Delayed stockdraw blocks oil recovery, say analysts

LONDON, (Reuters) - Bulging world oil stocks are proving even more difficult to slim down than producers had feared, delaying a recovery in the weakest crude prices in a decade, oil company executives and analysts said on Friday. Stocks remain so high that forecasters believe lowly oil prices will struggle to break away from the $13 a barrel value now attached to benchmark Brent blend crude.

"The inventory situation remains bleak — crude and distillate inventories remain high and now Atlantic Basin gasoline is well supplied as well," said Roger Diwan at Washington's Petroleum Finance consultancy. "Prospects for the market are worse that we thought a couple of months ago. The picture has got worse," said an analyst at one large oil company.

Dresdner Kleinwort Benson is only one of many analysts which have revised down oil price forecasts. Kleinwort now sees Brent averaging just $14.50 this year and $16 in 1999 from $19.30 in 1997. Poor market fundamentals abound despite a double dose this year of output cuts by major oil producers.

The second round of reductions, led by the Organisation of the Petroleum Exporting Countries, has yet to be fully implemented but already talk has arisen that a third round might be needed.

The analysts' latest figures show that world oil supply overwhelmed fading demand in the first half of the year by even greater volumes than initially calculated. Stocks at the end of June hit all time records as Asia's financial crisis and a warm northern hemisphere winter sliced into demand growth.

Asia is expected to do no better than return zero demand growth this year with China compensating for lower consumption in other parts of the region. London's Centre for Global Energy Studies now estimates that oil stocks in the 75 million barrels daily market grew by a massive two million barrels a day in the first half of 1998.

"Such a huge accumulation has boosted global forward stock cover by no less than six days," it said. Most analysts were predicting OPEC's cuts would at least start a sizeable drawdown in stocks in the second half of the year. Two rounds of OPEC cuts were aimed at withdrawing 2.6 million bpd of supply.

But deteriorating Asian economies and slowing growth in the West mean the sums now look less favourable to oil exporting nations.

Petrofinance has halved its forecast for the stockdraw in the second half to just 450,000 bpd. The consultancy says rising UN-monitored Iraqi exports mean the net reduction in OPEC output this year is likely to be only 1.2 to 1.4 million bpd.

From rugger to the playing fields of commerce

By Feizal Samath

Who needs foreign expertise when Sri Lanka has a huge reservoir of professionals and talent and should be looking overseas for business opportunities? Many local companies are looking at South Asia, the ASEAN region and the Middle East for investment opportunities utilising Sri Lankan expertise.

Among conglomerates, John Keells and Aitken Spence have hotels in the Maldives and are looking for properties in South India while Hayleys has a string of overseas offices.

The latest addition to this list is the burgeoning Asia Capital group, which is looking at foreign opportunities in financial services and research and already two are in the pipeline.

"We are looking at one particular venture in the Middle East and that appears to be a good one" says Dirk Flamer-Caldera, Chief Executive Officer (CEO) of Asia Capital. Flamer-Caldera said that they were not planning on overseas operations "just for the sake of having an office abroad. We want to go overseas if there are significant profits to be made."

The company has a strong stockbroking research unit, that has benefited from international expertise, and good research teams, which Flamer Caldera feels, can be set up in any part of the world as joint ventures with others. "That is another area we are looking at.

"The offices of Asia Capital at the World Trade Centre Towers in Fort are spacious and comfortable, reflecting the group's desire to grow in Sri Lanka and possibly abroad. Like many other offices located at the posh Towers, the Asia office has one of the best views of the ocean and the Galle Face green.

In the firm's luxurious lobby on the 21st floor, company executives rush in and out of doors and occasionally discuss matters in the corridor, giving the impression of a company on the move or anxious to reach conglomerate status.

Flamer-Caldera may have studied and worked abroad, where he made his first million "bucks", but like many Sri Lankans, he has come home to roost and believes the country has a lot of expertise that should be exported. Praising other companies for setting up overseas operations, Flamer-Caldera talks about the large number of Sri Lankans who are doing well abroad, and says;

"Look at the world and see how many Sri Lankans are in prominent positions contributing to research and the advancement of technology. It must be quite a long list."

His group is in the league of Sri Lankan firms that have a nice mix of - Sri Lankans who have worked and lived abroad, local businessmen and foreign investors and their expertise.

It also probably reflects a new-found desire among Sri Lankan professionals abroad to return to their homeland and set up shop in an economy that is growing and showing resilience despite a 15 year old war between government troops and Tamil separatist guerrillas.

'The private sector in this country is amazingly resilient given the kind of problems they have faced in the past 10 years or so. They keep getting hit and coming back. That is something to be proud of. I don't think any other country in the world with the same kind of problems has such a resilient private sector," Flamer-Caldera said. Flamer-Caldera is a familiar face from the past - on the rugby field. While Dirk played rugger for S. Thomas and took off abroad, the others in the Flamer-Caldera clan of brothers played for S. Thomas and then the CR and FC.

Flamer-Caldera, now 47, winces when going down memory lane, his playing days, and recalling those "bone crushing tackles". But he enjoys talking about the sport "in the good old days" and in fact Asia Securities (Private) Ltd, the company's hugely-successful stock-broking arm, has a generous sprinkling of rugby players and cricketers.

The Asia group, beginning with Asia Stock Brokers (now Asia Securities (Private) Ltd) in September 1990, made a rumbustious start with some mega-deals on the stock market, that made investors look up and ask; "Who are these people?"

The company, helped by David Watts, a fund manager for international stockmarket player George Soros, bought into the Oberoi hotels which was offered by the government under its privatisation programme. Later Asia took stakes in the Ramada (now Trans Asia Hotel) and the Intercontinental. It was Asia that brought Soros into the Colombo stockmarket.

Watts was one of the managers of Soros' Quantum Investment Fund and, though handling just a small segment of the fund, the amount was phenomenal. Now most of Quantum's shares in the hotels have been sold to other investors.

Asia Brokers in a short time rose to be the biggest broker in Sri Lanka and with an eye on expansion, the company decided to go into the merchant banking business.

It raised money in the stock market and its public issue - 1.2 billion rupees - is still the largest ever raised. W.I. Carr, the multinational research firm owned by Credit Agricole (one of the largest banks in the world) and Banque Indosuez group, invested in the company and is now a substantial shareholder.

At that time, Watts became chairman of the firm and a foreign national with merchant banking experience was brought in to function as the chief executive officer. Flamer- Cal-dera, while still being a key shareholder, and other Sri Lankans pulled out of the board allowing Watts a free hand in management.

But troubles soon surfaced. In the year ending March 1997, the company reported a loss of 110.9 million rupees. However in the year to March, 1998, there was a turnaround and Asia showed a profit of 217.1 million rupees. Flamer-Caldera said they found the foreign CEO's performance unsatisfactory and in December last year decided to re-take the company from Watts and Co.

Local shareholders, led by Flamer-Caldera, Asanga Seneviratne and Rusi Captain, put together a consortium and bought all the shares held by Watts and others at a significant premium. It was a new beginning for the company.

Flamer-Caldera, recalling that period, said that the new board directors discovered two major problems at that time.

"One was that the company was perceived as not having a steady flow of income with income being on an ad hoc basis. We made 200 million-plus profits last year but most of that money came from stock market transactions and capital gains."

"That left shareholders and the public wondering what the company was doing. We had to address the question of how to maintain a steady income every year to justify a reasonable price for our shares. The second problem was that we had a large capital base but most of the money was in fixed income securities which was losing its lustre with interest rates coming down."

Thus began the major shift in policy and direction for the company, and Asia Capital - with a cash-rich capital base - started looking at other business with which it could form strategic alliances and syn-ergies.

Since last December the new management, Asia Capital has ploughed in cash into, what it calls, attractive businesses that would provide the kind of earnings that would enrich its coffers. Asia Siyaka Commodities was formed with a group of experienced tea, coconut and rubber professionals who broke away with Forbes Ltd, and is now established as the fourth largest commodities broking house.

Says Flamer-Caldera: "This firm had two significant developments. It fitted in nicely with our stock broking operation and now it is a complete brokerage house. Commodities is an attractive business and has the potential to give us nice returns. It is also a cash intensive business.

For instance, Asia Siyaka lends 150-200 million rupees in capital to producers as advances, etc, and this money in turn could be obtained from Asia at attractive rates."

The second transaction, a mutually benefiting one, was the acquisition of a 20 percent stake in Richard Peiris, a blue chip company.

"In our opinion it was a blue chip that was about to be a major conglomerate. One of the problem areas for Richard Peiris was that it was a capital-starved firm and we were in a perfect position to provide it capital at the best possible rates. There was a big synergy here and we saw ourselves adding to the Richard Peiris growth exponenti-ally."

The Asia CEO says that its investment in Richard Peiris would provide Asia with about 60 million rupees in steady earnings each year. Then came Lanka Orient Leasing Co (LOLC) in which Asia took a 10 percent holding, aimed at getting a foothold in the leasing market.

"Leasing is a tricky business and many leasing companies here have got their hands burnt. Because of this, instead of setting up our leasing firm, Asia decided to invest in a firm that had a good future and a good team," he said.

So much about the past. What about the future? Flamer-Caldera, the rugby-player turned businessmen, is pensive when he says the future is bright and the growth potential, enormous. Asia Capital, with its sizable capital base, is very interested in the fixed income securities and debt market and see the demand for debt rising. They plan to be more active in raising debt for companies.

Flamer-Caldera wants Asia to be the leading investment bank in Sri Lanka in the next decade but sounds a note of caution about the positioning of the company in the near future.

"We need to be dynamic but at the same time, cautious. We would expand, we would grow and gain market share but with an element of conservativeness," he says.

Encouraging words indeed, for shareholders who want fast but also solid growth. Flamer-Caldera's theory of stockmarket trends makes a lot of sense. He says local investors are no longer only interested in the profitability of companies for share prices to rise. The global situation also plays a key role. Recalling the different stages of growth of Sri Lanka's stockmarket, the Asia CEO says at the beginning, it was speculation that guided the market.

"Locals started buying when foreigners were in the market. That changed to a phase when investors poured over the books of companies to study profits, trends, etc as a guide and the era of knowledgeble investment had begun."

"Now we see another phase - the Sri Lankan investor has gone global. He or she looks at the Singapore market and if that has fallen 10 percent, he sells here. If the Japanese Yen falls - which automatically cripples regional markets, Colombo is also affected."

Flamer-Caldera says that is where the Sri Lankan market is now and says this is the reason why current share prices of local conglomerates do reflect the huge profits companies have shown in the last fiscal year.

Asia vs Latin America

The Asia crisis has highlighted severe structural flaws in the former Tiger economies. Their banking and over-investment problems, in particular, will require prolonged adjustment.The question of whether these problems have completely undermined the factors leading to strong pre-1997 growth is examined by revisiting our 1997 Tiger score analysis.

We then look at the long term growth prospects in Asia and Latin America and the opportunities equity investors can expect. The analysis concludes the following:

*Asia's Tigers still look intrinsically strong given their high education standards and free market focus. The 1998 scores were lower than last year, but still high and generally better than in Latin America.

Moreover, the crisis is proving to be a spur to new reforms which could raise scores in future.

*Latin America continues to improve as the benefits of the structural reforms introduced since the late 1980s come through. But poor export performance and poor education standards remain serious problems.

*Recovery in Asia requires substantial reform. Sorting out problem banks and overleveraged corporates, dismantling crony capitalism and accelerating deregulation must have top priority.

More fiscal stimulus, and probably more foreign help (new loans and to re-organise debt) will also be needed to keep the social costs of restructuring manageable, whilst lower interest rates will be necessary eventually too.

*Achieving higher growth in Latin America requires reforms to lift savings, boost manufactured goods exports, overhaul labour markets and to improve the efficiency of public spending.

*There is a good chance that Asia will aggressively stick to its reform agenda. In this event a strong recovery in 2000 should be possible after 1998-99's deep recession. A return to high, 5-6% pa, growth could be achievable in 2-3 years.

Latin American growth will be held back in 1998-99 by lower capital inflows and overheating worries. Growth should then pick up and top early 1990s levels. But expansion is still likely to come in lower than in Asia.

*The main risks to this outlook in Asia are first reform fatigue leading to policy drift, higher inflation and lower growth and second that the continuing decline in property prices in many countries, depresses, domestic spending and financial systems for much longer.

In Latin America the main risks are a devaluation crisis in 1998-99, possibly triggered by Brazil and/or serious political problems in 1999-2000.

*After 1989 Latin equities dramatically outperformed Asian stocks, even before the Asian crisis. Asian equities are high risk, but cheap now.

The next 6-12 months may be a good time to switch some of an investment portfolio out of Latin America and to start averaging into Asian markets.

The dos for Latin America

To achieve and sustain higher growth Latin America needs to target four remaining problem areas.

1. Low savings: The region invests more than it saves, and foreigners cover the gap. This puts a low ceiling on the growth that can be achieved without hitting external problems.

Relatively stable direct investment inflows have increased on the back of improved operating environments and extensive privatisation programmes.

But a significant proportion of the savings gap is still funded by volatile porffolio inflows and external debt.

Governments need to help reduce this vulnerability by pushing through fiscal reforms which boost tax receipts and cut sub-ntional spending. Pensions reform to encourage private savings and to control state social security burdens is also needed.

These reforms are well advanced in many countries, but have still to be comprehensively tackled in Brazil.

2. The overdependence on commodity exports: Latin America exports less than Asia, and is more dependent on volatile primary products. This makes growth highly cyclical and can hold back diversification if, as in Chile, super-competitivenes in the primary sector leads to strong capital inflow and significant real fx rate appreciation.

Only Mexico has sharply reduced its commodity export dependence. The lesson here is that Latin America needs more flexible fx regimes and regulatory and trade reforms which encourage exports of manufactured goods.

3. Reform labour markets: Surveys show only Peru, Chile and Mexico scoring well on labour flexibility indices.Governments need to do more to curb trade union power, cut payroll taxes and to deregulate labour markets which limit the flexibilty of wages and hold down employment.

4. Low quality government spending: Growth is also held back by poor physical infrastructure, poor social services, a lack of confidence in judicial systems, and by poor education standards particularly at the primary and secondary level.

Outlook:Modest Growth The Asia crisis and overheating worries will pull down Latin growth in 1998-99. If significant progress is made in all the problem areas 5-6% pa growth would be sustainable over the long term.

But only modest progress is likely, and 4-5% pa growth is probably the best that Latin America can achieve.

The Risks

Currency Crisis: Latin America has used overvalued currencies to keep inflation low. As a result, periods of currency strength have been punctuated by balance of payments crises and deep devaluations.

All major currencies in the region are overvalued now.

In addition, it may be difficult to cover large foreign financing needs in 1998-99 if Asia's problems remain acute and/or US stocks sell off sharply.

A large market-induced devaluation in Brazil, would probably topple Argentina's currency peg and lead to large currency falls elsewhere.

Political Crisis: Free market reforms have yet to make significant inroads into Latin America's acute income disparities. Therefore popular support for reform should not be taken for granted.

In addition, the political boost from removing hyper-inflation is fading now. Going forward, delivering higher growth and better social services will become more important.

Presidential elections are due in Brazil and Venezuela later this year, in Argentina and Chile in 1999 and in Mexico in 2000. There could well be election upsets.

But any upset is more likely to lead to weak governments which struggle to push reform forward at a rapid pace, rather than a return to populist policies.

Asia : Cheap but still risky

In Asia, rock- bottom sentiment, deep economic recessions, banking and corporate sector restructuring and the probability of further currency weakness, will hold equity markets back for some time.

During the next 6-12 months the region will be high risk, and could well present far more opportunities for the direct foreign investor than the equity investor.

But valuations are currently very cheap and a great deal of the severe adjustment which lies ahead has probably been discounted. We expect Asia to stick with reform, with relatively little backtracking, and so economies should be looking better from mid 1999.

This should encourage a pre- emptive equities rise, even against the headwind of two factors which makes Asia's equity recovery particularly difficult to call.

Firstly stock markets will stay dominated by banks and property stocks where recovery will lag the rest of the economy.

Secondly, recovery will involve the substantial swapping of debt for equity. This is a long term positive, but near term, increased issuance could hold back price gains.

On a 1-2 year time horizon Asian equities look attractive, reflecting the prospect of economic recovery and the impact of structural changes which will increase foreign ownership of companies and transform traditional management regimes to focus more on shareholder value.

The markets most likely to recover first are Thailand and Korea which should continue to aggressievely implement adjustment policies. Korea also has the advantage of significant number of export stocks, a plus also shared by Taiwan, another strong candidate to join the first recovery wave.

The Philippines should also perform well in 1999 having been south east Asia's most clearcut contagion victim.

Japan could also recover from 1999 if the authorities deliver on promises of faster reform. Indonesia and Malaysia are likely to lag, and their problems will hold back Singapore short term.

Hong Kong and China face prolonged recessions/ economic slowdowns which will grind down equities. Relief over the long term will probably only come through devaluations.

LATIN AMERICA: A difficult 1998-99

Latin American equities outperformed in 1996-97 as free market reforms enabled the region to bounce back quickly from the Tequila crisis. Since the beginning of 1998, the Asia crisis has taken its toll and equities have struggled.

A sustained recovery looks unlikely over the next 6-12 months, especially given our view that the US market is unlikely to make much progress over this period.

The spillover from Asia will keep commodity prices weak and lift current account deficits. International investors are also likely to stay acutely aware of Latin America's unhealthy combination of overvalued exchange rates, a high dependence on often short term capital inflows, and potentially very high political risks. In 1998-99, at least, this will keep interest rates high and slow growth.

Individual market prospects: Over the longer term, equity market prospects will depend on the pace of structural reform. Brazil markets should do well. The country has further to go on reform.

Courtesy American Express Bank Economics for Internet

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