Dubai Crisis, a buying opportunity, only impact could be higher oil prices

The Dubai World debt repayment freeze crisis has hit the world over the last three days and has caused significant damage to the markets over this period. Should this be of any major concern and will it have any lasting impact on the markets, I really do not think so.

I think most people have lost perspective about the scale of the entire problem and the fact that it is not a systematic problem but a localized one. Overall the size of the entire restructuring is not so major relative to what has happened globally last year and in the early part of the current year. In light of multi trillion dollar bailouts given in that period this issue is likely to have a very limited impact and is likely to fizzle out as soon as it came to light.

Even if one takes the issue on merits, the total restructuring/freeze of debt repayments involved is around USD 50-60 billion dollars. As against this it is estimated that the total assets of Dubai World which includes a large amount of real estate and infrastructure investments, its holding in DP World the port operator, its equity holding in both UAE as well as overseas companies is estimated to be worth anywhere between USD 40 to USD 100 billion. Although this range is pretty wide even at the lower end of the asset value the gap is not much and the asset value is at currently depressed asset prices. Secondly it was in any case not a one shot repayment requirement but those spread over a period of the next several years.

The other important factor is that despite all the noise about no support from Abu Dhabi to this company it is very clear that a government owned company will not be allowed to default, specially given that the actual gap in the intrinsic value of the company and its liabilities is not very significant. The other factor is that except for Dubai which underwent a boom mainly on borrowed money and hopes of expatriates coming in and buying property and other assets at abnormal levels, Abu Dhabi continues to boom. At the current estimated run rate of 2.7 million barrels per day and the current oil prices of around USD 75 per barrel the daily oil revenues are in the region of USD 200 million i.e. around USD 72 billion per year. The 2009 budget for Abu Dhabi was a balanced one and had estimated oil prices to be much lower than what they are currently. Althought Abu Dhabi does not speel out the estimate of oil prices for setting the budget, it is estimated that the balanced budget presented for 2009 estimated an average oil price of USD 50-55. As against that the actual average is likely to be around USD 10 per barrel higher which is an additional revenue of over USD 10 billion. As such with no debt on its books and huge asset holdings of various forms whose value is estimated to be in multiples of USD 100 billion of dollars there is no real threat of instability in that region.

A restructuring of the pattern of growth in Dubai was in any case called for as the world has changed a lot since the time Dubai embarked on its growth path and the huge over surplus of real estate in that Emirate will take more than 5 years if not more to get absorbed. Under the circumstances additional investments that were going into further real estate development needed to be controlled and is likely to happen now. Moreover other countries of the region are unlikely to face any crisis as most other countries like Saudi Arabia, Qatar, Kuwait, Oman etc. etc. have their own strengths and have not gone through the kind of overinvestment cycle that we have seen in Dubai. Most of these countries had balanced or surplus budgets for 2009 with an average oil price assumption of around USD 50 per barrel. As such the normal practice of Western analysts of clubbing particular regions together is not really right. This is not a Gulf crisis it is just a small city state of Dubai crisis. At the current crude oil prices most other oil producing Gulf countries are doing well.

I believe that one side effect of this crisis will be that oil prices will move up. So why should this happen, after the crisis came out oil prices actually cracked in a knee jerk reaction. The reason is that most developed countries would not like any new financial crisis to take place. Given the large investments of Western Banks and other companies in the Gulf region they would like these economies to remain stable. As such I believe that there will now be a tacit understanding for oil prices to remain reasonably elevated so that financially these countries remain well positioned. As such oil prices are likely to be in the USD 70-90 per barrel range. They might not go up much above this given the fact that oil consumption demand growth is still subdued.

It is also important from a geopolitical stand point as the stability and prosperity of this region is important for hardliner elements to be kept at bay and moderate regimes to continue in these countries.

In bull markets normally there will not be fundamental reasons for markets to come down. Normally there will be events or news flow which is normally of short duration impact and brings about corrections. I strongly believe that this is again one such opportunity to buy into the markets.

“Many of the biggest and most far reaching investments we make in our lives are investments that have little or nothing to do with money”