Saudi Investment Fireworks

In my most recent blog entry I focused on the pressure being exerted on the Kingdom of Saudi Arabia by credit default swap (CDS) investors.  No surprise that the Saudi CDS rates continue to rise, as the probability of Saudi Arabia not meeting sovereign debt obligations continues to rise.

As the screws turn tighter on Saudi leaders to come up with solutions in the midst of soft petroleum markets, the Kingdom is tapping into old fashioned Western style financial instruments and manipulative strategies to help maximize Saudi crude assets.

In the past Saudi Arabia was able and was comfortable controlling crude market pricing by either increasing or decreasing production.  The US shale producers are making that simple tool much more difficult to administer as futures markets over react driving price points well beyond Saudi targets.

Meanwhile civilian strife or potential thereof is adding flames to the budget heat.

As reported by CNBC reporter, David Johnson:

"Saudi Arabia is somewhere in between: a stable nation with a sizable backup of reserve assets, somewhere around $624 billion as of December.  But much of that stability is bought with government jobs and generous public spending and with falling oil prices, the country has had to dip into its reserve assets to make up the difference.

Of course, the analysis depends on no major economic changes or events affecting Saudi Arabia. It also assumes oil prices remain low, which experts consider likely for the time being.

Looking at the country's finances in August, when oil swung between $48 and $41 a barrel. It had fallen a long way from its highs of $65 a barrel a few months before, but our lower estimate for its direction was way off. At the time, CNBC estimated the Saudis would be broke in August 2018, yet that was based on oil at $40 a barrel and before the Saudis cut public spending. 

The 2016 Saudi budget includes a spending cut of 13.8 percent from 2015 levels, though projections from Barclays puts that cut closer to 5 percent. Even so, the country is expected to reach a budget deficit of 12.9 percent of GDP in 2016, according to the investment bank."

That’s why the Kingdom may be considering to use an unconventional weapon in the oil war, which is to break the riyal ‘s peg against the US dollar. In other words, let the riyal fall.
That will make Saudi oil less expensive in global markets, help the country regain its market share in the US, and finish up the war against American frackers.

A weaker riyal will further help Saudi Arabia execute on its new strategy of producing and exporting refined products.
The problem is that this weapon may backfire and hurt Saudi Arabia’s economy. The prospect of a lower riyal, for instance, could cause a capital flight. And it could fuel inflation soon after it takes place, widening the Kingdom’s social budget deficit.

Saudi Arabia will be pulling out all the stops with its newly announced emphasis on sovereign equity fund investments, going public with a 5% equity of Saudi Aramco and currency manipulation tactics. 

Risky stuff.   Keep on your toes as the Saudi financial fireworks begin lighting up the volatile energy markets.

Will Saudi Arabian CDS Spreads Pressure the Kingdom to Cry Uncle Again

   
November 28, 2014 was the day that rocked the energy complex off its moorings. Tremors and aftershocks continue into 2016 as energy market participants struggle to understand the future of an unhinged market.

The hinge came off when Saudi Arabia announced it was no longer willing to be the price stabilizer for crude, rejecting cries from OPEC member countries to lower crude oil production.

Saudi Arabia blocked calls from poorer members of the OPEC oil exporter group for production cuts to arrest a slide in global prices, sending benchmark crude plunging to  four-year lows.

Brent oil fell more than $6 to $71.25 a barrel after OPEC ministers meeting in Vienna left the group's output ceiling unchanged despite huge global oversupply, marking a major shift away from its long-standing policy of defending prices.

This outcome set the stage for a battle for market share between OPEC and non-OPEC countries, as a boom in U.S. shale oil production and weaker economic growth in China and Europe have sent crude prices tumbling.

"It was a great decision," Saudi Oil Minister Ali al-Naimi said as he emerged smiling after around five hours of talks.  

The jury is still out on whether this was a great decision for Saudi Arabia.  They are rapidly losing desperately needed oil revenues. Increased domestic expenses along with the war with neighboring Yemen is posing increased budgeting stress. “This war is draining the Saudis militarily, politically, strategically,” said Farea al-Muslimi, a Yemen analyst at the Beirut-based Carnegie Middle East Center.
“The problem is, they’re stuck there.” 

Saudis have been busy cutting domestic spending and raising taxes to cope with the lower oil revenues. Not a good recipe for a country whose people have never been good at 
accepting austerity measures.

The ratings agencies are starting to take notice. Standard Poor's Ratings Services in October lowered Saudi Arabia's long-term foreign currency sovereign credit rating to A+ from AA-, citing a widening budget deficit resulting from weaker oil prices. The ratings agency projected the country's fiscal shortfall will jump to 16% of gross domestic product in 2015  from 1.5% in 2014. S&P said it expects Saudi Arabia to draw down its fiscal assets and issue debt to finance its deficit, though the country does not have much monetary-policy flexibility given the riyal's peg to the U.S. dollar. "The outlook remains negative, reflecting the challenge of reversing the marked deterioration in Saudi Arabia's fiscal balance," said S&P.

Deja vu may soon be coming for the kingdom of Saudi Arabia. In January of 1999 Saudi Arabia could no longer idly watch the continued descent of crude prices causing the kingdom's five year credit default swap (CDS) spreads to skyrocket. They cut crude production resulting in a prolific fifteen year crude bull market. 

There is nothing like good old fashioned market pressure that will soon be applied by Saudi CDS spreads that may lead to a repeat of 1999 crude production reductions.