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Gas Flaring…

Global Gas Flaring Reduction, (CGFR), is a partnership set up at the 2002 UN World Summit on Sustainable Development. It has recently published data estimates on natural gas regularly burned and released into the atmosphere during the production of oil and gas by the world’s drilling companies. The gas released when crude oil is brought to the surface is known as “associated gas”. This practice is referred to as flaring and venting world flares and vents. According to this survey, 150 billion cubic metres (bcm) of gas per year are flared/vented, of which 20 bcm/year is in Nigeria (13% of world total) and 15 bcm in Russia (10% of world total).

The official figures of CGFR could be underestimated the reality. As a matter of fact, in July 2007 an International Energy Agency (IEA) report released some measurements carried out with the use of satellite imaging. According to this report, Western Siberia only by itself is flaringes 60 bcm/year. To give a benchmark / draw a comparison, France's annual gas consumption approximates 50 bcm/year and the EU25’s gas demand wasd 490 bcm/year in 2005. Therefore, if the IEA report is accurate true, the equivalent of more than 10% of the 25 EU members’ gas demand would be wasted goes to waste in Western Siberia.

According to the official data provided by Russia's Industry and Energy Ministry, the utilization rate for associated gas in Russia has fallen to 73.5% today from 85% ten years ago. The distance of many flaring oil fields from any pipeline infrastructure make investments to cut flaring to curb flaring unviable in Siberia and emerging small producers lack of economic incentives small emerging producers lack the economic incentive to recover associated gas.

The situation is no better in Nigeria, despite the presence of consolidated oil & gas majors. According to Anthony Adegbulugbe, advisor to President Obasanjo, half of the 48 bcm/year of gas produced in Nigeria by International Oil Companies (IOC) continues to be flared.

…and the CO2 Opportunity

Under the Kyoto Protocol, mechanisms allow private investors to voluntarily develop projects that reduce GHG emissions, and be awarded with Carbon Credits (in return for their incremental financial effort), whose market value is driven by the dynamics of the thriving international emission markets. A project to reduce emissions must pass through a rather demanding registration process in order to be considered reckoned by the UNFCCC (the international supervisory authority) as worthy of be granted Carbon Credits,

These projects, known as the Clean Development Mechanism (CDM) and Joint Implementation (JI) projects are unique opportunities to finance investments to reduce gas flaring by selling the carbon credits into the emission markets. CDM & JI procedures can well suit gas flaring reduction projects as:

o They allow considerable flexibility in the final use of the recovered gas (sale or on-site consumption), and

o The volumes of carbon credits might may be significant.

Gas Flaring…

Global Gas Flaring Reduction, (CGFR), is a partnership set up at the 2002 UN World Summit on Sustainable Development. It has recently published data estimates on natural gas regularly burned and released into the atmosphere during the production of oil and gas by the world’s drilling companies. The gas released when crude oil is brought to the surface is known as “associated gas”. This practice is referred to as flaring and venting world flares and vents. According to this survey, 150 billion cubic metres (bcm) of gas per year are flared/vented, of which 20 bcm/year is in Nigeria (13% of world total) and 15 bcm in Russia (10% of world total).

The official figures of CGFR could be underestimated the reality. As a matter of fact, in July 2007 an International Energy Agency (IEA) report released some measurements carried out with the use of satellite imaging. According to this report, Western Siberia only by itself is flaringes 60 bcm/year. To give a benchmark / draw a comparison, France's annual gas consumption approximates 50 bcm/year and the EU25’s gas demand wasd 490 bcm/year in 2005. Therefore, if the IEA report is accurate true, the equivalent of more than 10% of the 25 EU members’ gas demand would be wasted goes to waste in Western Siberia.

According to the official data provided by Russia's Industry and Energy Ministry, the utilization rate for associated gas in Russia has fallen to 73.5% today from 85% ten years ago. The distance of many flaring oil fields from any pipeline infrastructure make investments to cut flaring to curb flaring unviable in Siberia and emerging small producers lack of economic incentives small emerging producers lack the economic incentive to recover associated gas.

The situation is no better in Nigeria, despite the presence of consolidated oil & gas majors. According to Anthony Adegbulugbe, advisor to President Obasanjo, half of the 48 bcm/year of gas produced in Nigeria by International Oil Companies (IOC) continues to be flared.

…and the CO2 Opportunity

Under the Kyoto Protocol, mechanisms allow private investors to voluntarily develop projects that reduce GHG emissions, and be awarded with Carbon Credits (in return for their incremental financial effort), whose market value is driven by the dynamics of the thriving international emission markets. A project to reduce emissions must pass through a rather demanding registration process in order to be considered reckoned by the UNFCCC (the international supervisory authority) as worthy of be granted Carbon Credits,

These projects, known as the Clean Development Mechanism (CDM) and Joint Implementation (JI) projects are unique opportunities to finance investments to reduce gas flaring by selling the carbon credits into the emission markets. CDM & JI procedures can well suit gas flaring reduction projects as:

o They allow considerable flexibility in the final use of the recovered gas (sale or on-site consumption), and

o The volumes of carbon credits might may be significant.

Gas Flaring…

Global Gas Flaring Reduction, (CGFR), is a partnership set up at the 2002 UN World Summit on Sustainable Development. It has recently published data estimates on natural gas regularly burned and released into the atmosphere during the production of oil and gas by the world’s drilling companies. The gas released when crude oil is brought to the surface is known as “associated gas”. This practice is referred to as flaring and venting world flares and vents. According to this survey, 150 billion cubic metres (bcm) of gas per year are flared/vented, of which 20 bcm/year is in Nigeria (13% of world total) and 15 bcm in Russia (10% of world total).

The official figures of CGFR could be underestimated the reality. As a matter of fact, in July 2007 an International Energy Agency (IEA) report released some measurements carried out with the use of satellite imaging. According to this report, Western Siberia only by itself is flaringes 60 bcm/year. To give a benchmark / draw a comparison, France's annual gas consumption approximates 50 bcm/year and the EU25’s gas demand wasd 490 bcm/year in 2005. Therefore, if the IEA report is accurate true, the equivalent of more than 10% of the 25 EU members’ gas demand would be wasted goes to waste in Western Siberia.

According to the official data provided by Russia's Industry and Energy Ministry, the utilization rate for associated gas in Russia has fallen to 73.5% today from 85% ten years ago. The distance of many flaring oil fields from any pipeline infrastructure make investments to cut flaring to curb flaring unviable in Siberia and emerging small producers lack of economic incentives small emerging producers lack the economic incentive to recover associated gas.

The situation is no better in Nigeria, despite the presence of consolidated oil & gas majors. According to Anthony Adegbulugbe, advisor to President Obasanjo, half of the 48 bcm/year of gas produced in Nigeria by International Oil Companies (IOC) continues to be flared.

…and the CO2 Opportunity

Under the Kyoto Protocol, mechanisms allow private investors to voluntarily develop projects that reduce GHG emissions, and be awarded with Carbon Credits (in return for their incremental financial effort), whose market value is driven by the dynamics of the thriving international emission markets. A project to reduce emissions must pass through a rather demanding registration process in order to be considered reckoned by the UNFCCC (the international supervisory authority) as worthy of be granted Carbon Credits,

These projects, known as the Clean Development Mechanism (CDM) and Joint Implementation (JI) projects are unique opportunities to finance investments to reduce gas flaring by selling the carbon credits into the emission markets. CDM & JI procedures can well suit gas flaring reduction projects as:

o They allow considerable flexibility in the final use of the recovered gas (sale or on-site consumption), and

o The volumes of carbon credits might may be significant. ------------------------------------------------------------------------------------------------------------

Risk and Liquidity: An Update

by xxx and xxx, Economic Research - Fixed Income

Policy rates, although considerably tighter than a year ago, do not seem especially restrictive by historical standards.

Whilst there is some evidence of a moderation in narrow liquidity, with knock-on effects to some riskier assets, broad liquidity growth remains strong.

In this environment, levels of risk appetite remain supportive, expected asset price volatility is low, and risk continues to be priced cheaply.

As inflation falls and real rates start to climb above neutral in advanced economies, we expect broad liquidity and risk appetite to fall, leaving prices of other risky assets increasingly vulnerable.

Policy rates, although considerably tighter than a year ago, do not seem especially restrictive by historical standards.

Anecdotal evidence suggests that liquidity is less plentiful in some segments of the market bearing down on some of the riskier assets, but broad liquidity growth remain strong.

In this environment, levels of risk appetite remain supportive of equity valuations as expected asset price volatility remains low and investors continue to price risk cheaply.

As inflation falls and real rates start to climb above neutral in mature economies, we expect broad liquidity and risk appetite to fall, leaving prices of other risky assets increasingly vulnerable.

Global monetary conditions unrestrictive

Since the end of 2003/beginning of 2004 when interest rates in the principal developed economies bottomed out, policy rates have been progressively tightened. However, while the average interest rate across advanced economies has more than doubled since end-2003 (Chart 1), by many measures the current monetary conditions do not seem especially restrictive.

This is evident in our proprietary FMCI (see Market Mover 5 January 2007) and real rate measures (Market Mover 13 October 2006), but it is also clear in the current levels of global liquidity growth. In this environment, levels of risk appetite remain supportive, expected asset price volatility is low, and risk continues to be priced cheaply.

Global monetary conditions unrestrictive

Since the end of 2003/beginning of 2004 when interest rates in the main developed economies bottomed out, interest rates have been progressively tightened. However, while the interest rate across mature economies have more than doubled since the end of 2003 (Chart 1), the current monetary conditions do not seem especially restrictive by many measures.

This is confirmed by our proprietary FMCI (see Market Mover 5 January 2007) and real rate measures (Market Mover 13 October 2006), but it also bears out in the current levels of global liquidity growth. In this environment, levels of risk appetite remain supportive, expected asset price volatility is low, and risk continues to be priced cheaply.

Narrow money growth is still contracting…

Since its growth turned negative last July (Chart 2),the stock of advanced economy narrow money has continued to contract. While the principal drag remains the contraction of the Japanese monetary base, the ongoing moderation of growth in the monetary base of the UK, eurozone and the US, since the spring of last year, has also contributed. Given the stabilisation in the rate at which the rest of the world is accumulating foreign exchange reserves, this sharp fall has translated into a steady trend down in global narrow liquidity growth.

Narrow money growth is still contracting…

Since its growth turned negative last July (Chart 2), the measures of narrow money in mature economies have continued to contract. The principal drag remains the contraction of the Japanese monetary base, but since the spring of last year the ongoing moderation of growth in the monetary base of the UK, the Euro zone and the US, have also contributed. Given the stabilisation in the rate at which the rest of the world is accumulating foreign exchange reserves, this sharp fall has translated into a steady downward trend in the growth of global narrow liquidity.

The discrete cut in the Japanese money stock associated with the end of quantitative easing will drop out of the y/y comparison soon. If the advanced economy narrow money stock were to remain at its current levels, this base effect will push its growth rate back up close to zero by the spring.

But the continued moderation of narrow money growth elsewhere either because of slowing growth (US) or the ongoing tightening of monetary policy (UK, eurozone) will leave narrow liquidity growth depressed over the course of this year.

The separate / distinct cut in the stock of Japanese money associated with the end of quantitative easing will drop out of the y/y comparison soon. If the mature economies’ narrow measures of money were to remain at their current levels, this base effect would push their liquidity growth rate back up towards zero by spring.

But the continued moderation of narrow money growth elsewhere, because of softer US growth or the tightening of monetary policy in the UK and the Euro zone will lead to a slackening of the growth of narrow liquidity this year.

…with important implications for the prices of

some riskier assets

The contraction in narrow liquidity appears to have had a powerful impact on a number of riskier assets. For example, the recent heavy sell-off in crude oil prices is consistent with the sharp contraction in narrow liquidity that began in the middle of last year (Chart 4). Intuitively, as excess liquidity sloshes its way around the system, it will find its way into speculative investments, including commodities.

…with important implications for the prices of

some riskier assets

The contraction in narrow liquidity appears to have had a powerful impact on a number of riskier assets. For example, the recent heavy sell-off in crude oil prices is consistent with the sharp contraction in narrow liquidity that began in the middle of last year (Chart 4). Intuitively, as excess liquidity sloshes its way around the system, it will find its way into speculative investments, including commodities.

Similarly, after a remarkably tight relationship for a number of years, we warned in last July’s update of the detachment between base metal prices and liquidity fundamentals. The subsequent decline in metal prices – including a 30% fall in the copper price since last summer – represents a correction back towards levels more consistent with liquidity fundamentals.

Similarly, after a remarkably tight relationship for a number of years, we warned in last July’s update of the detachment between base metal prices and liquidity fundamentals. The subsequent decline in metal prices – including a 30% fall in the copper price since last summer – represents a correction back towards levels more consistent with liquidity fundamentals.

But broad liquidity growth remains elevated

Broad liquidity growth also dipped in the spring last year as the discrete moderation in Japanese narrow money growth spilled over into broad money with a short lag (Chart 3). However its deceleration was nowhere near as dramatic (Japanese broad money growth remained positive), and without a parallel moderation in broad liquidity growth in the other principal economies, its growth rate quickly stabilised at a relatively high level.

But broad liquidity growth remains high

Broad liquidity growth also dipped last spring as the moderation in Japanese narrow money growth spilled over into broader money measures with a short lag (Chart 3). However its deceleration was nowhere near as dramatic (Japanese broad money growth remained positive), and without a parallel moderation in the other principal economies, broad liquidity growth rates quickly stabilised at a relatively high level.

Advanced economy broad liquidity growth therefore remains stubbornly elevated, in striking contrast with the contracting narrow money stock. As a result, the money multiplier (the ratio of broad to narrow money) across advanced economies has picked up sharply from a low of less than 9 to close to around 10 by the end of 2006. Once again, this development primarily reflects Japanese liquidity developments (and to a lesser extent a notable up tick in the multiplier in the US). Divergent movements in broad and narrow liquidity are suggestive of increasing risk and leverage in the system.

Mature economies’ broad liquidity growth therefore remains stubbornly high, in striking contrast with the contracting narrow money stock. As a result, the money multiplier (the ratio of broad to narrow money) across advanced economies has picked up sharply from a low of less than 9 to close to around 10 by the end of 2006. Once again, this development primarily reflects the Japanese liquidity scenario (and to a lesser extent a notable up tick in the multiplier in the US). Divergent movements in broad and narrow liquidity are suggestive of increasing risk and leverage in the system.

Superficially, this level of liquidity creation may seem to suggest that capital markets are becoming too frothy. And this rise in the ratio may be understating developments given the difficulties in quantifying the activities and leverage of hedge funds. However,although some recessionary episodes in some countries have been preceded by a tick up in the money multiplier, the relationship is far from perfect. This is perhaps unsurprising given the clear influence of both economic activity and financial innovation on the ratio.

Superficially, this level of liquidity creation may seem to suggest that capital markets are experiencing froth. And this rise in the ratio may be understating developments given the difficulties in quantifying the activities and leverage of hedge funds. However, although some recessionary episodes in some countries have been preceded by an up tick in the money multiplier, the relationship is far from perfect. This is should not be surprising given the clear influence of both economic activity and financial innovation on the ratio.

Risk appetite remains supportive

In the context of these high levels of broad global liquidity, risk appetite remains supportive of asset prices, and financial markets continue to expect low levels of volatility. The BNP Paribas measure of risk appetite (RAPS) stands at 52.9 for end-December 2006 and so is broadly at par (Chart 5).

Risk appetite remains supportive of global asset prices

In the context of these high levels of broad global liquidity measures, risk appetite remains supportive of asset prices, and financial markets continue to expect low levels of volatility. The BNP Paribas measure of risk appetite (RAPS) stands at 52.9 at the end of December 2006 and so is broadly at par (Chart 5).

Chart 5 shows that VIX volatility has shown no discernable trend since 2005 and remains at relatively low levels. Thus, expected financial market volatility looks limited as the supply of bank and nonbank liquidity has driven the price of risk downwards. Correspondingly, risk appetite remains near its par level (which may be viewed as consistent with real rates being close to ‘normal’) despite the ongoing risks of a global economic slowdown stemming from the US.

Chart 5 shows that VIX volatility has shown no discernable trend since 2005 and remains at relatively low levels. Thus, expected financial market volatility looks limited as the supply of bank and non bank liquidity has driven the price of risk downwards. Risk appetite which may be viewed as consistent with real rates being close to ‘normal’neutral remains close to par despite the ongoing risks of a global economic slowdown stemming from the US.

The prolonged period of expansionary US policy from 2001 to 2006 has created a cycle in risk appetite (Chart 6). Low policy rates over 2001-4 led to a sharp increase in risk appetite from its September 2001 lows. But the gradual and elongated tightening cycle from 2004 to 2006 first brought about a sharp fall in risk appetite and then a stabilisation back to par, as it became clear that US rates had peaked at 5.25%.

The prolonged period of expansionary US policy from 2001 to 2006 has created a cycle in risk appetite (Chart 6). Low policy rates from 2001 to 2004 led to a sharp increase in risk appetite from its September 2001 lows. But the gradual and protracted tightening cycle from 2004 to 2006 first brought about a sharp fall in risk appetite and then a stabilisation back towards par, as it became clear that US rates had peaked at 5.25%.

Conclusion

High levels of global liquidity and par levels of risk appetite mean that risky assets continue to have considerable support. But, as we have noted, tighter monetary conditions, which first effect narrow liquidity, have already impacted on commodity prices such as oil. As inflation falls and real rates start to climb above neutral in advanced economies, we would expect broad liquidity and risk appetite to fall leaving prices of other risky assets increasingly vulnerable. Indeed, statistically, we have found there is fairly strong evidence that growth in narrow liquidity ‘causes’ broad money creation at a later date.

Conclusion

High levels of global liquidity and risk appetite that hover around par mean that risky assets continue to be well supported. But, as we have noted, tighter monetary conditions, which first effect narrow liquidity, have already born out on commodity prices such as oil. As inflation falls and real rates start to climb above neutral in mature economies, we would expect broad liquidity and risk appetite to fall leaving prices of other risky assets increasingly vulnerable. Indeed, statistically, we have found there is fairly strong evidence that growth in narrow liquidity ‘causes’ broad money creation at a later date.

[1] United States’ First Secretary of the Treasury.