We are indeed living in interesting times. The developments of today seem like flex point, after which things start to change.

Jan 30 - Feb 05, 2006

In my last article I reported the policy decision by China to move away its assets from US dollar to a diversified portfolio. Indeed the performance of dollar during the last couple of weeks has been weak and the fundamentals do point to further weakening. I also briefly pointed out on the geopolitical and economic standoff between China and US, which involves not only trade and exchange rate related disputes on the economic front but also include a confrontation over securing long term energy resources, mainly oil.

The oil factor and its importance in shaping the political landscape has become a well known and well written subject. Few analysts disregard the role of oil in US motives to expand its presence in the Middle East. If we thought the race would stop with Iraq, we might be proven wrong. The growing political pressures against Iran, has once again fuelled the prices of oil (as well of other commodities). As I write the article on Saturday, 21st Jan, the headline on Financial Times reads 'Iran urges oil cuts and plans asset move'. The Iranian government has asked the OPEC to reduce oil production by 1mn barrels a day and is threatening to destabilize global oil supply in consequence to any political development against it. Iran is also planning to move its financial assets out of Europe. These developments, along with related developments in China, herald long term economic and financial changes on a global macroeconomic scenario, which is extremely important for our economic planners and financial managers to understand and respond to.

In my last article I mentioned that China has signed a 20 years agreement with Iran to supply it with oil. Consequently, we would expect China not to support any political developments initiated by President Bush which could destabilize the country. Tensions with Iran can potentially keep oil prices above or at least near their current levels of USD65+ a barrel. The announcement by Tehran to urge OPEC to cut oil production took oil prices to a four month high of USD68 per barrel. The audiotape messages by Al-Qaeda also add to the volatility in the markets and form excellent news-flow for speculators to take advantage of. In the week that ended, gold jumped to a 25 year high of USD567.6 a troy, sugar futures also rose to their 25 year high at USD17.21 per pound, platinum reached all time high of USD1050 per troy ounce, copper is already at its 25 year high of USD4552.5 per tone. The developments are certainly not favorable for the cost of production of global industries.

However, it also indicates a profitable opportunity for Pakistani businesses to expand into minerals and primary sector exploration. Indian companies have expanded their operations to Africa in search of commodities. Domestic oil exploration companies might consider such ventures as well. For the small investor, exposure in equities related to commodities continues to be attractive. Unfortunately, the speculative nature of Karachi Stock Exchange blurs the opportunity for long term investment and degenerates investors into short-sighted speculative traders (who always end up losing).

The more significant impact of the Iran-US political tensions are for the Pakistani government. Pakistan had been hoping to secure gas supply to the country through the Iran-Pakistan-India gas pipeline. However, being a US ally, it is not unlikely that there would be unfavorable political pressures against the project. Some analyst do suspect that India's decision to pull out of the pipeline project was under US influence in exchange of the nuclear energy deal. Faced with such a conundrum there are two choices with the government, either go ahead with what it considers a long term beneficial project and follow suit with China in making a deal with Iran, or search for alternative countries and alternative energy resources. If the external pressure cannot be dealt with, then perhaps looking into Central Asia might be the other option. Tajikistan-Afghanistan-Pakistan pipeline project would always be a risky proposition given the political instability in Afghanistan. So perhaps the only alternative left with the government might be to search for alternative energy resources.

Ethanol has emerged as the magic oil alternative and is successfully being used in Brazil. China and India are also running pilot projects in selected areas where they have increased the ethanol-oil mix to 10%. In Pakistan, such a move is likely to be opposed by the OCAC as it would hurt their interests. However, looking into ethanol production seems like a valuable option. Realizing the potential value of ethanol, global funds and hedge funds have taken positions in the commodity market (and hence we see sugar futures reaching record highs). The Alternative Energy Board in Pakistan should carry out feasibility study of ethanol and the financial institutions should look at the commodity for investment purposes.

We are indeed living in interesting times. The developments of today seem like flex point, after which things start to change. Oil might not remain the commonly used energy source, and political situations in the neighborhood of Pakistan might tense up. Economies may not consider the US dollar or even the Euro, a safe investment asset and follow suit with China and Iran to diversify their capital. Asia Pacific countries like South Korea, Thailand, Singapore and Middle East might be the beneficiary of these changes. A rising Japan post-Post Office reforms may emerge as a growth economy as well.

The author is a Rhodes Scholar at Oxford.