The Morning Porridge - Saudi Arabia about the pay the piper?

Blain’s Morning Porridge September 29th 2016

“All these moments will be lost in time.. like tears in the rain.. time to die.”

So much to ponder this morning: Oil and Saudi Arabia, the ECB, and European banks. All are equally fascinating, interrelated in the great game of inflation expectations, and potential directional signals on where markets go from here.

Last nights “surprise” OPEC agreement to agree to agree about talks on cutting oil production is fascinating. Not from the likelihood it may not ever happen, (the earliest we will know is the Vienna meeting in November), but what it tells us about how the sands are shifting around Saudi Arabia. Deliberate Saudi over-production caused the oil glut and was a policy designed to take out expensive US producers. Voodoo economics didn’t work – US producers cut and adapted, and the rest of the world hasn’t played along.

Last night’s agreement represents a fundamental shift in Saudi – a wake up and smell the camel-waste moment. The result is the kingdom is suffering rising twin deficits amounting to over 20% of GDP. As global oil revenues have tumbled on the back of crashing prices, Saudi faces a cash and spending crisis for which it’s largely unprepared. Social issues are mounting. The elites “salaries” have been slashed. It’s being forced towards the international debt markets – a massive deal is on the new issue stocks. My colleague Martin Malone expects to see Debt/GDP rise from 15% to 50%.

This is a picture we’ve seen before.

While Saudi won’t become Venezuela overnight.. are there parallels? Perhaps. Meanwhile, last night’s overturn of Obama’s veto on US citizens suing Saudi over 9/11 is very interesting – and potentially further trouble.

However, it does sound like Iran and Saudi are going to try to coordinate on oil supply. Despite the fact these two very different nations will disagree on absolutely everything, it’s in their mutual interest to do so. Oil analysts expecting a $10 rise in prices are pinning their hopes on Sunni/Shia rapprochement.

I’ve been looking at some research suggesting a seismic shift in Middle East investment into the US as a safe-haven on regional fears it won’t happen – meaning Saudi can’t just assume the global investor base will blithely fund its coming debt binge. That adds pressures for them to play nice with other pariah states, including Russia and China. And even the Iranians..

Or, other commentators suggest the big Middle East funds – the SWFs – could be obliged to channel funds to Saudi to preserve regional stability – therefore liquidating current US holdings..

Swings and roundabouts indeed.

Meanwhile, Mario Draghi was in “robust” form yesterday telling Europe’s languid political classes about the need to do more in terms of structural reform – yada, yada, heard that one before - but also the need for other policies to boost recovery in Europe. Optimal fiscal policy? That’s an interesting call.

The likelihood of banking embarrassment in Germany means his comments about banks being able to operate successfully in zero interest rate environments were particularly elucidating.

Let’s see.. if interest rates are zero, then borrowers don’t pay any interest and can extend their loans indefinitely? Then banks can’t have any NPLs, and will therefore be absolutely default free?

Suddenly I understand.

ECB NIRP is absolute genius. European banking is fixed and nothing to worry about. (US Readers – massive sarcasm alert!)

My day started in the Bloomberg studio where I was somewhat surprised to read a comment from Man’s CEO that Deutsche Bank is “healthy”. Right….

I’m not sure I buy that.

Banks are enormously complex beasts. They are not simple businesses. To turn around a bank is complex. To reinvent a bank – which is what Deutsche Bank, UBS, CS, and others are desperately trying to do, is one level below impossible.

Earlier this year we had commodities firm Glencore teeter on the edge of disaster. Swift action, clear plan, and it’s back from the brink. That is not going to happen with banks. In my 30 years of markets I can’t think of a single bank that’s got in trouble that has staged anything like a similar comeback. Once bank’s catch a cold, it often develops into dangerous pneumonia.

Deutsche – and the others – are anything but healthy. The need to reinvent. The news flow yesterday was positive-ish. Rumours of a SWF capital injection, rumours of a domestic rescue plan, but the reality is more likely to be further deterioration. If that develops into a full crisis any rescue will come at the cost of contingent capital deals being triggered (which will send shock-waves around banking confidence) and the strong/inevitable bail-in of senior debt holders.

Others say the senior debt is safe. Delighted they think so. Call me and tell me how much you want to buy?

Out of time..

Bill Blain

Head of Capital Markets / Alternative Assets