Speculators test Saudi currency as oil crisis deepens
“A de-peg of the Saudi riyal is our number one ‘black-swan’ event for oil in 2016,” said Bank of America
By Ambrose Evans-Pritchard
Saudi Arabia's oil minister Ali al-Naimi
Saudi Arabia’s currency regime is at risk of blowing up if oil prices fall further and the US dollar spikes higher, Bank of America has warned.
The Saudi strategy of flooding the world with oil in a bid to drive out rivals may be hard to square with the country’s fixed dollar-peg, which is increasingly under scrutiny by currency traders as the US Federal Reserve prepares to raise interest rates.
12-month forward currency contracts are surging as traders bet the peg will break
This is even higher than the peak after the 9/11 terrorist attacks in New York, and is approaching extremes seen in January 1999. Credit default swaps pricing bankruptcy risk has jumped to 153, the highest since the global financial crisis.
Mr Blanch said a devaluation by China would leave the Saudis badly exposed and might ultimately force their hand. “A de-peg of the Saudi riyal is our number one ‘black-swan’ event for oil in 2016,” he said.
The 30-year old dollar peg is the weak link in Saudi strategy. It matters more than dissent within OPEC as the cartel prepares for a stormy meeting in Vienna on December 4. To varying degrees, Algeria, Venezuela, Nigeria, Iraq, and Iran all want production cuts to stabilize the market.
Russia has been able to cushion the effects of the oil price crash by letting the rouble fall from 32 to 65 against the dollar since mid-2014. This protects oil revenues of the Russian state in local-currency terms.
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Saudi Arabia is taking the blow head-on, and is facing an extra tourniquet effect as Fed tightening pushes the global dollar index to a 12-year high. The central bank’s holdings of foreign securities fell $23bn in October. They are down $90bn since February. Foreign reserves are still $647bn but not all is usable.
The Saudi government has had to cancel a raft of infrastructure projects and push through drastic spending cuts to rein in a budget deficit near 20pc of GDP. It denies reports that contractors are not being paid.
Bank of America warned that a break-down of the Saudi dollar-peg would send the riyal tumbling, with major knock-on effects. “Oil could collapse to $25,” it said in a client note.
The IMF's warning on Saudi Arabia's fiscal crisis unless action is taken
The report said it is the lesser of evils for Riyadh to trim oil output and nudge Brent crude prices back over $50 rather than risk a currency crash. Most experts say devaluation would devastate the political credibility of the Saudi dynasty, already facing criticism at home as the war in Yemen drags on.
Russia abandoned its peg long before reserves ran out, partly because the defence of the rouble imported vicious monetary tightening. Kazakhstan ditched its dollar peg in August. But the riyal may be a harder nut to crack.
Brown Brothers Harriman said the Saudi peg is the bedrock of financial policy and will not be surrendered lightly. Any attempt by speculators to mount an attack is likely to fail. "They have the political will, and they have enough reserves to keep going for another two years if they husband their resources. They should not be underestimated," said Marc Chandler, the bank's currency strategist.
Saudi Arabia is no longer rich. Per capita income is $21,000, the same as Greece
Mr Chandler said speculators should bear in mind that the Saudis revalued their currency upwards in the 1980s to catch traders off guard, inflicting painful losses to teach a lesson. The Saudis then devalued later once they had made the point.
Patrick Dennis from Oxford Economics said the dollar link has been pivotal in the modern history of the country. “We think that the Saudi authorities are very unlikely to abandon their peg. It has been intact for nearly 30 years and withstood more difficult periods than now,” he said.
The question is whether the Saudis deem the peg to be so important that they would rather abandon their current OPEC strategy, if push comes to shove. “Frankly, it is a lot easier politically to deliver a modest supply cut than to implement a full-blown currency devaluation,” said Mr Blanch.
The Saudi strategy of flooding the world with oil in a bid to drive out rivals may be hard to square with the country’s fixed dollar-peg, which is increasingly under scrutiny by currency traders as the US Federal Reserve prepares to raise interest rates.
“The crucial point is what happens to the Saudi riyal. Saudi Arabia’s foreign exchange reserves still provide an ample buffer, but they have been falling fast,” said Francisco Blanch, the bank’s energy strategist.
“Should Brent crude oil prices drop to $30, we estimate the foreign exchange reserve drain could accelerate to $18bn per month. Saudi Arabia may face a critical choice: cut oil supply, or de-peg,” he said.
The 12-month riyal forward contracts – watched by experts for signs that traders are betting on a collapse of the peg – has spiked violently to 535 from just 13 points in June.
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12-month forward currency contracts are surging as traders bet the peg will break
This is even higher than the peak after the 9/11 terrorist attacks in New York, and is approaching extremes seen in January 1999. Credit default swaps pricing bankruptcy risk has jumped to 153, the highest since the global financial crisis.
Mr Blanch said a devaluation by China would leave the Saudis badly exposed and might ultimately force their hand. “A de-peg of the Saudi riyal is our number one ‘black-swan’ event for oil in 2016,” he said.
The 30-year old dollar peg is the weak link in Saudi strategy. It matters more than dissent within OPEC as the cartel prepares for a stormy meeting in Vienna on December 4. To varying degrees, Algeria, Venezuela, Nigeria, Iraq, and Iran all want production cuts to stabilize the market.
Russia has been able to cushion the effects of the oil price crash by letting the rouble fall from 32 to 65 against the dollar since mid-2014. This protects oil revenues of the Russian state in local-currency terms.
.
Saudi Arabia is taking the blow head-on, and is facing an extra tourniquet effect as Fed tightening pushes the global dollar index to a 12-year high. The central bank’s holdings of foreign securities fell $23bn in October. They are down $90bn since February. Foreign reserves are still $647bn but not all is usable.
The Saudi government has had to cancel a raft of infrastructure projects and push through drastic spending cuts to rein in a budget deficit near 20pc of GDP. It denies reports that contractors are not being paid.
Bank of America warned that a break-down of the Saudi dollar-peg would send the riyal tumbling, with major knock-on effects. “Oil could collapse to $25,” it said in a client note.
The IMF's warning on Saudi Arabia's fiscal crisis unless action is taken
The report said it is the lesser of evils for Riyadh to trim oil output and nudge Brent crude prices back over $50 rather than risk a currency crash. Most experts say devaluation would devastate the political credibility of the Saudi dynasty, already facing criticism at home as the war in Yemen drags on.
Russia abandoned its peg long before reserves ran out, partly because the defence of the rouble imported vicious monetary tightening. Kazakhstan ditched its dollar peg in August. But the riyal may be a harder nut to crack.
Brown Brothers Harriman said the Saudi peg is the bedrock of financial policy and will not be surrendered lightly. Any attempt by speculators to mount an attack is likely to fail. "They have the political will, and they have enough reserves to keep going for another two years if they husband their resources. They should not be underestimated," said Marc Chandler, the bank's currency strategist.
Saudi Arabia is no longer rich. Per capita income is $21,000, the same as Greece
Mr Chandler said speculators should bear in mind that the Saudis revalued their currency upwards in the 1980s to catch traders off guard, inflicting painful losses to teach a lesson. The Saudis then devalued later once they had made the point.
Patrick Dennis from Oxford Economics said the dollar link has been pivotal in the modern history of the country. “We think that the Saudi authorities are very unlikely to abandon their peg. It has been intact for nearly 30 years and withstood more difficult periods than now,” he said.
The question is whether the Saudis deem the peg to be so important that they would rather abandon their current OPEC strategy, if push comes to shove. “Frankly, it is a lot easier politically to deliver a modest supply cut than to implement a full-blown currency devaluation,” said Mr Blanch.
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