Ian Huntley  analyzes how the middle eastern unrest will affect oil prices, the Australian share market and the global economy.

25 Feb 2011 - Morningstar

With Libyan leader Muammar Gaddafi thankfully looking to be on the way out, hopefully a really long way out, it's possible the Libyan oil shock could subside almost as quickly as it flared.

According to latest reports, he has lost control of Eastern Libya, which holds the majority of the country’s oil. Whether this revolutionary bushfire spreads to other major countries is difficult to know. From what I have read, the odds of it spreading to Saudi Arabia are relatively low at present, and one would think the Saudis might handle any situation far better. To date Egypt has handled it better than mad Gaddafi.

Every Middle Eastern despot should go see that great movie The King's Speech and do a rapid, in-depth study of the way the British monarchy bent with the wind, preserving a changing role for itself, and relinquishing power to the masses. A great friend, Lord P yesterday gave me a studious run down of the last 400 years of British history on that theme. Lord P, you are needed by many a despot as adviser, but would need to watch your neck.

A fascinating side angle to this bushfire is brought up by the excellent Stratfor intelligence service. China is investing heavily in despot countries where others refuse to go on human rights grounds. Often when the despot goes, so does the investment! Favour changes with the wind! Will China face "country risk" issues? African history is rife with such issues, often with very nasty turns.

At this stage, the oil price has jumped about US$15 a barrel after a long period post-financial crisis of demand driving up the price while OPEC manages a tight supply. OPEC has plenty up its sleeve to manage a Libyan blow-out. An issue is whether the reserve oil supply is of the right grade to replace high-quality Libyan crude.

The upheavals take place when it seems remarkably evident that the Hubbert peak analysis of oil itself is remarkably correct - supply has reached a plateau and may well fall over the next 20 years - some, including Warren Buffett's trading partner Charlie Munger, suggest 25 per cent. The high price is fostering alternatives from tar sands, bioenergy, and in particular gas, whether on land as from Qatar, sub-sea as with our North West Shelf, or from coal and shale beds.

It is absolutely amazing that just a few years ago, the US was about to import LNG. Now with an explosion in their own gas production, from technological break throughs in extraction from coal and shale beds, the US is poised to be an exporter. The next step is to follow in Qatar’s footsteps and convert gas to liquids, thus working to an oil supply independent of the Middle East, Venezuela, and other despot ridden oil suppliers.

Energy problems are not going away, the oil market remains tight, and there will be many price flare-ups. The current one is on the verge of being sufficient to damage already weak consumerism in the US. Wal*Mart has reported weak sales for seven consecutive quarters now, a reality check to those waving improving consumer confidence figures as a guide to better retail showings ahead.

First, the confidence levels are still poor, and second, they are boosted by including an improved sharemarket performance in the key data. Sharemarket performance helps, but it needs to reflect a lot of other things like rising employment, rising disposable incomes and, might I add, a better housing outlook!

Otherwise, it reminds me of Charlie, a boy who used to fish with me. He had a sharp eye for the feeding, circling birds we seek as a guide to where thrashing surface fish schools might bring home a feed. "Ian," he said one day, "could we grab some gulls and tow them in the air to bring the fish around?"

"Sorry, mate," I replied. "The seagulls follow the fish, the fish don't follow the gulls -  and they can't fly for a start!"

I guess Charlie logic is a little like our government reckoning that if we bring in a carbon pricing scheme it will (1) reduce emissions and (2) bring the rest of the world in to following our example. China and India represent close to 40 per cent of the global population, we do not register on the population scale though our emissions are high on a per capita scale, but nothing in a global quantity sense. Without Chindia and the US, we are just towing seagulls, and lifting costs for our households, and if we subsidise them, further pressuring our budget. US President Barack Obama has, well, other fish to fry at present.

Now after many years of careful thought I rate Gough Whitlam as our greatest ever prime minister.

Wait, before you heap scorn. He terrified a whole generation with economic policies so bizarre as to beat science fiction. Remember Tirath Khemlani and his buckets of money for us? So ever after, Australians learned it was best to keep our house in order - and may it stay that way.

Remember, the first step on a slippery slope just keeps on sliding. Hopefully this strange government will honour Mr. Whitlam's greatest legacy, though I have great qualms.

Personally, I agreed with former prime minister Kevin Rudd when he took up Treasury Secretary Henry's forecast of a larger population ahead, nothing remarkable over 30 years or so, and said he welcomed a "Big Australia". I didn't agree with him on much else, though. It really comes home as we see gradually rising pressure on the wages market, and wages inflation is the worst inflation. Gough had it everywhere, setting possibly a developed western world record! Oh, nasty political comment, Huntley!

Well, just think of my comment in recent weeks that what makes this resource boom different is the very high level of household mortgage debt now a record in our history. Gough Economics gave us high double-digit interest rates. Back then households were lowly geared. Just think of the possible devastation if we had that today. One cause could be heavy-duty government spending colliding with private enterprise spending especially as workplace legislation is changed to favour union power. No wonder National Broadband Network chief (NBN) Mike Quigley is concerned about wage pressures as he competes with the resource industry for labour and skills. Luckily, the Building the Education Revolution is winding down, just a pity it didn't focus on lifting the quality of the education as against school halls.

We need more people - and rapidly - and we need the infrastructure to keep everyone happy. We need an Aussie version of the Statue of Liberty instead of the current rancid debates. Perhaps the Australian "Southern Cross" flag in one hand, the aboriginal flag in the other.

Sharemarket outlook

The oil shock needs to dissipate quickly, otherwise it will certainly set back the dawdling US recovery. A year out, wages inflation could become more of a concern, and incipient food inflation around the world could be causing further problems. I am sticking with my outlook for this year of 4000-5000 on the All Ordinaries index, with a 20 per cent chance of an upward break of some 500 points.

I also mentioned that 2012 could be a down year and am thinking about this very closely, always remembering that it is the unknown unknowns that usually get you! Best to have a quality, diversified portfolio, little or no debt, and some cash on hand. Broadly, I continue to see us in the foothills ahead of a teen's decade bull market that will likely kick off in the second half 2012 or early 2013.

We are very lucky that Australia is a major energy and food exporter! I just pray our government has learned from Mr Whitlam!

This report appeared on www.morningstar.com.au 2011 Morningstar Australasia Pty Limited

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