Saudi Arabia has been the traditional voice of price moderation and long-term stability in the global oil market, given that it has the world’s highest long life reserves and lowest cost of production of crude oil. In the 1980’s and 1990’s, under successive oil ministers (Sheikh Ahmed Zaki Yamani, Hisham Nazer, Ali Al Naimi), the kingdom acted as OPEC’s swing producer, the defacto central bank of oil, to prevent price spirals and defuse supply shocks. So Saudi Arabia raised its output by millions of barrels when the Iranian revolution erupted in 1979, when Iran and Iraq waged a “tanker war” in the Gulf in 1987, when Saddam Hussein invaded Kuwait in 1990. Saudi Arabia knew that a global recession would be catastrophic for oil demand and did its best to stabilize prices in a range that would not harm the West and Asia’s industrial constellations. Even though Venezuela, Libya, Algeria, Iraq, Iran and even Brezhnev’s USSR bitterly contested Saudi Arabia’s oil price moderation, the kingdom’s geopolitical and strategic allies in OPEC were the UAE and Kuwait. This was as true in 1976 when OPEC had a two-tiered price structure as in 2018 when the UAE and Kuwait have the highest compliance rate in the Saudi-Russian brokered OPEC output deal.
Saudi Arabia did not hesitate to flood the global markets with black gold to enforce quota discipline in OPEC or punish rivals for geopolitical supremacy in the Gulf. In 1986, Saudi Arabia abandoned its role of “swing producer” and ramped up its own output by 2 million barrels a day to punish quota cheating by Nigeria, hedge against Britain’s North Sea oil exports and punish revolutionary Iran and the Soviet Union, then in military occupation of Afghanistan. Oil prices crashed to $8 in 1986. A generation later, Saudi Arabia abandoned its role of “swing producer” in November 2014 and Brent crude prices plummeted from $115 in June 2014 to $28 by early 2016. It is financial suicide for any global investor not to have a nuanced, real time grasp of the kingdom’s oil pricing and output strategy. Decisions made in a palace in Riyadh or a luxury hotel in Vienna can trigger shock waves on Wall Street and the world financial markets.
The oil crash cost Saudi Arabia at least $300 billion in lost revenues and epic fiscal pain. Yet the kingdom has restored its primary in OPEC, led to a rise in Brent crude from $28 to $64 in the past two years and slashed the bloated global oil inventories to normal levels. Saudi Arabia also coordinated its oil output cut strategy with Russia, even though the Kremlin and the House of Saud backed opposing sides in the Syrian civil war.
Saudi Arabia wants Brent crude to trade higher than $60 to finance the most expansionary State Budget in the history of the kingdom, kick start the Vision 2030 economic reforms, rebuild its sovereign wealth fund reserves and privatize the state-owned energy crown jewel Saudi Aramco. This means Saudi Arabia will not be a price dove in 2018 even as synchronized global growth boosts petroleum demand and the OECD inventory surplus plunges from 340 million barrels in June 2017 to barely 60 million barrels now. The military escalation between Israel and Iran in the skies above Syria thus threatens to create a geopolitical “supply shock” in the market at the precise time as global inventories are tightening. This is not October 1973, January 1979, August 1990 or March 2003 in the Middle East but I believe we are on the precipice of a potential price spiral in Brent crude that Saudi Arabia will not defuse on the eve of the Saudi Aramco IPO. The cognoscenti in the wet barrel (oil tanker) market in London tell me that Saudi Oil Minister Khalid Al Falih wants Brent crude at $70, not $60 any longer. This insight, if true, is a game changer for international energy and financial market.
No less than 24 oil producers have signed the Saudi-Russia oil cut deal. The global oil glut is now kaput. Brent at $70 – 75 means a higher valuation for the Saudi Aramco IPO, a more successful Vision 2030 reform agenda and lower pain of fiscal austerity. Yet every oil boom contains the seeds of its own destruction in 2018. Why? The Permian Basin in Texas, a geological prize as epic in scale as Burgan or Ghawar mega oil fields in the Arabian desert. After all, US shale is the planet’s marginal supplier of black gold in 2018.
Macro Ideas – Macro strategies in Southeast Asian financial markets
2017 was all about a beta play in Asia. After all, Chinese equities were up more than 50% and the MSCI Asia ex Japan index delivered a stellar 45% return. 2018 is an alpha story – it is necessary to be nimble, to time market entry and exits in select currencies, countries and sectors. Here is a snap shot of my ideas du jour in Asian currencies and equities.
The Indian rupee can well depreciate to 66 against the US dollar given the rise in oil prices, wider current account deficit, lower real rupee interest rates and the RBI’s reluctance to significantly raise foreign investment limits on Indian G-Secs. Domestic demand and higher commodities prices mean the current account deficit can well deteriorate to 2.5% in the next fiscal year even as higher inflation compresses real rupee yields. A bloodbath in the global debt market means an inevitable offshore capital exodus from Dalal Street and a weaker rupee.
Vietnam was one of the world’s best performing volatility adjusted frontier markets in 2017, with Argentina and Ghana. There is no doubt that the Southeast Asia tiger on the Mekong Delta has captured the imagination of the world’s fund manager, even if the nation is still ostensibly a Marxist Leninist one party communist state. Despite the significant rise in crude oil prices since last June, Vietnam exhibits exhibits the best economic fundamentals since its WTO application era in 2006. A stable Vietnamese dong, a government committed to restructuring state owned banks and companies, low local interest rates, major FDI investments by US, Japan, China and South Korean companies, strong demand growth and a productivity growth that dampens inflation.
Vietnam’s stock market is not cheap at 18 times earnings yet its largest banks and consumer shares can well deliver 16 – 20% earnings growth in 2018. I can easily envisage the best growth prospects among Vietnam’s large cap banks, mobile phone companies, food producers and oil/gas companies.
I believe investors should slash exposure to Philippines. There is no doubt that the Manila central bank (BSP) will be forced to tighten monetary policy to combat inflation in the most local liquidity dependent major stock market in ASEAN. Excessive credit growth, a fall in the peso and the central bank’s ill-judged cut in the reserve requirement ratio has set the stage for a surge in the inflation rate and a potential liquidity shock that will lead to at least a 15 – 20% hit in the stock market. The rise in the Volatility Index (VIX), crude oil price and US Treasury bond yields on Wall Street will dampen foreign investor interest in high beta, highly valued emerging stock markets like the Philippines in any case. There is also a glut of secondary debt and equity issuance in the local stock market that does not bode well for returns in 2018.
I am partial to industrial metal and commodities shares in Asia as inflation’s resurgence will trigger a sector rotation to hard asset themes. Historically, the best time to own industrial metal shares is when inflation exceeds the Federal Reserve’s 2% limit and begins to accelerate in late stage of a global macroeconomic cycle. This is even more true when synchronized global growth accelerates and new applications (electric vehicles?) boost the demand for industrial metals like copper and even silver.
Thailand is one of Asia’s most attractive consumer growth and manufacturing economies (the Detroit of Asia) though the SET index is dominated by oil and gas companies and major banks. There is no doubt that Fed rate hikes and higher US Treasury bond yields will lead to foreign funds outflows from the kingdom of Siam, given the current high valuations in Bangkok large caps. Yet robust earnings growth and pricing power make me positive on Siam Cement and Bangkok Chain Hospital after the correction.
A weaker US dollar and 6.9% GDP growth in China was a steroid shot for Southeast Asian emerging market in 2017. So regional market could suffer if the US dollar rises on Fed rate hikes or Chinese growth stalls. Thailand, Indonesia and Malaysia elections will raise political risk. India’s fiscal slippage and banking corruption crisis are also a tangible risk. China’s takeover of Anbang insurance proves that financial risk is rising alarmingly in the Middle Kingdom. Does this mean Asian contagion in 2018?
