Lower oil prices could drain Saudi FX reserves by $18B per month: report

Published November 22nd, 2015 - 10:51 GMT

The foreign exchange (FX) reserve drain on Saudi Arabia could accelerate to $18 billion per month if Brent crude oil prices average $30 per barrel, adding pressure on the kingdom’s currency, a report said.

Saudi Arabia has been forcing prices lower by increasing production into an oversupplied market so far and it also rushed to issue debt in its local market to fill a soaring budget gap, added Bank of America Merrill Lynch in its research report “Global Energy Weekly”.

"In fact, Saudi Arabia’s FX reserves are still high and point to an ample buffer for now, but they have been falling at a relatively fast rate.

However, should China allow for significantly faster FX depreciation than is currently priced in by markets, we believe oil prices could fall further. Naturally, the FX reserve drain on Saudi could accelerate to $18 billion per month if Brent crude oil prices average $30/bbl, sharply reducing the kingdom’s ability to retain its currency peg," the report said.

“We have previously argued that Saudi Arabia’s surging output is responsible for almost half of the 520 million barrel global petroleum inventory build in the last 7 quarters. Can the government maintain this strategy of flooding the oil market?” the report said.

“In our view, it is unlikely that Saudi leaders would want to exacerbate its ongoing reserve drain by pushing prices below $40 per barrel. After all, pressure will quickly build on the riyal’s 30 year peg to the USD if Brent crude oil prices keep falling. And frankly, it is a lot easier politically to implement a modest supply cut at first than allow for a full-blown currency devaluation. But a CNY (Chinese Yuan) meltdown could ultimately force Saudi’s hand.

“We see cases for both a soft and hard-landing in commodities. In short, a depeg of the Saudi riyal is our number one black-swan event for the global oil market in 2016, a highly unlikely but highly impactful risk. Surely, if Saudi opts to modestly cut supply to push Brent crude oil prices back above $50 per barrel over the next year, EM (emerging markets) growth could stabilize at these low levels and eventually recover,” the report said.

However, if Saudi cannot resist the gravitational forces created by a persistently strong dollar and depegs the Saudi riyal to follow Russia or Brazil, oil prices could collapse to $25 per barrel.

Weaker commodity prices would in turn add more downward pressure on EMs, the report said.

Thus, even if micro supply and demand dynamics are improving, the path for oil prices in 2016 will heavily depend on how the USD moves against the CNY and the Saudi Riyal, according to the report.

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