MONTHLY ECONOMIC NOTE APRIL 2011

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1 MONTHLY ECONOMIC NOTE APRIL 211 OCTOBER 2 Analyst: Adedayo Idowu a.idowu@vetiva.com Global Oil and Food Prices; Drivers and Dependencies Prominent Themes Oil and Food prices are likely to remain important drivers of headline inflation in 211 as we have seen in most Emerging and Frontier markets. Developed economies on the other hand, are yet to feel the full impact of this price uptrend as aggregate demand remains within band. Nonetheless, pre-emptive steps are being taken through monetary tightening to manage the gradually rising inflationary expectations and sustain credibility. For instance, the European Central Bank (ECB), despite the fragile growth in the peripheral economies recently raised rates by 25bps to 1.25%. (First hike since July, 28). Crude oil prices have moved sharply on the Middle East and North Africa tensions with fears of supply shortages sending prices to a 32 month high of $126/bbl. We however believe the concerns around the trajectory of Libyan oil production though appropriate appear overdone and, current oil prices at these levels do not reflect fundamentals. We believe as these speculative assumptions are brought home, energy prices could soon become vulnerable to correction around $1/bbl as the speculative positions gradually unwind. Supply side shortages with increasing demand continue to exert upward pressure on Food prices. Severe weather patterns over the past year have impacted supplies of key Food commodities such as Wheat, Rice and Corn amongst others. Though the role of speculation cannot be discounted, in this case, we believe demand and supply fundamentals underpin high Food prices going forward. Little attention is paid to the links between Food and Oil in economies. While point input-output estimates are not available, we extrapolate that the Food sector uses about 7% - 15% of all the energy in most industrialized economies- from the beginning to the end of the Food value chain (irrigation, transportation, storage and cooking). Higher Oil prices are likely to drive Food prices higher by increasing input and production costs which will eventually be passed on to the final consumer, with huge implications for inflation. As such, we expect an aggressive monetary tightening through especially amongst emerging economies, with developed economies adopting a more modest policy response. Fig 1: Headline Inflation in Select Countries (%) Fig 2: Food Component of CPI; Select Countries (%) Nigeria Egypt Pre-dominantly higher inflation in frontier markets, while gradually climbing higher in the developed markets 1 6 Kenya China S/Africa US Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec 211 Jan China US Eurozone Nigeria Feb 2 UK Germany Source: Various Statistical Bulletins, Vetiva Research Source: Various Statistical Bulletins, Vetiva Research Please see last page for important disclosures Monthly Economic Note 12 April 211 I Pg. 1

2 Do Crude Oil Prices Reflect the Fundamentals? The 211 forecast on oil consumption had been upbeat, supported by rising demand from the emerging markets, mainly China and the Middle East, and the depletion of crude oil stock piles. This forecast was based on analysis from the Energy Information Administration (EIA) stating that Global Crude Oil consumption grew at its second-fastest pace in over three decades in 21, rising 2.8% to 86.7 million barrels per day (mbpd) surpassing the 28 levels of 86.3mbpd. Ideally, forecasted global demand in 211 of 87.9mbd is not expected to put a strain on global supply. To be specific, annual production from both OPEC and Non OPEC countries is estimated to be around 87.4mbd with a spare capacity of 4mbpd, which is sufficient to accommodate production gaps from Libya. Fig 3: Crude Oil Production in select MENA Countries 12% 5% 3% 2% World 21 crude production: 86.29mmb/d MENA 21 crude production: 3.24mmb/d MENA share of world 21 crude production: 35% 79% Saudi Arabia Iran Algeria Libya Rest of the World Source: Energy Information Administration (EIA), Vetiva Research The concerns around the trajectory of Libyan oil production, though appropriate, appear overdone. Estimates of current shut in production vary from a low of 5, barrels/day (b/d) to over 1 mbpd, from a total production of 1.8 mbpd. However, we note that Libya s production is c.5% of MENA oil production and c.2% of global oil production, which is not a deal breaker. Whilst we understand the quality of Libya s light sweet crude makes it attractive to select European buyers, we note there are alternatives in Nigeria s Bonny Light and Algeria s Saharan Blend. Moreso, Saudi Arabia, the UAE and Qatar have increased supply in the recent quarter; with spare capacity to increase production further if need be. Clearly, current oil prices at these levels do not reflect fundamentals. Overall, we think Analysts projections of c.$15/barrel (the tip off before last recession) may not be feasible. Please see last page for important disclosures Monthly Economic Note 12 April 211 I Pg. 2

3 Jan-9 Dec-9 Nov-91 Oct-92 Sep-93 Aug-94 Jul-95 Jun-96 May-97 Apr-98 Mar-99 Feb- Jan-1 Dec-1 Nov-2 Oct-3 Sep-4 Aug-5 Jul-6 Jun-7 May-8 Apr-9 Mar-1 Feb-11 May-87 Jun-88 Jun-89 Jul-9 Jul-91 Aug-92 Aug-93 Aug-94 Sep-95 Sep-96 Oct-97 Oct-98 Nov-99 Nov- Dec-1 Dec-2 Jan-4 Jan-5 Feb-6 Feb-7 Mar-8 Mar-9 Apr-1 Apr-11 An Oil price correction, how soon? In our opinion, if the MENA crisis does not escalate to major producers such as Saudi Arabia (low probability), energy prices could soon be vulnerable to correction as the speculative positions unwind. In the short term, China s monetary tightening, earthquake in Japan (second largest oil importer in Asia), and the recent interest rate hike in Europe all point to waning demand. In the medium term, the possibility of a Libyan ceasefire is likely to offset some of the speculation in the market, and as such, we see the possibility of a correction to $1/barrel levels. The fact is that global output growth, remains fragile, and in fact slower than expected; albeit, sentiments favour the spike. Fig 4: Crude Oil Spikes: Fundamentals or Demand/Supply Concerns ($/barrel) Source: Energy Information Administration (EIA), Vetiva Research Bringing Food Prices back to the fore Food prices which have been higher than their 28 peak took a breather in March after reaching a record high in February. Is this the beginning of a correction? In this case, though the role of speculation cannot be discounted, we believe demand and supply fundamentals underpin high food prices going forward. Fig 5: Spikes in the Global Food Price Index (Points) Beginning of another reversal? Source: Food and Agricultural Organization (FAO), Vetiva Research Please see last page for important disclosures Monthly Economic Note 12 April 211 I Pg. 3

4 Increasing demand on the back of a rapid economic growth in Emerging markets, especially Asia, and the increasing use of Food in the production of Biofuels, supply shocks as an aftermath of volatile weather patterns and trade policies thereafter, have continued to exacerbate price instability and price increases in the global market. March stands out as an outlier from the trend which is explainable given that Japan, (Largest importer of corn and Asia s largest importer of Wheat) had to grapple with a national crisis which temporarily affected demand. We expect that demand will normalize this month, and the upward trajectory of food prices to continue as people are likely to pay significantly more for Food as opposed to eating less. The Food and Oil Nexus Little attention is paid to the links between Food and Oil in economies which is apparently very strong. While point input-output estimates are not available, we extrapolate the Food sector uses about 7% - 15% of all the energy in most economies: from the beginning to the end of the Food value chain (irrigation, transportation, storage and cooking). This nexus makes the levels of Crude Oil an important factor in the production and distribution of Food. Higher oil prices are likely to drive Food prices higher by increasing the cost of input and production costs which will eventually be passed on to the final consumer. Furthermore, the increasing use of crops to produce biofuels has created an alternative use for Food. Consequently, an increase in the price of Oil leads to an increase in the demand for biofuels, and ultimately Food crops. The outlook for Food prices seems mixed, with the certainty of elevated prices in the short term, while the long term direction remains unclear. We however need to monitor the following: Climatic Changes Growth Scenarios for the economies currently driving demand, especially the emerging economies Oil price outlook (How far north?) Protectionism tendencies And black swan events not included here. Vetiva Capital Research is available via the following platforms: Bloomberg: VCML <GO> Capital IQ: Thomas Reuters: thomsonreuters.com/financial Factset: Please see last page for important disclosures Monthly Economic Note 12 April 211 I Pg. 4

5 DISCLOSURES SECTION Analyst Certification The research analysts who prepared this report certify as follows: 1. That all of the views expressed in this report articulate the research analyst(s) independent views/opinions regarding the companies, securities, industries or markets discussed in this report. 2. That the research analyst(s) compensation or remuneration is in no way connected (either directly or indirectly) to the specific recommendations, estimates or opinions expressed in this report. Other Disclosures Vetiva Capital Management Limited or any of its affiliates (collectively Vetiva ) may have financial or beneficial interest in securities or related investments discussed in this report, potentially giving rise to a conflict of interest which could affect the objectivity of this report. Material interests which Vetiva may have in companies or securities discussed in this report are herein disclosed: Vetiva may own shares of the company/subject covered in this research report. Vetiva does or may seek to do business with the company/subject of this research report Vetiva may be or may seek to be a market maker for the company which is the subject of this research report Vetiva or any of its officers may be or may seek to be a director in the company which is the subject of this research report Vetiva may be likely recipient of financial or other material benefits from the company/subject of this research report. Disclaimer This research report is based on public information which the research analyst(s) consider credible and reliable. Facts and views presented in this material have not been reviewed by, and may not reflect information known to, professionals in other business areas of Vetiva, including the investment banking team, as Vetiva has established information barriers between its Research team and certain business groups. Whilst reasonable care has been taken in preparing this document, no responsibility or liability is accepted either by Vetiva, its officers or any of its employees for any error of fact or opinion expressed herein. No reliance should be placed on the accuracy, fairness or completeness of the information contained in this report as it has not been verified by the research analyst(s) involved or the companies whose securities have been referred to except as otherwise disclosed. Neither Vetiva nor any of its officers or employees including the research analyst (s) warrant or represent the accuracy or completeness of information set out in this report. Any ratings, forecasts, estimates and opinions set forth in this report constitute the analyst(s) position as at the date of this report and may not necessarily be so after the report date as they are subject to change without notice. It is also instructive to note that a company s past performance is not necessarily indicative of its future performance as estimates are based on assumptions that may or may not be realized. The value, price or income from investments mentioned in this report may fall as well as rise due to economic conditions, industry cycles, market indices, operational or financial conditions of companies or other factors. Thus, Vetiva and its officers and employees shall not accept liability for any loss arising from the use of this report or its contents in making investment decisions or recommendations. This report provides general information only. It is not intended to provide personal investment advice and does not take into account the specific investment objectives, financial situation and the particular needs of any specific person. Investments discussed in this report may not be suitable for all investors and the reader(s) should independently determine their suitability and evaluate the investment risks associated with such investments. All investors are solely responsible for their investment decisions. Any decision to purchase or subscribe for securities in any offering must be based solely on existing public information on such security or the information in the prospectus or other offering document issued in connection with such offering, and not on this report. Vetiva, through business units other than Vetiva Research, may have issued and may in the future issue trading ideas or recommendations that are inconsistent with, and reach different conclusions from, the information presented in this report. Such ideas or recommendations reflect the different time frames, assumptions, views and analytical methods of the persons who prepared them, and Vetiva is under no obligation to ensure that such other trading ideas or recommendations are brought to the attention of any recipient of this report. To the extent this report discusses any legal proceeding or issue, it has not been prepared as nor is it intended to express any legal conclusion, opinion or advice. Information relating to the tax status of companies whose securities are discussed in this report is not intended to provide tax advice or to be used by anyone to provide tax advice. By accepting this research report, you agree to be bound by the foregoing limitations. Vetiva Capital Management Limited is registered with the Securities & Exchange Commission to conduct Financial Advisory, Fund/Portfolio Management, and Trusteeship business in Nigeria. This document is for information purposes only and for private circulation. No portion of this document may be reprinted, sold or redistributed without the written consent of Vetiva Capital Management Limited. Vetiva research report is disseminated and available primarily electronically, and, in some cases, in printed form. Additional information on recommended securities/instruments is available on request. 211 Vetiva Capital Management Limited. All rights reserved. Please see last page for important disclosures Monthly Economic Note 12 April 211 I Pg. 5

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