GCC Markets Under Pressure

The recent precipitous decline in oil prices is beginning to weigh in on GCC equity markets with the MSCI GCC Index falling by 2.6 per cent since the beginning of October against a 30.7 per cent decline in Brent crude during the same period—importantly the correlation coefficient between the two series back to January 2017 is 0.83, suggesting a significant relationship. President Trump’s ongoing oil market intervention through Twitter and various statements since June 2018—which in our view has been the root cause of the precipitous decline in oil prices into bearish territory recently—is testing Saudi Arabia’s (and broader OPEC+’s) tolerance.

Indeed, Saudi Arabia clearly considers to be hard done by the one of many “made in the USA” factors that have been at work in driving the oil price down, with the US primarily responsible for much of the current oversupply. Saudi Arabia adhered to US pressure to revive oil output back in June this year to offset the expected sharp declines in Iranian crude exports, to only then be caught off-guard with a higher-than-expected level of US waivers for purchases of Iranian oil in early November.

Point of view

We remain convinced that both Brent and WTI are “oversold” and that they will rebound from their current bearish market mode—technical indicators signal a rebound is on the horizon, with the current 14-day Relative Strength Index (RSI) below 30 (the critical threshold level flagging excessive declines). However, the rebound is likely to be cyclical in tone given that higher oil prices will only incentivise shale growth (faster learning rates, productivity gains, lower tax rates, project redesign, as well as access to low cost of funding which continues to drive engineering cost deflation), leading to market share gains that will likely be difficult to reverse. Moreover, a sustained period of higher oil prices will assist in repairing shale players balance sheets and fund renewed investments, leaving for a potential greater supply response in 2019 and beyond.

Looking ahead

Given the importance of oil as a component of GDP, exports and revenues for GCC countries, the high correlation between oil prices and GCC financial markets will remain a permanent fixture for the foreseeable future. The next catalyst point for oil markets will be the G20 summit in Buenos Aires on 30 November wherein the messages conveyed by the Big 3—the US, Russia and Saudi Arabia—on coordinated oil production market management and policy potentially giving markets guidance on the likely course of action in Vienna on 6 December. Our base case is for OPEC+ members to see through the pressure from President Trump and concentrate efforts on curbing the current oversupply in the market by conforming to a new production cut agreement next month in Vienna.

Source:MUFG

The question therefore turns to the speed and magnitude of the cuts, as well as the quota allocation of each member state—which at this stage is not priced into markets. As it stands, the spectrum of OPEC+’s possibilities are wide—with anything between 500,000 barrels per day to up to two million barrels per day of cuts possible—and (i) the dynamics between the US, Russia and Saudi Arabia; (ii) OPEC+’s members expectation of the demand outlook for 2019; and (iii) where the front end of the curve is trading—all amalgamating as critical factors of the decision-making process.

Central to OPEC+’s decision process heading into Vienna will be Saudi Arabia’s relationship with the US and Russia. The Kingdom remains cognisant that the US may have geopolitical leverage over the country but we view that the Saudi authorities will see through US pressure and concentrate efforts on their ‘Saudi First’ policy and thus prioritising its domestic needs for oil prices to hover closer to its fiscal breakeven price of $72 per barrel in 2019, above entertaining calls from President Trump to further raise production levels.