OPEC's Oil-Price Line in the Sand

Oct 7, 2006 (Dow Jones Newswires from the Wall Street Journal)

OPEC announced Thursday that it intends to steady the oil price at something like the current level of about $60 a barrel. It may be able to defend this level in the months to come, but over the long haul this effort is doomed.

It certainly sounds ambitious by the standards of two years ago. The price then was $45 a barrel, and most experts and exporters thought that was too high to last. But experience changes standards. After more than a year of $60-plus prices, the level seems more plausible.

Plausibility matters, because the price defense is going to require some production cuts, at least for the short term. OPEC needs a target that its swing producers, especially Saudi Arabia, are willing to defend. Otherwise the group won't be able to stop squabbling over who should take the pain. At least for now, it looks like the will to succeed is there.

There are other trends working in OPEC's favor. The balance of supply and demand is still pretty tight. Although higher prices have slowed demand growth, the direction remains positive. That's largely because of the emerging markets, which accounted for 90% of incremental demand growth in 2005. And while new sources of oil eventually will come onstream, it's a slow process. For the moment, OPEC members control marginal supply. Outside of the cartel, production hasn't budged since 2004.

Second, financial conditions remain supportive of a high oil price. Low real interest rates and the recycling of petrodollars by oil exporters have mitigated the pain of higher oil prices. American households have blithely borrowed to fill the tanks of their SUVs.

But OPEC faces one huge obstacle. The cost of producing oil is much less than $60. Even Canadian oil sands, which require expensive and energy-intensive processing, are profitable at something like $50. Eventually, the lure of profits will bring on new supply, damping the price.

Fortress Within

WALL STREET firm Morgan Stanley is hunting for a hedge fund manager. FrontPoint Partners, with whom it danced in the past, might be a good fit. But there are more ambitious targets to consider, such as Fortress Investment Group.

The Wild West era of the alternative asset-management industry is coming to a close. As a result, its practitioners are considering ways to cash out and grow like any normal business. Their options include going public and selling to bigger financial institutions.

But the first avenue looks more difficult today than it did just a few months ago. The implosion of Amaranth Advisors, troubles at other big funds like Vega and continued middling performance across the industry are making investors wary of the industry. RAB Capital, for example, a U.K.-listed hedge fund manager, has seen its stock plunge by a third in the past month. Even a Fortress, with $24 billion in hedge-fund and private-equity vehicles, would find it difficult to withstand these market pressures.

That may be one reason the firm has yet to file for an IPO despite months of contemplation. At RAB's valuation of 15% of assets under management, Fortress would be worth about $4 billion. But to Morgan Stanley, Fortress might be worth more. It would jump-start the Wall Street firm's attempts to gain a foothold in hedge funds and private equity, where it considerably lags behind chief rival Goldman Sachs. The two sides know each other a bit: top Fortress and Morgan Stanley honchos dined last week.

Of course, to entrepreneurs, going public and selling out aren't interchangeable outcomes. But a flirtation with the public markets is clearly a step closer to the exit than sitting still. Morgan Stanley has gotten its mojo back of late. Its stock price is up, risk-taking is being rewarded and talent has returned to the firm. To complete the turnaround, it needs to build a fortress in asset management. It might be quicker to buy one.

Private-Equity Eye?

THE BLOW-UP of Amaranth and a few cases of outright fraud have spurred calls for more oversight of hedge funds. Private equity, however, which has also attracted billions of dollars of pension money in recent years, has largely avoided the regulators' spotlight. Still, it may only take a few buyout scandals for this to change.

Like hedge funds, larger private-equity managers have to register with the SEC as investment advisers. But small buyout funds avoid all scrutiny. And even the registered funds have minimal disclosure requirements. Yet the private-equity world is growing rapidly. Investors have poured $172 billion into 253 funds in the U.S. so far this year, according to Dow Jones Private Equity Analyst (a publication owned by Dow Jones & Co., publisher of The Wall Street Journal). With all that money sloshing around, it would be surprising if there were no bad eggs.

AA Capital, a $194 million fund that was spun off from the Dutch bank ABN Amro in 2001, could be one. The Securities and Exchange Commission has accused the fund of misappropriating nearly $11 million of its clients' cash. The SEC complaint charges that the firm's president, John Orecchio, put some of this money into a Michigan horse farm and slipped a wad to the manager of a Detroit strip club. Calls to AA Capital weren't returned.

Questionable use of limited partners' funds may not be the only type of abuse going on in private equity. There could also be inaccurate valuations. The longer lock-up periods and lack of a market price for private-equity investments make that relatively easy to practice and hard to detect. Some buyout firms are no doubt pushing the envelope when it comes to valuing portfolios. It's even conceivable that the increasing number of transactions between buyout funds have led some to swap favors in order to boost reported returns.

The leading private firms have lobbied hard to avoid getting caught up in hedge-fund regulation. These efforts could be thwarted if there's any more mischief among the minnows of their industry.

Copyright (c) 2006 Dow Jones & Company, Inc.


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