Emerging Markets Strategy

A Brief Note on Oil

Date: 2016-09-05 - Prepared by: The GISI

Last weekend, in China, Vladimir Putin and Saudi Arabia’s Mohammed bin Salman agreed that (a) oil producers would be better off if oil stabilized between $50 and $60 and (b) they should find a compromise with Iran on its level of production.

Saudi Arabia's deputy Crown Prince—Mohammed bin Salman—is overconfident. Saudi Arabia needs stable oil prices more than Russia does. Saudi’s currency is still pegged and its economy hasn’t really adjusted to the rapid fall in oil price. If any of the six GCC economies is unable to defend its peg, they will all devalue—one after another.

What if the population of Bahrain panics and decides to convert its savings into USD, EUR and/or gold? Bahrainis have many reasons to dump their currency. Unless Saudi Arabia transfers US$ to Bahrain, the currency peg will break.

History of all markets―developed or emerging―shows that whenever the local population loses faith in the value of its currency, the currency devalues. The world hasn’t seen a single exception. The longer Saudi Arabia  plays Russian roulette with oil prices, the greater the risk of a violent currency devaluation across GCC.

Russia, on the other hand, has devalued. As Russia’s former president Boris Yeltzin once told Bill Clinton, “don’t underestimate our people’s ability to suffer.”  Russia is largely a self-sufficient country—if only it was managed more effectively.

Although Vladimir Putin epitomizes well-organized, hard-working and disciplined management, he is not a typical leader/manager in Russia. To give you an idea of how inefficient Russia’s management often is, let me share a real example.

Igor Sechin―the current executive chairman & CEO of Rosneft―once called an urgent meeting of all levels of management at 13:00. The topic was unknown. Until 23:00 people waited in a crowded room. When he finally arrived, he revealed the topic of the meeting:“improving management effectiveness in Rosneft.”

Many oil companies, from Azerbaijan and Kazakhstan to Nigeria and Venezuela, are managed as “effectively” as Rosneft is. This is one of the reasons the oil industry has so much inertia and is slow to react to rapid changes in markets.

In July 2016, researchers at the Bank of Canada issued an interesting note on oil. Their conclusion was that although oil prices in 1986 declined by around 50% and remained at those levels for a decade, the 2014 fall by 50% won’t last as long. Today there is less spare capacity, oil demand hasn’t fallen by as much as in the 1980s, and the cost of incremental production is much higher...

This document is only available to members

Request your free trial OR Login Here