreements. According to the Bloomberg, Japanese government-backed entity will sell yuan-denominated bonds in China to deepen China’s domestic capital markets and other measures will be applied to facilitate the trade among Chinese and Japanese companies in their domestic currencies. These actions should reduce trade costs as measures are designed to eliminate the usage of the US dollars in exchange of currencies. Moreover, those agreements will ease the entrenchment of the Chinese yuan as a reserve currency.

However, China’s one-way determined exchange rate’s policy puzzles the most. If Japan, South Korea, US, European and other trade partners decide to set the domestic currencies and China’s yuan exchange rates then who will be right.

Security’s Beta – an indicator of systematic risk

Assessment of creditworthiness of financial institutions or financial instruments is one of the supervision measures. Standard & Poor downgraded the long-term credit rates for major financial institutions including Bank of America, Goldman Sachs, Barclays and HSBC on 30 November. On16 December, Fitch reported the rating cuts for seven largest banks: Bank of America, Goldman Sachs, BNP Paribas, Barclays, Deutsche Bank and Credit Suisse and Citigroup. Even though the downgrades reflect the assessment of the enhanced rating methodologies those involve systematic risk analyses based on macro indicators, industry and regulatory environment, will the valuation reinforce the discipline of the financial performance and reduce systematic risks?

According to the Rating Methodologies for Banks prepared by the Frank Packer and Nikola Tarashev and published in BIS Quarterly Review, June 2011, the assessed tolerance of complex financial instruments, evaluated trends of credit growth and the increase of asset prices as well as greater focus on high quality capital would have provided an important information about the stability of entity during the pre-crisis period. As the intermediation role of banking sector is significant and financial stability is essential for economy’s development, public authorities commit to support banks by additional capital injections, asset purchases or liquidity provisions. Consequently, rating agencies use “stand alone” and “all in” ratings those reflect the financial strength of the institution without the support and with the sovereign and international institutions interventions.

Capital strengthening through the retained earnings is one of the most efficient ways to enhance the resilience of financial institutions during financial shocks. However, financial institutions commit to dividend payments as long as retained earnings are essential to attract investors.

The Goldman Sachs Group, paid dividends on all series of preferred stock on the 10th of November for the following series of its non-cumulative preferred stocks: $239.58per share of Floating Rate Non-Cumulative Preferred Stock, Series A; $387.50 per share of 6.20% Non-Cumulative Preferred Stock, Series B; $255.56per share of Floating Rate Non-Cumulative Preferred Stock, Series C; and $255.56per share of Floating Rate Non-Cumulative Preferred Stock, Series D.

Barclays paid 1p per ordinary share and 4p for America Depository Security which represents 4 shares on 9 December 2011.

Bank of America Corporation announced about regular quarterly dividend of $18.125 per share on the 7.25 percent Non-Cumulative Perpetual Convertible Preferred Stock, Series L.

HSBC declared that the third interim dividend of $0.09 per ordinary share will be paid on 18 January, 2012, the dividend of $0.45 per American Depositary Share, which represents five ordinary shares will be paid on 18 January 2012, the dividend of $0.3875 per Series A American Depositary Share was paid on 15 december, 2011.

The Board of Directors of Credit Suisse most likely will suggest dividends for financial year 2011 with the results of the fourth quarter of 2011 on February 9, 2012.

Moreover, majority of banks were downgraded because of the challenges in the financial sector, id. est. systematic risks those affect financial stability. Security’s Beta describes the sensitivity of its return to the systematic risk, the average change in the return for each 1% change in the return of market portfolio. Deutsche Bank’s Beta is 2.20, Beta of Bank of America is 2.19. So, those banks are more vulnerable that HSBC, Credit Suisse and Goldman Sachs. Beta of HSBC presents 1.19, Beta of Credit Suisse amounts 1.38 and Beta of Goldman Sachs is 1.39.

Consequently, securities’ Beta should be involved in the assessments of systematic risks and factors those reduce securities sensitivity to the portfolio fluctuations could be explored further.

The end of 2011 - political and economic changes in Russia

Week lasting demonstrations in Russia is a protest against a possible electoral fraud. According to the statement of the Central Election Committee of Russian Federation prepared on the 5th of December, 2011, the preliminary results, those represent 95 % of the overall counted votes of Russian Legislative Election, 2011, were the following: representatives of United Russia got 49.54% of total votes, Communist Party of the Russian Federation received 19.16%, A Just Russia collected 13.22%, Liberal Democratic Party of Russia got 11.66%, Yabloko received 3.3%, Patriots of Russia gathered 0.97% and Right Cause got 0.59%. However, citizens expressed mistrust in counted votes and dissatisfaction with the dominated United Russia party.


Could it be that a long lasting protest lift the prices of energy resources and diminish value of domestic corporations? Similarly, could a shift in political influence be a reason of transformation of state’s corporations?

According to the Balance of Payment of the Russian Federation for January-September of 2011, the estimated $73.6 billion of Current Account’s surpluses are mainly emerged from the oil, oil products and natural gas exports those amount $249.1 billion and represent an increase of 36.34% compared to the data of the previous year. As can be seen from the data of the Key World Energy Statistics, 2011 published by the International Energy Agency, Russian Federation was the largest producer in the world of crude oil in 2010. The production of crude oil, NGL, feedstocks, additives and other hydrocarbons in Russia amounted 502 Mt, which comprised 12.6% of the total world production in 2010. The other largest producers were Saudi Arabia with the annual production of 471 Mt which represented 11.9 % of the total world production and United States with the annual production of 336 Mt and 8.5% of the total world production in 2010. So, long lasting political instability in the country could affect the supply and market prices of energy resources.

Moreover, The World Trade Organization’s Working Party sealed the deal on Russia’s membership negotiations on the 10th of November 2011. The Working Party will send its accession recommendations regarding Russia’s terms of entry to the Ministerial Conference. It is expected that during the conferece held on the 15-17 December the Russia’s WTO membership will be approved. Consequently, Russia’s commitments to pursue open, transparent and non-discriminatory global trading could encourage investment and a new round of privatization of state’s corporations.

Should the strategies of Sovereign Wealth Funds be a subject of regulation?

George Osborne, the Chancellor of the Exchequer of the UK delivered financial statement on Tuesday 29 November, 2011. He announced about the extended Government's enterprise finance guarantee scheme for businesses with annual turnover of up to £44 million. The ceilings were set of £40 billion. The Chancellor also introduced a newly launched National loan guarantee scheme for new loans and overdrafts to businesses with turnover of less than £50 million. The initial £20 billion – worth fund for national loan guarantees will be available within the next two years and it is expected that those guarantees will let to reduce the borrowing interest rates by 1 percentage.


Moreover, along these measures innovative solutions to launch £1 billion business finance partnership was presented. The partnership with other investors such as pension funds and insurance companies could enable the Government to invest in funds those lend directly to mid-sized businesses. Similarly, over 500 investment infrastructure projects to support economic development were identified first time. Alongside the Government guarantee schemes and traditional fund rising through borrowing, the Government had negotiated an agreement with two groups of British pension funds which unlocked an additional £20 billion of private investment for implementation of infrastructure projects.

The Government’s launched partnerships with investors aimed to facilitate funding for development of domestic businesses suggest the following: is it a rudiment of the Sovereign Wealth Fund?

In general, Sovereign Wealth Funds are founded from central bank’s reserves those are accumulated as a result of budget and trade surpluses. Additionally, SWF may be set from the revenues received from the exports of natural resources. The purpose of established SWF may vary. Some of them possess objectives to stabilize the budget and the economy from excessive volatility and intend to diversify the sources of revenues. Others have goals to reduce excessive domestic liquidity and invest in higher return assets. The rest may have political strategies which are aimed to increase savings for future generations or fund domestic social and economic development projects.

Though Sovereign Wealth Funds tend to have longer-term investment horizons, the research made in 2008 revealed that seven least transparent Sovereign Wealth Funds were estimated to account for the half of all holdings. Thus, lack of accountability and transparency evoked concerns whether asset prices could be distorted through non-commercially motivated purchases. (The source: ECB, Occasional Paper Series, No 91/July 2008, The impact of sovereign wealth funds on global financial markets prepared by Roland Beck and Michael Fidora).

Some protective regulations against purely political investment decisions of Sovereign Wealth Funds were mentioned in the draft of Rethinking Global Investment Regulation in the Sovereign Wealth Funds Era prepared by the Dr. Efi Chalamish (02/09/09). Foreign investment may be blocked by national regulations if investment is classified as government-owned entity. Countries may also prohibit foreign investment based on the type of industry in which the invested company operates. Moreover, an individual acquisition may be screened and decisions could be made according to the commercial value and associated risks. Additionally, adopted open market policies could be pursued to ensure that made investment do not serve only to the single foreign country.

Analysing International Economic Law, it could be mentioned the Santiago Principles suggested in 2008. The aim of these principles is to protect state’s interests and increase SWFs’ transparency and accountability. The principles were prepared by the IMF jointly with the World Bank and proposed to adapt on voluntarily bases. However, the other set of rules to avoid adaption of any protectionist measures and be opened to markets policies were created and accepted voluntary by the OECD which represents states of the leading developed economies.

According to the Sovereign Wealth Fund Institute’s data, the 54 SWFs managed over $4.76 trillion in September 2011. The 58% of total funds were set up from oil & gas related sources. The largest owners of the Sovereign Wealth Funds by the region is Asia with 40% of total assets, the second largest region is the Middle East with 35% of total assets and 17% belong to Europe.

The 2011 Pregin Sovereign Wealth Fund Review disclosed that the financial assets under SWF’s management grew about 11% during each several years. Consequently, the rising Sovereign Wealth Funds play bigger role in rebalancing of capital flows.

The influence of the Sovereign Wealth Funds on the financial markets and improved regulations may be explored further. However, my attention is already turned on their investment strategies. The Pregin Sovereign Wealth Fund Review reveals that the Investment Portfolio division of Hong Kong Monetary Authority’s Exchange Fund has plans to move into hedge fund investment, having diversified into investments in emerging markets, private equity funds and overseas property in 2010 as a means of increasing returns while Norway’s Government Pension Fund – Global, one of the largest SWFs in the world, is set to complete its first real estate investment in early 2011 and plans to make further investments in the asset class over the course of the year.