#65 Political Tectonics: The Slow Drift

The recent souring of EU-Russia relations and U.S.-Russia relations is a greater cause for concern for the post Cold War status quo than most people realize. Gone are the Yeltsin years of warm rapprochement between nuclear super powers Russia and America. The realities of multipolarity are beginning to dawn on the recently predictable Pangaea world of diplomacy. The post 911 world has shaken the "stable" world order on its foundations. What we are in fact witnessing is the start of a slow drift to a truly multipolar world. A world of divided power and divided interests.

This divided world comes at a rather bad time in world history. Humanity needs to make a series of concerted, fundamental global changes in an array of areas ranging from energy security to climate change and poverty. Instead of focusing on these critical issues that are beneficial to the well being of all mankind, we are increasingly distracted by the deplorable and volatile political situation in Iraq and the Palestinian territories.

The gradual but steady shift in Latin American political attitudes vis a vis the United States should also not be underestimated. In the case of Venezuela, Chavez is not only talking the talk, but clearly walking it as well. The recent moves to nationalize the oil industry and pull out of multilateral institutions such as the World Bank is a vivid example of how the combination of self interest and anti-Americanism is shaping a new diplomatic paradigm in world politics. The trend of resource nationalization is a trend that should be followed with absolute caution, be it in Russia, Myanmar, Bolivia, or Venezuela.

In fact, we are only at the beginning of a long energy squeeze that is bound to exacerbate, in great part due to the current climate of global political fragmentation. The up and coming leadership change in the White House comes at a critical moment in time: can a new President repair the years of void respect for American political leadership and lack of Democratic enlightenment?

In any case the new presidency faces a number of tough challenges. A new administration and President in the United States is going to face a much harsher international diplomatic climate for reaching consensus. Unilateralism is surely a no go area now, something which even current President George Bush Jr. has understood given the precarious international political climate that has arisen in large part due to this unilateralism. The imminent talks with Iran are a good example of this. They are by no means a stroke of enlightened political leadership, but rather a measure of acute desperation.

#64 The Non-Genocidal Face of Sudan

Sudan, Africa's largest country, is best known for the crisis (others would call it genocide) in Darfur. But there is another story to Sudan as well. A much more positive one. Sudan happens to be one of Africa's fastest growing economies and, ironically, one of the more stable as of late. What's more, Sudan is currently also one of the world's fastest growing economies.

Sudan's President Omar Al-Bashir announced recently that the country's economic growth rate reached 8% in 2006, adding that the growth rate is expected to increase to between 9-13% in the next year. In fact, according to IMF figures, real GDP growth has reported an average of 6.7% over the past seven years: 8.4% in 2000, 6.2% in 2001, 6.4% in 2002, 4.9% in 2003, 5.2% in 2004, 7.9% in 2005 and 8% in 2006. Other sources put the GDP figure even higher at an average annual growth rate of slightly more than 7% over the past seven years. GDP in 2005 stood at US$ 6,747,748, compared to a mere US$4,950 in 1980. This is remarkable given the grave situation in Darfur and the economic blockade imposed by a large number of nations, as well as the long North-South Civil War that ended with the official signing by both sides of the Nairobi Comprehensive Peace Agreement on 9 January 2005, granting Southern Sudan autonomy for six years, to be followed by a referendum about independence.

Not surprisingly, two major factors in the growth equation are China and oil. Oil revenues have become a major part of GDP, contributing to 49% of the total GDP in 2004, compared to 5.9% in 1999. China imported 81% of Sudan's entire oil exports to the world, while oil accounted for 98.8% of Sudan's exports to China. Of Sudan's total exports to the world in 2003, 40.9% went to China. China is indeed by far Sudan's most valuable trading partner, as, according to the OECD, Sudan's main partners 2004 were China (64.3%), Japan (13.8%) and Saudi Arabia (3.7%). In terms of Sudan's importance for China's economy, Sudanese oil accounted for no more than 5.5% of China's total imports of oil in 2004. Sudanese activist Ali Askouri has gone so far as to proclaim Sudan "The first country to become a Chinese colony."

Another interesting fact that is very much worth noting is that Arab investments in Sudan surged by more than 15 times from US$657 million in 2004 to US$2,341 in 2005. Despite all this, however, we should hope that the crisis in Darfur is not permitted to fade any more into obscurity than it already is. If the figures provided by the United Nations are correct, more than 200,000 people have been killed and two million displaced in the fighting. This should not be worth an economic boom. Khartoum says only 9,000 people have died, but this is not taken seriously by many. In any case, China, for one, does not seem inclined to budge even one inch from their principle of non-interference in the affairs of other countries (a policy that was established more than 50 years ago by then foreign minister Zhou Enlai). Without China, little can be done in Darfur. Without China, little economic growth would be witnessed in Sudan. China reigns supreme.

#63 The Energy Champion

Every time we hear about Russia in the news in reference to oil and gas, it seems to be about Russian muscle flexing. In the past few years alone, Russia has used her vast energy reserves as a weapon in times of disagreement against not only the European Union, but also Georgia, Ukraine, her ally Belarus and, most recently, Estonia. But credit must be given where credit is due: Moscow is in a league of its own when it comes to securing her energy interests.

The proof? Just today (May 12, 2007) Russia announced an agreement with Kazakhstan and Turkmenistan to build a new natural gas pipeline north from the Caspian Sea, carrying gas from Turkmenistan through Kazakhstan to Russia. This is a major smack in the face of the EU, which had hoped to lessen their dependence on Russian gas by finding an alternative supplier in the form of Turkmenistan. This was to be done by creating a new pipeline under the Caspian Sea that would go through Turkey to Europe, thereby bypassing Russia. The gas routes as they stand today can be seen in the picture above (source: the Economist).

Even if the idea proposed by the EU were to take hold, some analysts doubt whether it would make a significant difference. ICG energy analyst Charles Esser pointed out that the EU could count on at most 20bn cubic metres of gas per year from a Caspian pipeline, which amounts to no more than 4% of EU consumption in 2004. Nevertheless, given the fact that the exact amount of gas present in Turkmenistan is unclear, a significantly high number could lead to the expansion of current plans and seriously reduce EU dependency on Russian gas in the long term. In any case, the deal announced today is a clear victory for Russia, as it effectively means that Turkmen and Kazakh gas will only be exported to Europe via Russia, putting the Europeans at the mercy of Russian caprice more than ever before.

China will no doubt see this deal as a loss as well, since they too were vying for direct control of Turkmen gas in their global quest to secure their energy needs in the most far-flung of places. In April 2005, deceased Turkmen President Saparmurat Niyazov had blessed the construction of a pipeline to China that would send 30 billion cubic meters of gas to China starting in 2009. Whether this deal will now go through is uncertain, though it seems unlikely that the Russian-Turkmen agreement will affect it. It does, however, give Gazprom and Russia a powerful bargaining tool in any future discussion, negotiation or conflict with China.

Say what you will of the Russian mafia-like monopolizing tactics, but effective they most certainly are.

#62 Economic Darwinism in the Market Place through Hedge Funds and Private Equity

The notion of "survival of the fittest" is not only something attributable to the development of species, but, in a more contemporary sense, to world markets as well. The defragmentation process of regional markets that has been set in motion by the followers of those who advocate closer integration of global markets is a force to be reckoned with.

In the past regulation created barriers that protected regional and national firms from the more efficient and competitive adversaries that operate in more capital efficient and less regulated environments, where capital is allocated to the most productive parts of the economy. This is increasingly changing today, with hedge funds and private equity groups jumping at the new found opportunity to take advantage. Hedge funds and private equity are in fact the aquarium algae eating fish that take out the dirt and keep the water clean for the other fish. This is not to say that firms targeted by private equity directly equate to fish guano. No, these firms are simply more able to asses the true value of a firm, albeit like a skeleton being sold off bone by bone to piecemeal investors.

When firms perform less than optimal, the question amongst shareholders - which can include private equity groups or hedgefunds - is whether management resources have been utilized optimally to achieve maximum utility in comparison to capital market benchmarks. As hedge funds often operate with long-short positions, performance or under-performance is crucial. It is no surprise, therefore, that hedge funds are perhaps the most shortsighted investors in terms of their investment horizons. They often propagate and support the shedding of assets, business, or other holdings if it contributes to short term operational results.

With hedgefunds as shareholders, it becomes essential for the firm to not only "know thy self" but also "know thy shareholders." Shareholders are not a homogeneous group; a pension fund, for instance, may have a longer term perspective and subsequently influences firm management in that direction. Hedgefunds have a different investment and return horizon. By their very nature they are required to give high returns in a relatively short time period. This can create a conflict of interest with regards to the strategy and horizon between firm management and a disparate group of shareholders.

This makes the concept of value difficult to grasp for the management of firms, as they have to deal with a heterogeneous group of investors with different time horizons. This destroys any homogeneous expectations of value and allows for arbitrage based on different views on time, value and strategy. The key word, really, is arbitrage: a key pricing component in the pricing of assets. By means of shareholder activism, buyouts, long-short strategies and others, hedgefunds and private equity improve market efficiency through re-pricing. Hedgefunds reprice through long-short strategies and private equity reprice via financial engineering and other management strategies. Technically hedgefunds can do the same by pressuring management. Either way, the end result is the same.

The power of shareholders in efficient, unconstrained capital markets is a key component in the arsenal of hedgefunds and private equity groups alike. Without transparency and various takeover and management defense mechanisms, shareholders would not be entitled to the influence they deserve as owners of a firm. Yet for years many firms in the Netherlands enjoyed the benefit of various defense constructions against hostile takeovers. This in the end suppressed the value of firms so notably that the phenomenon became known as the Dutch discount.

What empowers private equity and hedgefunds even more is the world of cheap capital that we live in. Low interest rates and low spreads on many forms of debt (excluding subprime market) is stocking the weapons arsenal of hedge funds and private equity alike. The bitter reality of this low interest world in which we live in consequentially empowers the lashes of capital and market efficiency through the empowerment of hedge funds and private equity. In terms of the functioning of markets, I would argue that it is a good thing.

Unfortunately, hedge funds and private equity do not spend much time on press relations, and whenever there is talk of hedge fund activity or private equity, it is equated with some evil power bent on selling off assets and mass firings. The truth is that if management of firms under question such as ABN-Amro had performed more adequately, the scenario we are seeing today would have been less likely. In the end the question is often whether a company is worth more as a whole than the sum of its parts. If the sum of its parts is more valuable than the whole, then management must have failed its shareholders in creating significant value.

Furthermore, management could be accused of empire building and not shedding assets that would be to the benefit of its shareholders. Management has the same tools available as private equity; the difference is the perspective on value. The time window for performance delivery has also narrowed in recent decades, in part due to increased accounting transparency that enables more financial performance benchmarking. This, in tandem with increased integration with global markets, has helped to create enormous "peer" pressure to perform.

This should by no means induce us to feel sorry for management, as performance is more than handsomely rewarded. It is the common employee of the firm who stands to lose the most in this hyper-competitive world. Employees bear the burden of under-performance and often gain, relatively speaking, little when performance is good. Except perhaps for the continuation of job security and perhaps performance. This is not a picture that top management would adhere to. It is a bitter reality. I can imagine ABN-Amro employees being more than a little disgruntled if the management leaves with a nice big bonus due to a hostile take over and all they are left with is uncertainty. ABN is in that regard comparable to the titanic: the only rescue vessels available are for the captain, the shareholders and a select group of officers. The bulk of the crew are left behind in an ocean of uncertainty. This is not entirely fair, as a good captain should go down with his ship, instead of being rewarded for steering the ship into an ocean of icebergs.