Dubai Crisis Points to a Lower Price for Oil

Includes: OIL, USO
by: Oil-Price

Recently, on November 25 to be precise, the government of Dubai came out with a shocker - a crisis. Now termed the ‘Dubai Crisis’, the government sought a window period of six months to repay debts to the tune of $60 billion. The firm in question was Dubai World and its real estate arm Nakheel. In fact, Nakeel has an Islamic bond with the maturity date of December 14. The debts could now be considered ‘credit default’ by the creditors.

'Nowhere like Dubai', that was the catch phrase of Dubai Tourism. Indeed, the land was the ultimate destination for something termed ‘Luxury’ in the vocabulary. The construction sector was booming and the rapid economic growth enticed many people to Dubai. According to a study, there were over 5.5 million foreigners in the UAE, as the land attracted investments even from places like India, Pakistan and Iran-the returns justified the investments too.

Real estate was the most ‘happening ‘of all sectors in Dubai. The infamous Nakeel was involved in the construction of the palm-shaped islands, a high tower of about a kilometer high and a group of islands in the shape of a world map. Some other dream construction in Dubai includes a waterfront to the size of Hong Kong, and a fantasy park called ‘Dubailand’, to mention a few. These projects have now been put on hold. News is percolating of job losses in Dubai. Nakeel axed 500 employees; Al-Shafar General cut 1,000 jobs, while Damac properties did the same to 200 jobs.

Dubai could get an interim relief if Abu Dhabi, its neighbor, bails it out. But the initial reaction from the country isn’t favourable for Dubai, as Abu Dhabi says it would rather “look into each case on its own”.

The Dubai crisis is bad news as it comes at a time when the global economy was finding its feet. There was even positive growth for the third quarter in countries like Philippines, China, Vietnam, Singapore, South Korea and even in the US. But with the Dubai crisis, stock markets around the world tumbled with investors marching to safer options. Some of the banks like HSBC (HBC), Royal Bank of Scotland (NYSE:RBS) and Standard Chartered (OTCPK:SCBFF) saw their shares fall due to their presence in Dubai.

Impact on oil prices

At this point, oil seems poised for a lower price. How?

In the aftermath of the crisis, oil prices fell as investors moved away from oil and gold. The scenario on November 27 (the previous day was a holiday in the US due to Thanksgiving): The January contract for benchmark US light sweet crude slid to$76.05/bbl, a decline of 1.91. The February contract dropped to $77.36/bbl, declining by $1.83.

How is Dubai linked to oil? Dubai, at the moment, doesn’t have oil resources like some of its neighbors. Reaching its oil peak in the eighties, the country only has about 98.2 billion barrels of oil. It was the depletion of oil which spearheaded its diversification into sectors like tourism and real estate. In fact, the growth was stupendous that many analysts had predicted a ‘correction’ in the property market. Now, Dubai will be forced to drill more oil, which could cause prices to spiral down.

OPEC in the picture

OPEC, which contributes about forty percent of the world’s oil, is scheduled to meet in the Angolan capital of Luanda on December 22. This is important because it is during these meetings that the production quotas are determined. The cartel left the production quotas unchanged in their last meeting. In Luanda too, they may repeat this decision:

"Given the circumstances, there will not be an output increase and OPEC will not permit members to do it," Iran’s Oil Minister Masoud Mirkazemi said at a press conference, "These days the market situation is not right to raise output. This is my forecast,” he added. Kuwaiti Oil Minister Sheikh Ahmad al-Abdullah al-Sabah said “The oil prices at $75-80 per barrel are "good and acceptable”. The second largest oil producer of OPEC, Iran, has said that the country didn’t expect the oil cartel to increase output. Venezuela which has a quota of 1.986 million barrels per day may also maintain the same production level.

Pointers for lower oil prices

Dubai, indeed, does not have a major influence outside the UAE. But many analysts predict more defaults from Dubai and also from countries like Hungary and the Baltic states of Latvia, Lithuania and Estonia which have debts exceeding their GDPs (Gross Domestic Products). Daniel Tenengauzer and Benoit Anne of BofA Merrill Lynch Global Research said that “one cannot rule out--as a tail risk--a case where this would escalate into a major sovereign default problem, which would then resonate across global emerging markets in the same way that Argentina did in the early 2000s or Russia in the late 1990s.”

Hence oil prices may go down. This prediction though there is widespread optimism about a recovery: The British Prime Minster, Gordon Brown said that the Dubai crisis will not cause major damage to world economy. "My own view is the world financial system is stronger now and able to deal with the problems that arise," said Brown. Finance Minister Yuval Steinitz said that he also forecasts only minor effects, if any, on the Israeli economy from the Dubai crisis.

The oil prices did recover the next week, but how?

  • Iran detained five British marines, which made investors fear a standoff between Iran and the western powers. (The marines have been released since.)

  • Pirates seized a tanker carrying crude oil from Saudi Arabia to the US.

Both scenarios are just temporary phases and do not clearly reflect oil prices. What about the possible demand from China? Economic Information Daily from China published comments of Ji Xiaonan, Chairman of the Supervisory Committee saying that Dubai's debt crisis could be a good opportunity for China to purchase gold and oil assets. Ji Xiaonan was quoted as saying that the Dubai debt crisis "could give China an opportunity to put some of its foreign exchange reserves into gold or oil”. China is on massive fiscal stimulus and if the Yuan appreciates, exports will become costly. Giles Chance, author of the recently published book China and the Credit Crisis. "On the surface it seems fine, but underneath it's quite chaotic."

Thankfully, there are sane voices too.

A report in Sucden Financial Research said "It should be noted that fundamentals remain weak, as current above-average temperatures raise concerns for oil demand levels in the US". An analyst in KBC market services, a division of KBC Process Technology Ltd. in the UK, has this to say, “We keep making the point that for the developed economies there is little sign that demand is improving—yet. Everybody talks about demand recovery but lift-off keeps being postponed.” And the World Bank president, Robert Zoellick mentioned that the Dubai crisis “may prompt a second or third look at investments in emerging markets.”

What’s more, the impact of the crisis on banks is still not known. It would be immature to expect resilience in the world economy with unsure markets everywhere. Also, Dubai is not going to get new buyers for its property anytime soon. Indeed, the housing markets will remain speculative as will the investments in oil and gold. All signs thus point towards a lower price for oil.

Disclosure: None