Tuesday, December 27, 2016

How Donald Trump Should Transform America's Middle East Policy

Disentanglement will require both farsightedness and political courage.

By Paul R. Pillar
The National Interest
December 27, 2016

THE OBAMA administration’s intended “pivot” to Asia was a valid statement not only about the importance of developments in that region but about the disproportionate attention and resources the United States has expended elsewhere, and especially in the Middle East. An immense share of the blood and treasure the United States has lost overseas in the past couple of decades has been in the Middle East, an expenditure that has not brought proportionate benefits. The net effect on U.S. interests has been, in many respects, negative.

America’s concentration on the Middle East has persisted for a variety of reasons, some of them reflecting the region’s special characteristics and some having more to do with domestic politics or habit. There is oil, of course, which has been a major reason for special attention ever since Franklin D. Roosevelt met with Ibn Saud on an American cruiser in the Suez Canal during the closing months of World War II. As the birthplace of the world’s three great monotheistic religions, the Middle East is connected to the religiously rationalized violent extremism that has preoccupied Washington for the last fifteen years. Old habits dating from the Cold War, of viewing the region as a chessboard for great-power competition, have been encouraged by Russia’s recent activities there. And the attention feeds on itself; much of the hand-wringing over a conflict such as the one in Syria is due not only to admittedly bloody events on the ground but also to hand-wringing that already has taken place and sustains the notion that the conflict is somehow a test of U.S. mettle.

The new U.S. administration will not be able, any more than its predecessors, to formulate policy toward the Middle East from scratch, and it will be subject to the usual tyranny of the in-box. To some extent, devoting substantial attention to leftover problems is commendable. And the United States has broken a lot in the Middle East. Nonetheless, the new administration needs to return to basics and consider, with more care than most current policy debate exhibits, what in the region constitutes U.S. interests and what does not. The very extent of American involvement in the Middle East has implied many objectives (for example, deposing the president of Syria) that come to be mistakenly treated as if they were themselves U.S. interests. Moreover, responsibly devoting attention to what one has broken has too often digressed into treating sunk costs as investments to be actively worked in the hope of somehow getting a positive return—a view often taken toward Iraq, not surprising given the scale of the costs that the United States has sunk there.

A zero-based perspective would identify several important interests in the Middle East, even though collectively they are not commensurate with the U.S. resources that have been devoted to that region. Oil still matters, although in ways that have less to do with domestic consumption than with effects on the global economy. Reducing violent extremism is another legitimate interest in the Middle East, given its ability to physically harm American citizens and property. Although the connection between circumstances on the ground in the Middle East and terrorist threats in the West is routinely overstated, events in the region do inspire attacks elsewhere. The United States has an interest in the losing streak of the so-called Islamic State (ISIS), to dispel any remaining winning image that would help to galvanize would-be radicals in the West.

Curbing weapons proliferation should be among the new administration’s priorities. A regional state whose nuclear program was the subject of much alarm—Iran—has had its program rolled back and any path to a nuclear weapon blocked by a multilateral agreement that went into effect in 2015. The agreement, which includes the most stringent restrictions and most comprehensive monitoring to which any state has willingly subjected its program, provides a model for further nuclear nonproliferation efforts in the region. In the meantime, however, proliferation of conventional weapons is the more serious problem, as punctuated by the scattering of Libya’s arsenal following the overthrow of Muammar el-Qaddafi.

The Middle East’s geographic status as a continental crossroads entails another set of interests, involving military access and transit and including uninhibited passage through the Suez Canal as an ingredient in the global projection of U.S. military power. But means should not be confused with ends. A military presence in the Middle East does not by itself have positive value for the United States—and can prove counterproductive, as reactions to American boots on the ground, with the violent consequences that sometimes have ensued, have demonstrated.

At least as important are the outcomes the United States should not want to transpire. It is in the national interest that no single power come to dominate the Middle East and that, instead, competing players balance against one another. Such balances preclude any single country posing significant threats outside the region and facilitates outsiders, including the United States, freely conducting their business inside it. Fortunately—and unlike East Asia, where a major question is how dominant an increasingly powerful China will become—there is no plausible threat of such a regional dominator emerging in the Middle East. The regional state with the most powerful military and most advanced economy, Israel, throws its military weight around, but will not become the overlord of a largely Arab region. The military strength of the most populous Arab state, Egypt, has rusted away, and the country is seized with economic and other internal problems.

The next most populous state in the region, Iran, also is not a candidate for regional domination, despite ritualistic rhetoric suggesting that it is. It is struggling economically, and its military is not a technological match for the advanced armed forces of the Gulf states, let alone an instrument for regional dominance. With regional conflict increasingly drawn along sectarian lines, the Shia-centered state ideology of Iran is not a basis for hegemony in a Middle East that is mostly Sunni as well as Arab. Nearly four decades after the revolution, Iranian leaders realize as much as anyone else that any hopes they may have once had for similar revolutions in the area have been dashed—with the Arab Awakening not having augmented Iranian influence and in some places, such as Syria, straining it. Such a realization is reflected in Iranian regional policies, which entail the defense of existing regimes (in Syria), including where such defense parallels U.S. efforts (in Iraq). Where Iran is not defending a status quo, it is interfering far less than regional rivals such as Saudi Arabia (in Yemen). It favors change that almost everyone else in the region also favors (in the Palestinian territories).

The United States also has an interest in averting armed conflict that becomes so severe that human suffering escalates and instability and refugees are exported. The basic point to remember is that the ill effects to be avoided flow from armed conflict itself, more so than from any specific outcome of a conflict. The most pressing U.S. interest in the Middle East is to minimize the expenditure of American blood and treasure and avoid actions that stimulate violent reprisals. This concept often gets disparaged as not being a basis for strategy and as nothing more than “don’t do stupid sh*t.” Whether the next administration refrains from doing stupid sh*t will be a big part of whether, four years from now, its policy meets with success or failure.

Some standards used to measure the supposed advance or retreat of U.S. interests in the Middle East should not be. One is democratization, notwithstanding the intrinsic value of popular sovereignty. Apart from providing channels for grievances that might otherwise find more violent and extreme avenues, it has little direct effect on U.S. interests in the region. The very weakness of democracy in the Middle East makes it a poor criterion for favoring some states over others. Tunisia is probably the most democratic country in the region, but it is small and peripheral to the issues that will most engage U.S. policymakers. In Israel and the territories it controls, a well-established democracy operates within the dominant population, but it is a system founded on ethnic and religious distinctions and in which a large subjugated population lacks political rights. Iran has presidential and parliamentary elections that matter and in which the entire population participates, but its democracy is vitiated by the power of unelected elements in the regime to do things such as arbitrary disqualification of candidates. Democracy in Lebanon is constrained by bargains struck by confessional groups, in Egypt, it is a formal facade for rule by a military strongman and, in monarchies such as Kuwait, elected assemblies, where they exist, can be dissolved at the whim of the monarch.

A misleading standard that has come into vogue more recently is treatment of the region in Cold War terms, in which increasing or decreasing Russian activity is equated with U.S. retreats or advances. This conception is flawed. There is no global ideological competition comparable to that between the Soviet Union and the United States. In the Middle East, there is no regional ideological corollary to Nasserite Arab socialism. Russian and U.S. interests in the region are not zero-sum. And besides, any Cold War–style scorecard would show that Moscow’s long-standing position in Syria is about its only direct and long-term presence in the region, and is far more modest than the U.S. positions from Egypt to Bahrain and much else in between.

One of the principal characteristics of the Middle East pertinent to policymaking during the next U.S. administration is the fallout of the Arab Awakening. The region is still trembling from upheaval; hopes for democracy and stability are all but dashed. Objectives of outside powers, including the United States, should be couched in terms not of any grand new direction for the region but rather of limiting damage from what is going on there already. Lines of conflict in the region are at least as complex as anywhere else in the world, with ethnic, religious, national and ideological affinities intersecting in ways that defy efforts to simplify. Oversimplifications represented by such concepts as axes of evil, region-wide lineups of moderates versus extremists or a Russia-Iran-Syria axis as the defining attribute of security problems in the region should be consigned to the garbage.

The Middle East is the scene of serial and recent U.S. military misadventures. The biggest of those misadventures, the 2003 invasion of Iraq, still accounts for much of the regional shaking, having stimulated civil warfare in Iraq, region-wide sectarian conflict and the birth of what became ISIS. The one win on an otherwise losing scorecard—the expulsion of Iraq from Kuwait in 1991—was a response to a situation unlikely to recur during the next few years: naked aggression in which one state swallows another. Policymakers should take this history not as a basis for fear of using the military instrument but rather as a reminder to consider carefully its limitations and side effects before applying it to Middle Eastern problems.

WITH THAT background in mind, the initial principle that the new administration should observe in making policy toward the region is the Hippocratic one of first doing no harm. A second principle is to keep costs and risks commensurate with prospective gains to U.S. interests. A third is to recognize that not all problems, even heart-rending ones, are solvable, and that if they are, the United States is not always best suited to solve them. Often the interests and objectives of other players in the region are better engaged, and this sometimes means taking advantage of the balancing of conflicting interests.

Which brings us to the basic realist tenet that the United States should maximize its leverage and its opportunities by dealing freely with every state in the region, unfettered by habitually applied labels of friend or foe. Doing so is not an abandonment of friends but instead a recognition that every state has some interests that parallel, and some that conflict with, those of the United States. This approach exploits whatever interests of foes parallel interests of the United States, reduces the danger of friends or purported friends becoming tails that wag the dog, and enables the United States to benefit from the game of playing other actors against each other at least as much as the United States is a target of others playing that game.

U.S. policy toward the Middle East should be made with attention not just to addressing immediate problems but to what comes afterward, and what comes after that—the sort of attention that was sorely lacking with the decision to invade Iraq. Policymakers in Washington also need to consider carefully how their actions shape wider perceptions of the United States. Overall U.S. policy toward the Middle East in recent decades, especially including U.S. military activity there, has driven the perception that the United States is anti-Muslim—a perception that fuels violent anti-U.S. extremism and has reverberations beyond the Middle East itself.

THESE PRINCIPLES diverge in some obvious ways from prevailing public and political discourse in the United States about foreign policy. There is a strong tendency to assume that the United States can solve any significant problem overseas if it puts its mind (and its heart and its resources) to it. There is a propensity to think of the Middle East in terms of friends and foes, and of loyally supporting the former while confronting or isolating the latter. Certainly there is a politically driven inclination to think more about immediate situations, and to be seen doing something about them, than to focus on long-term repercussions. In some respects, the biggest challenge to the new administration will be in dealing with the inevitable domestic political opposition. Realistic policy proposals must consider the need to overcome that opposition, while remembering that sound policy cannot cave in to it.

Syria will be a prime subject of the most immediate clamoring for action. But the extremely complicated war—actually, a collection of wars—in Syria is a classic case of a mess with no good solution. Much criticism of current policy has consisted of exasperation over continuation of the deadly mess while giving insufficient attention to the inadequacies and uncertainties of any alternative. The difficulty of trying to pursue a good cause without also aiding bad ones is symbolized on the ground by the cooperation and intermixing of supposedly moderate opposition forces with the local Al Qaeda affiliate.

The United States does not have a significant interest in the political composition of a future regime in Damascus. “Assad must go” slogans should be discarded. The Assads provided the closest thing to stability that an independent Syria has ever known. The only conceivable alternatives in sight would be no better on the stability front and apt to be even less appealing ideologically. Bashar al-Assad will not realize his declared aim of recovering every inch of Syria, but neither is there a resolution of this war in sight that does not leave his regime, with Russian and Iranian backing, with the western spine of the country that it currently controls.

Understandable repugnance over the regime’s brutality should not lead to the heart overriding the policymaking head. Nor should policymakers make the mistake of responding to human suffering by escalating the war. Escalation in the form of a no-fly zone, for instance, should not proceed without better answers than have been provided so far to questions about who does the fighting to maintain whatever situation on the ground a prohibited airspace is supposed to protect. Other questions that need answers involve force-protection requirements and what they mean for the overall scale of any military operation, and the risks of further escalation in the form of direct U.S.-Russia clashes.

The most positive contributions the United States can make regarding the Syrian situation involve multilateral diplomacy that encourages outside players to promote de-escalation and that supports whatever compromises exhausted inside players can accept. Being multilateral means going beyond the U.S.-Russia duopoly that crafted so many failed cease-fires and including Turkey, Iran and the Gulf states. U.S. diplomacy should build on shared interests in not seeing carnage continuing indefinitely, while recognizing relative motivations behind those interests that differ. Like it or not, Russia’s motivation to maintain its decades-old foothold in Syria, even with a client regime that rules only part of the country, is stronger than any corresponding U.S. interest there. The Assad regime’s motivation to continue to exist is stronger still.

The United States, meanwhile, continues to have an interest in the collapse of the ISIS ministate. Reduction of that entity already has enough momentum that the questions facing the new administration will be less about how to speed up that collapse than about cultivating conditions that are not conducive to violent extremism. There is no net gain to U.S. interests if less of ISIS means more of something like the Levant Conquest Front, the renamed Al Qaeda affiliate that has been fighting alongside “moderate” opponents of the Assad regime. In some places, the regime may be the least bad replacement for ISIS, as with the regime’s recapture of Palmyra earlier in 2016.

Next door in Iraq, ISIS will likely be dispossessed of Mosul by the time the new U.S. administration takes office. Specific questions will concern who gets to provide civilian administration over recaptured territory and how to manage what will probably be a lingering counterinsurgency in surrounding portions of northern Iraq. The United States does not have a stake in exactly how the lines of control and responsibility are drawn; it does have an interest in minimizing the infighting among opponents of ISIS that perpetuates instability and conflict in that part of Iraq. Several of the pertinent actors—including Turkey, Kurdish militias and the central government in Baghdad—are friends of the United States, which can use its good offices to reduce the fallout.

The next administration must confront larger issues in Iraq by helping Baghdad stand on its own feet. At the same time, a sustainable, stable Iraq will require a decentralized power structure. The Iraqi government does not face anything like the externally backed challenges to its existence that the regime in Damascus does, and Prime Minister Haider al-Abadi has shown commendable understanding of the need for inclusiveness in governing the country. The United States should use its aid to encourage acting on that understanding, and use diplomacy to encourage others, especially the Gulf states, to support Abadi’s government. An open-ended presence of U.S. troops should not be part of this formula; such a presence does not buy long-term stabilizing habits of inclusiveness, as was demonstrated by the earlier failure of a much larger U.S. troop presence to buy such habits. It instead negates the concept of the regime standing on its own feet and introduces moral hazard by shielding any narrow-minded Iraqi policies from their security consequences.

Taiwan Warns Of Increasing Threat As Chinese Warships Conduct Drill

By J.R. Wu 
December 27, 2016

Taiwan warned on Tuesday that "the threat of our enemies is growing day by day", as Chinese warships led by the country's sole aircraft carrier sailed towards the island province of Hainan through the South China Sea on a routine drill.

The drill comes amid renewed tension over Taiwan, which Beijing claims as its own, following U.S. President-elect Donald Trump's telephone call with the island's president that upset Beijing.

"The threat of our enemies is growing day by day. We should always be maintaining our combat alertness," Taiwan Defense Minister Feng Shih-kuan said on Tuesday.

"We need to strengthen the training (of our soldiers) so that they can not only survive in battle but also destroy the enemy and accomplish the mission," he said.

Feng's remarks were given in a speech at a ministry event marking the promotion of senior military officers.

The Chinese warships rounded Taiwan, passing between the Japanese islands of Miyako and Okinawa and through the Bashi Channel between Taiwan and the Philippines, said Taiwan's defense ministry.

China has given few details of what the Soviet-built Liaoning aircraft carrier is up to, save that it is on a routine exercise.

China's air force conducted long-range drills this month above the East and South China Seas that rattled Japan and Taiwan. China said those exercises were also routine.

China claims most of the South China Sea, through which about $5 trillion in ship-borne trade passes every year. Neighbors Brunei, Malaysia, the Philippines, Taiwan and Vietnam also have claims.

The Pentagon did not directly comment on the latest drill but said that the United States recognizes lawful use of sea and airspace in accordance to international law.

"We continue to closely monitor developments in the region. We do not have specific comments on China's recent naval activities, but we continue to observe a range of ongoing Chinese military activity in the region‎," Pentagon spokesman Gary Ross told Reuters.

In Taipei, a Defense Ministry official said the Liaoning was maintaining a southwest course towards Hainan and not heading deeper into the disputed South China Sea near the Spratly Islands that lie close to the Philippines, Malaysia and Vietnam.

"It is still heading southwest towards Hainan," a senior Taiwanese military official told Reuters, on condition of anonymity.

The official said the carrier had not sailed close to Itu Abu, referring to Taiwan's only holding in the Spratly Islands, and that Taipei continues to monitor its movements.

The Liaoning has taken part in previous exercises, including in the South China Sea, but China is years away from perfecting carrier operations similar to those the United States has practised for decades.

Last December, the defense ministry confirmed China was building a second aircraft carrier but its launch date is unclear. The aircraft carrier program is a state secret.

Beijing could build multiple aircraft carriers over the next 15 years, the Pentagon said in a report last year.

Article Link To Reuters:

Tuesday, December 27, Morning Global Market Roundup: Asia Stocks Mixed In Muted Session, Dollar Recovers Some Losses

By Nichola Saminather
December 27, 2016

Asian stocks were mixed on Tuesday, in thin trade and with little to guide them as most major markets were closed on Monday for Christmas holidays, while the dollar reclaimed its losses from Monday.

MSCI's broadest index of Asia-Pacific shares outside Japan .MIAPJ0000PUS was flat, with Australia and New Zealand closed for a holiday in lieu of Christmas.

Japan's Nikkei .N225 rose 0.3 percent, buoyed by a weaker yen.

China's CSI 300 index .CSI300 was little changed while the Shanghai Composite .SSECslipped 0.2 percent, despite positive data.

The mainland's industrial sector showed stronger profit growth in November, suggesting the economy was improving, but policymakers noted growth was too dependent on a rebound in the prices for oil products and iron and steel.

The Hang Seng index .HSI slid 0.3 percent.

"It is the time of the year when markets trade with hushed tones," Jingyi Pan, market strategist at IG, wrote in a note. "The magnitude of moves could remain capped with thin market trades expected to remain the case."

On Friday, Wall Street closed slightly higher in thin trade.

The 10-year U.S. Treasury yield extended gains by almost 1 percent on Tuesday, more than recovering Monday's losses.

The decline came after data on Friday showed U.S. consumer spending increased modestly in November as household income failed to rise for the first time in nine months. The data suggested the economy slowed in the fourth quarter after growing briskly in the prior period.

Still the slowdown in growth is likely to be temporary, with the labour market near full employment, house prices rising and the stock market rallying close to record highs. Consumer confidence, in addition, is at its highest level since July 2007.

European stocks were little changed on Friday, although banks rose after Deutsche Bank (DBKGn.DE) and Credit Suisse (CSGN.S) settled investigations into U.S. mortgage securities sales, while Italy's government approved a bailout for the nation's largest lender, Monte dei Paschi (BMPS.MI).

"Shares are overbought and due for a bit of profit-taking but moves toward a resolution of bank woes are helping in Europe, global economic data is mostly good and the period around Christmas/New Year is normally positive for shares," Shane Oliver, head of investment strategy at AMP Capital in Sydney, wrote in a note.

The bounceback in U.S. yields boosted the dollar, which also recovered Monday's losses with a 0.3 percent gain to 117.39 yen on Tuesday.

The Japanese currency retreated after data on Tuesday showed the nation's core consumer prices declined for the ninth straight month in November, and that household spending fell even as job availability hit a fresh 25-year high.

The dollar index .DXY, which tracks the greenback against a basket of six global peers, added 0.1 percent to 103.13, half a percent below the highest level since December 2002 hit a week ago.

The euro EUR=EBS was 0.2 percent lower at $1.0435 on Tuesday.

In commodities, oil prices gained on Tuesday, on output cuts by both OPEC and non-OPEC producers that are set to start in less than a week.

U.S. crude CLc1 added 0.1 percent to $53.09 a barrel. Global benchmark Brent LCOc1 was steady at $55.13.

Article Link To Reuters:

Toshiba May Book Big Loss On US Nuclear Acquisition, Shares Plunge

By Makiko Yamazaki
December 27, 2016

Toshiba Corp (6502.T) said on Tuesday it may book a goodwill impairment loss of several hundreds of billion yen on a U.S. nuclear power acquisition made by its Westinghouse division, sending its stock tumbling 12 percent.

Toshiba did not specify a figure in its statement. Potential losses reported by domestic media have ranged from 100 billion yen to 500 billion yen ($850 million to $4.3 billion)

Such a loss would deal another heavy blow to a sprawling conglomerate hoping to recover from a $1.3 billion accounting scandal as well as a writedown of more than $2 billion for its nuclear business in the last financial year.

Toshiba said a board meeting would be held later in the day and any necessary announcements would be made after that.

The potential loss relates to Chicago Bridge & Iron's (CB&I) (CBI.N) nuclear construction business that Westinghouse acquired in December last year for $229 million.

The firms have since clashed over calculations for working capital and who should shoulder potential liabilities related to cost overruns at two delayed U.S. nuclear power plant projects, with CB&I suing Westinghouse after Westinghouse said it was owed more than $2 billion.

Shares in Toshiba were trading down 12 percent in late morning trade after plunging as much as 16 percent at one stage to its lowest in more than a month.

Toshiba, led by new CEO Satoshi Tsunakawa, has positioned its nuclear and semiconductors businesses as key pillars of growth while seeking to scale down less profitable consumer electronics units such as personal computers and TVs.

It has forecast a full-year net profit of about 145 billion yen this financial year, a turnaround from a loss of 460 billion yen, thanks to strong demand for flash memory chips from Chinese smartphone makers.

But any big losses are likely to force Toshiba to boost a capital base that has been weakened by range of restructuring steps taken in the wake of the accounting scandal.

As of the end of September, Toshiba had shareholders' equity of 363 billion yen, or just 7.5 percent of assets, which could fall close to zero if the company is forced to log significant losses.

Tsunakawa, who took the helm in June, has pledged to rebuild trust in the firm and has said he would prioritise beefing up Toshiba's capital base.

Article Link To Reuters:

How JPMorgan Could Not Save Italy's Problem Bank

By Silvia Aloisi, Paola Arosio and Pamela Barbaglia 
December 27, 2016

On the morning of July 29, former Italian Industry Minister Corrado Passera was traveling in a high-speed train toward the medieval city of Siena, racing to meet the directors of the world's oldest bank to present them with a rescue plan.

Monte dei Paschi di Siena, Italy's third-largest lender, was destined to be wound down within months unless it could raise billions of euros and pull itself out of a swamp of bad loans that threatened to swallow up its five centuries of banking.

Passera's recapitalization plan was supported by Swiss investment bank UBS - Monte dei Paschi's long-time adviser - but the former minister was running out of time.

The Tuscan lender had already changed advisory horses - turning away from UBS and Citi, and instead engaging JPMorgan to engineer a survival strategy, according to bankers close to the matter. Its board was meeting that day at its HQ in a 13th-century fortress to decide whether to formally commit to the Wall Street player's plan, they said.

Veteran banker Passera felt he would at least have a chance to make his case. He didn't. As the train reached Florence, about 70 km from Siena, his phone rang. Monte dei Paschi's chairman told him the board would not hear him, according to a source familiar with the events.

The bank had instead pinned its fate on JPMorgan's plan to clear out 28 billion euros ($29 billion) in bad debts and raise 5 billion euros in equity - one that ended in failure in the early hours of Friday when the Tuscan lender said it could not find enough investors and asked the government to bail it out.

For the plan's skeptics, the failure to rescue the bank privately was testament to a misplaced belief in government circles that Italy could find a solution to its banking problem child without the need for a politically unpopular state bailout.

Passera's proposal - never made public - had involved a 2.5-billion-euro capital increase reserved for private equity funds and a 1-billion-euro share sale to existing Monte dei Paschi investors, according to the source familiar with events.

Bankers say that was unlikely to have met with any more success than JPMorgan's, given the lack of investor appetite for Monte dei Paschi and the wider banking sector. Italian banks are creaking under the weight of 360 billion euros of bad loans - a third of the euro zone's total - following the financial crisis.

But the fact the bank laid its entire trust in JPMorgan, and a plan that European regulators in Brussels and Frankfurt said from the outset was destined for failure, nevertheless underscores the government's mismanagement of a problem that continues to cast a shadow over the country and its economy.

Unlike Spain, Rome refused an EU-funded bailout for its banks when European rules for doing so were more lenient, and for too long failed to take decisive action to deal with its lenders' bad loans. Monte dei Paschi, which had already received state aid twice before, has become a symbol of the government's inefficiency in tackling the problems of its banking industry.

Renzi Lunch

Three weeks before Passera's wasted train journey, the idea of a privately funded bailout of Monte dei Paschi was born over lunch in Rome between JPMorgan's global chief, Jamie Dimon, and then Prime Minister Matteo Renzi, according to banking and political sources.

Renzi thought he had finally found the man who would fix one of his biggest political headaches, despite the fact that JPMorgan's plan would involve raising 10 times the market value of Monte dei Paschi, a feat virtually unheard of in Europe.

Renzi, who hails from the bank's home region of Tuscany, wanted to avoid a state rescue at all costs, because new European rules would require investors to bear losses in the event of a tax-payer funded bailout.

The bank's bondholders include tens of thousands of Italians, many of them part of his political power base.

A spokesman for Renzi did not respond to requests for comment.

JPMorgan in turn hoped to break into big Italian deal-making, a sphere where this year it lagged behind U.S. rival Goldman Sachs with its investment banking fees more than halving since 2014, according to Thomson Reuters data.

If the plan succeeded, JPMorgan and its co-adviser Mediobanca, alongside 10 other investment banks and state-sponsored banking fund Atlante, stood to share in fees worth 558 million euros, roughly equal to Monte dei Paschi's market capitalization, publicly available documents show.

By winning over the board of the Tuscan bank, JPMorgan and Mediobanca elbowed out rivals UBS and Citi, all battling to earn a jackpot of fees in a sector that could need 40 billion euros in capital over the next few years.

Monte dei Paschi said on Thursday the banks involved in the failed rescue plan would receive no fees.

Alarm Bells

Alarm bells began ringing loudly over the feasibility of the plan in early September, when Monte dei Paschi abruptly announced its chief executive, Fabrizio Viola, was quitting.

Viola had received a phone call from Economy Minister Pier Carlo Padoan who told him he needed to go, according to a source close to the matter.

Speaking about the episode on TV in October, Padoan said that given the Treasury was the bank's top shareholder following a previous bailout in 2013, it had to have a relationship with its top management. "With Viola, we assessed together what was best for the bank," he said.

After sounding out hundreds of investors during the summer, JPMorgan and other banks involved in the deal believed that a change of management was necessary to pull off the plan, because under Viola the bank had burned through 8 billion euros of new capital, according to sources close to the consortium of banks.

Monte dei Paschi replaced him with Marco Morelli, head of Bank of America Merrill Lynch in Italy, who rushed through a new business plan. He then launched an international roadshow, meeting 280 investors in Europe, the United States and Asia to seek their backing.

The response was muted. One official at a hedge fund who took part in a meeting held at JPMorgan's New York offices described the atmosphere as antagonistic and said the audience was confused by the complexity of the plan.

Desperate to find investors and meet regulatory demands, the bank's board held marathon meetings that often dragged on late into the night as they adjusted their plans and prospectuses, with pizzas and crates of mineral water being brought in.

It was not uncommon for statements to come out in the early hours of the morning. Morelli only managed to grab three hours sleep a night, according to an aide.

The death knell for JPMorgan's rescue sounded on Dec. 4 when Italians effectively cast a vote of no confidence in Renzi, rejecting his constitutional reforms in a referendum. He quit, setting the stage for months of political instability and scaring off potential investors in Monte dei Paschi.

The government crisis effectively sunk the bank's final hope: a 1-billion-euro investment by Qatar's sovereign wealth fund never materialized.

Sources close to the consortium of investment banks said they worked very hard to salvage the deal, but the referendum was the final nail in the coffin.

Article Link To Reuters:

China November Industry Profits Grow Well, But Chance To Sustain Gains Clouded

December 27, 2016

China's industrial sector showed the strongest profit growth in three months in November, suggesting the world's second-largest economy was improving, though policymakers noted gains were too dependent on rebounding prices for oil products, iron and steel.

Industrial profits have had a solid rebound this year after falling last year, boosted by a recovery in commodity prices as supply tightened due to a capacity reduction drive and an infrastructure boom.

Profits in November rose 14.5 percent to 774.6 billion yuan ($111 billion) from a year ago, the highest since August's record 19.5 percent spike, National Bureau of Statistics (NBS) said on Tuesday. Profits in October rose 9.8 percent.

Industrial profits rose 9.4 percent in the first 11 months from a year earlier, up from 8.6 percent in January-October.

"Industrial profits rose relatively fast due to a lower base last year, and the growth was overly reliant on a price rebound in raw material industries such as oil refining, and iron and steel," He Ping, an NBS official, said in a note accompanying the data.

Profits in manufacturing rose 13.7 percent for January-November from a year earlier, while those for the ferrous metal processing industry as well as oil and nuclear fuel refining more than tripled.

Broader Crackdown?

Producer prices rose at the fastest pace in more than five years in November as prices of coal, steel and other building materials soared, boosting industrial profits and giving firms more cash to pay off mountains of debt.

But analysts say recent signals from China's top leaders that more will be done in 2017 to crack down on asset bubbles is putting pressures on raw material prices, casting doubts over the sustainability of such a price rebound.

"The question is whether price rises in recent months resulted from a genuine improvement in demand, or financial speculation," said Zhou Hao, senior economist at Commerzbank.

"From what we are seeing, the leadership apparently thinks it's the latter."

Zhou said the government "might introduce new policy measures to curb raw material price growth."

Chinese steel futures fell sharply on Monday to the lowest level in over a month, as traders took cues from market talk that Beijing may tolerate slower economic growth amid rising debt and an uncertain global environment.

Stable Growth

Tuesday's data covers large enterprises with annual revenue of more than 20 million yuan from their main operations.

China's growth has stabilized this year, with 6.7 percent expansion in gross domestic product in the first three quarters. But corporate debt continues to rise, increasing risks as China looks to push ahead structural reforms.

Firms are seeing more payments being delayed, as accounts receivable at the end of November rose 9 percent from a year earlier. That increase was biggest than the rise in revenue from main operations.

"The difficulty in making repayments is still a relatively large hurdle that limits the production and operation of firms," NBS's He noted.

Tuesday's data also showed Chinese industrial firms' liabilities at the end of November were 5.6 percent higher than at the same point last year, despite rising at a slower pace than assets have.

China's industrial output should grow around 6 percent in 2017, like this year, a state-run newspaper quoted industry minister Miao Wei as saying on Monday.

($1 = 6.9494 yuan)

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Oil Steady In Quiet Holiday Season Trade; Supply Cut Deal To Kick In Jan 1

By Osamu Tsukimori
December 27, 2016

Oil prices were little changed on Tuesday in light pre-New Year holiday trading with markets adopting a wait-and-see stance less than a week before the first output cut deal agreed between OPEC and non-OPEC members in 15 years is scheduled to kick in.

London Brent crude for February delivery LCOc1 was down 1 cents at $55.15 a barrel after settling up 11 cents on Friday. Oil markets were closed on Monday after Christmas at the weekend.

NYMEX crude for February delivery CLc1 was up 10 cents at $53.12 a barrel, after closing at a 17-month high on Friday.

Jan. 1. bring the official start of the deal agreed by the Organization of Petroleum Exporting Countries and non-OPEC members to lower production by almost 1.8 million barrels per day (bpd). The accord is designed to bolster oil prices, squeezed for more than two years by a global supply glut.

"OPEC's output cuts are nearing, but because there's hardly any news on producers, the market is stuck in the doldrums," said Tomomichi Akuta, senior economist at Mitsubishi UFJ Research and Consulting in Tokyo.

While major OPEC members led by Saudi Arabia, will cut production, Libya and Nigeria - exempt because armed conflict has curbed their output - have been increasing production recently, Akuta said.

Libya has boosted production by about 22,000 barrels per day after major western pipelines were reopened and it could add 270,000 bpd within three months, the National Oil Corporation said.

"That raises concerns that despite the coordinated output cuts, the market may not tighten as much," Akuta said.

The U.S. Department of Energy expects to begin sales of roughly 8 million barrels of sweet crude from the country's emergency oil reserve in early to mid-January, according to a notice seen by Reuters on Friday.

Meanwhile Russia's oil exports would rise by almost 5 percent this year to 253.5 million tonnes and a "slight" increase was expected next year, Deputy Energy Minister Kirill Molodtsov said on Monday. Russia is among the non-OPEC countries who signed up to the production cut deal agreed with OPEC.

In China, end-November crude oil stocks fell 1.55 percent from the previous month to 29.89 million tonnes as domestic output shrank and winter demand grew, data from the official Xinhua news agency showed.

Hedge funds boosted bullish bets on U.S. crude oil for a third week in a row to a near 2-1/2 year high, data showed on Friday.

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Oil Producers Turn To Wind Power

European oil companies take on offshore wind projects; a way to diversify and leverage experience drilling at sea.

By Zeke Turner and Sarah Kent
The Wall Street Journal
December 27, 2016

The Netherlands wants to build the world’s largest offshore wind project, and an unlikely company is helping: Royal Dutch Shell PLC.

The oil-and-gas giant is facing shareholder pressure to develop its renewable business. Add in falling construction costs for such projects, and Shell has decided to join a handful of other oil companies aiming to leverage their experience drilling under punishing conditions at sea.

Norway’s Statoil ASA is already building its third offshore wind farm, in the Baltic Sea, and is developing the world’s first floating wind farm off the east coast of Scotland. Denmark’s state-owned Dong Energy AS—once a fossil-fuel champion—is now the biggest player in the offshore wind market.

A Shell-led consortium won a bid this month to build and operate a portion of the Netherlands’ giant Borssele wind project in the North Sea. Once complete, the Shell-built section will generate enough power for roughly a million homes at a price of €54.50 ($56.95) per megawatt hour—a customer rate approaching that of cheaper power sources like coal or gas.

Offshore wind’s competitiveness is highly subject to local power prices and government measures, including tax credits, subsidies and rate guarantees. Nonetheless, in European markets, the wind industry had thought near parity was years away.

“Right now the offshore wind project is competitive with any power source,” said Dorine Bosman, Shell’s manager developing its wind business.

Offshore wind-power projects involve driving steel foundations into the sea floor for towers that support building-size turbines with propellers wider than the wingspan of an Airbus A380. Though historically more expensive to build than onshore wind farms, offshore projects can take advantage of less restricted space and stronger, more consistent winds.

The technological arms race to build these complex projects economically is so heated that many companies, including Shell, won’t disclose how much they are investing, treating their commitments like a trade secret.

Fossil-fuel companies’ push into wind reflects their growing sensitivity to global efforts to limit climate change and how that will affect consumer demand for their main offering: oil and gas.

France’s Total SA wants 20% of its portfolio to consist of low-carbon businesses within the next 20 years. Shell established a new division this year focused on investing in sources such as wind, solar and biofuels. Statoil has a $200 million fund for projects such as wind technology and batteries.

‘It should be the ambition of everybody to not have subsidies.’—Shell executive Dorine Bosman

Investments by big European oil companies in wind and other renewable energy sources remain small—around 2% of their overall capital-spending budgets, according to McKinsey. The industry is cautious about betting big on alternatives after getting burned in the past.

It remains unclear if offshore wind can be a steady moneymaker without government support, which besides tax credits and minimum rates can include guaranteed access to power grids.

“It should be the ambition of everybody to not have subsidies,” Ms. Bosman of Shell said.

Lower costs—brought on by technological improvements, economies of scale and low interest rates—are helping move the sector in that direction. Earlier this year the wind-power industry was targeting a price of €100 per megawatt hour by 2020; subsequently three auctions of project rights this year in the Netherlands and Denmark settled on rates below that level.

Shell previously pulled back from involvement in offshore wind that proved unprofitable and says it will be primarily an oil-and-gas supplier for decades to come. But the improving economics of wind power have prompted the company to dip its toe back in the water, joining others in crowding the heavily subsidized specialists that once dominated the sector.

Dong Energy has sold off a large portion of its fossil-fuels business, including five Norwegian oil and gas fields, and now has 29% of the world’s built offshore wind capacity, according to spokesman Tom Lehn-Christiansen. Goldman Sachs Group Inc. took an ownership stake in Dong Energy in 2014, and the company went public in June.

Statoil has invested $2.1 billion since 2010, or about 20% of a single year’s capital budget, in offshore wind parks. After two years of whipsawing oil prices, offshore wind’s relatively stable prices are dreamlike for oil executives, said Irene Rummelhoff, Statoil’s executive vice president for renewables.

Even Exxon Mobil Corp., which hasn’t put the same emphasis on renewables, has dabbled with the technology, with the idea of using floating wind turbines to help power its offshore oil and gas platforms.

Although solar power is expected to be the fastest-growing renewable energy source over the next five years, the International Energy Agency forecasts offshore wind capacity will triple by 2021. While that will remain below 1% of global capacity, the growth prospects are particularly attractive in regions such as Northern Europe where sunlight is in short supply for half the year.

Japan, China, India and Taiwan are all poised to place bets on offshore wind now that its cost is coming down, according to the industry group Global Wind Energy Council.

In the U.S., President-elect Donald Trump has been skeptical of wind power, warning of its cost, unsightliness and risks to wildlife. However, Texas was a forerunner of onshore wind energy in the U.S. under the watch of former Gov. Rick Perry, Mr. Trump’s pick to lead the Energy Department.

Offshore wind in the U.S. got a boost this month when the country’s first park went online off the coast of Block Island, R.I. Days later, Statoil won a bid for a potential project in the Atlantic Ocean south of Long Island—its first offshore wind lease in the U.S.

Jeffrey Grybowski, CEO of Deepwater Wind, which developed the Block Island project, said the oil companies will face a tougher landscape in the U.S. compared with Europe because of bureaucratic hurdles and fewer incentives.

“We think our competitors are going to have a lot to learn,” he said.

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Shale Specter Haunts OPEC’s Feast As Oil Seen Rallying Into 2017

Energy analysts anticipating price at $58 a barrel in 2017; Could help shale suppliers without resolving OPEC’s challenges.

By Grant Smith and Alex Longley
December 27, 2016

After pulling off the biggest oil-market deal in a decade, OPEC faces a new balancing act in 2017: boosting prices without igniting shale.

The first shale boom spurred a global supply glut that started prices sliding in mid-2014, and was amplified that November by a pump-at-will OPEC strategy aimed at market dominance. During the ensuing rout, prices in New York fell from more than $100 a barrel to $26.05 in February, straining the budgets of companies and countries alike.

Now, the Organization of Petroleum Exporting Countries has a new plan for 2017: Trim output, boost prices and better exploit the world’s most significant natural resource. With the cuts, prices could average $58 a barrel, according to the median of 24 analyst estimates compiled by Bloomberg. While that 29 percent gain on this year’s average will aid OPEC members, it could also spur U.S. drillers to add rigs.

“OPEC is aiming for a much-needed lift to the oil price, given the stretched fiscal balance sheets of every producing nation,” said Ed Morse, head of commodities research at Citigroup. “The question really should be what happens afterwards -- how fast is U.S. shale going to come back?”

At 8.8 million barrels a day, the U.S. is already pumping almost as much crude as two years ago, with just a third of the rigs it operated at the peak, data from Baker Hughes Inc. and the Energy Information Administration show. Since May, drillers have added about 200 rigs, taking advantage of rising prices as talk of an OPEC supply cut circulated.

With OPEC’s oil revenues slumping to $518 billion last year from $956 billion in 2014, the group may have had little choice on the cutbacks. Even Saudi Arabia, the group’s biggest producer, has found itself burning through billions in cash reserves, slashing public-sector wages and tapping bond markets to plug a budget deficit.

The analysts predicting that Brent will average $58 a barrel next year expect $53 in the first quarter and $56 in the second. West Texas Intermediate will be about $1.40 cheaper than Brent in 2017, the estimates show.

Not Enough

Even $58 oil wouldn’t eliminate budget deficits for eight OPEC members assessed recently by the International Monetary Fund. To erase their shortfalls, crude would need to average at least $62 in 2017, according to the IMF.

With the cuts, “OPEC stands to gain a great deal, in terms of revenue enhancement,” said Jan Stuart, global energy economist at Credit Suisse Securities LLC in New York.

Challenges remain. For one thing, compliance with the output agreement. The group’s members “tend to cheat,” former Saudi oil minister Ali Al-Naimi said in a Dec. 2 speech, before the agreement between OPEC and non-members was finalized.

He also expressed skepticism that Russia, considered a wildcard during talks, would follow through on its promise to reduce its output by 300,000 barrels a day. "Will Russia cut?" Al-Naimi asked. "I don’t know. In the past, they didn’t."

Internal Threat

The biggest threat to OPEC’s plan could come from within. Nigeria and Libya got exemptions because conflicts in both countries damaged their output. If each nation reached its potential next year, then their additional barrels would almost wipe out the producer group’s supply cuts.

Iran too didn’t have to make cuts from the same starting point as other OPEC countries. Several years of sanctions lowered its production and revenues from exports and the country argued that it needed the right to make up for that period.

Another challenge could come from the dozens of U.S. drillers who survived the rout by becoming leaner and more efficient.

After three years of turmoil, there are already signs of a rebirth in America’s shale fields as prices have risen and stabilized at around $50. If they jump by another $10, shale output that’s now at 4.5 million barrels a day could quickly rise by 500,000 barrels, Citigroup’s Morse wrote in a Dec. 22 research note.

A bigger boost in prices could mean a million-barrel shale surge from the U.S., Macquarie Research analysts Vikas Dwivedi and Walt Chancellor noted in a Dec. 12 report to clients. That would all but obliterate the cuts OPEC agreed to in November.

Companies such as Continental Resources Inc. and Whiting Petroleum Corp. have already been rewarded by investors, with Continental’s shares more than doubling this year and Whiting’s shares climbing by about 30 percent. U.S. producers are already buying hedging contracts locking in higher prices for next year, according to the Macquarie note, giving them the financial flexibility to grow.

Still, OPEC could have some time to adjust, according to Mike Wittner, head of commodities research at Societe Generale SA in New York. As prices rise, costs may rebound as oilfield service companies seek to rebuild in better times. The result: OPEC’s biggest rivals could struggle to revive output quickly enough to disrupt the re-balancing of the oil market, according to Wittner.

“It’s going to take them a while to gear up,” Wittner said. “The investment’s got to gather pace, the drillers and the fracking contractors also need time. It’s a gradual process.”

Which suggests 2017 may not be the crunch time many expect. That could come in 2018, according to estimates from Oslo-based consultant Rystad Energy. While output including crude, condensate and natural gas liquids will increase by 93,000 barrels a day next year despite the promised cuts, it could jump by almost 10 times that in 2018, and then register similar rates growth through the end of the decade, Rystad estimates show.

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Minority Shareholders Wise Up In 2016

Don’t like the controlling shareholder? Great! There are thousands of firms you can invest in instead.

By Holman W. Jenkins, Jr.
The Wall Street Journal
December 27, 2016

“There ought to be a law” is always somebody’s idea of a solution when corporate governance problems crop up. It’s usually a bad idea, even with the past year’s excess supply of aggrieved minority shareholders.

The great virtue of our corporate system is that investors have thousands of companies to choose from. If a company’s governance or ownership structure aren’t what you think they should be, don’t buy its shares. Caveat emptor, in most cases, is a better regulator than any regulator.

That’s true even in a case like Viacom’s, where the problem was a prolonged squabble over a successor to a possibly incapacitated controlling shareholder. Sumner Redstone, the aged founder, had every incentive to avoid such a problem in the first place. He didn’t. And as uncertainty over his leadership dragged out, Viacom failed to adapt its mediocre and dispensable cable TV networks to the digital age.

Now his daughter, Shari Redstone, is in charge. Shareholders of CBS, another company in which she has an influential stake, have lately worried about being railroaded into a merger with Viacom to suit Ms. Redstone.

To those who say law and regulation should provide a solution, there is one: It’s called steering clear of companies with controlling shareholders if you don’t like the risk.

This applies also to Michael Dell of Dell Computer, whose 2013 management buyout left many shareholders feeling shortchanged. This year he lost a mostly symbolic shareholder lawsuit on the matter, but the case also reaffirmed our basic judgment at the time: Mr. Dell legitimately had his shareholders over a barrel.

Another buyer could have offered a higher price, but Carl Icahn, Mr. Dell’s chief critic, didn’t and neither did anyone else. Maybe potential buyers feared that outbidding a charismatic founder would win them a demoralized and devalued company. Who knows? But it’s not obvious what the solution would be except for investors to be careful when getting in bed with a charismatic founder in the first place.

Shareholders of Tesla last month didn’t like their money being used to bail out another Elon Musk-backed company, Solar City. But Tesla’s share value inordinately depends on Mr. Musk’s reputation as a genius and capitalist conjurer. Now those investors who bought into this story were being asked to chip in for Solar City if that’s what it takes to maintain the Musk bubble. We’d say that’s their lookout.

Ditto a recent lawsuit charging that Facebook founder Mark Zuckerberg was improperly coached when cajoling his board this year to let him maintain voting control as he sells shares to fund his philanthropic efforts. So what? Mr. Zuckerberg already has control so never was going to settle for any terms that don’t leave him in control.

Less easy to justify is expecting shareholders to stomach certain terms struck by CEO Jeffrey Katzenberg in April when he sold DreamWorks Animation to Comcast. He reserved for himself a continuing ownership stake in certain DreamWorks digital ventures. Understandably, in a pending lawsuit, shareholders say they should be compensated for the market value of these rights.

Which brings us to the most uproarious case of all. A declining newspaper industry increasingly makes it affordable for millionaires to strut like billionaires, at least in their hometowns. A one-time dot-com wunderkind, Michael Ferro, put up $44 million in February to buy a controlling stake in the Tribune Co., which owns his hometown Chicago Tribune as well as the attractively Hollywood-adjacent Los Angeles Times.

Almost no sooner than he took control, he found himself fighting a takeover offer from newspaper giant Gannett at a price indisputably alluring to his minority shareholders—63% above the then-market price. But as Gannett tells it, Mr. Ferro saw his dreams of playing kingpin threatened and declined to consider a sale unless he was offered a “piece of the action.” At least that’s what Gannett publicly charges.

Some bits of advice become clich├ęs because they have to be repeated over and over: Trust but verify. Fool me twice, shame on me. These are elements of eternal wisdom that investors can console themselves with when they get on the wrong side of highhanded controlling shareholders.

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