MENA Strategy – Defense! Challenges from many angles

·       Strategy to reduce US shale oil may not be successful as US can retaliate with tariffs. Oil prices would need to remain below USD 25/bbl to take enough US shale oil out of production, and remain below 50/bbl to avoid US shale from increasing again. Given demand destruction, no deal can address the fallout.

·       Most GCC countries need to reduce fiscal break-evens gradually. However, Bahrain and Oman, will need swift and large upfront adjustments and will need external support (guarantees, or a bail-out) or face insolvency.

·       Our selection remains defensive, based on a combination of being a beneficiary of COVID-19 outbreak (food producers), sustainable DPO (Telcos, utilities), support from a cash position or tangible capital (HRHO) or ability to bounce back (such as COMI). We now replace Emaar with Aldar and MTI with JUFO.

Oil demand destruction is significant – supply cannot be adjusted sufficiently. It may take years to go back to 2019 oil demand levels following the 20mbpd demand destruction. As such, no production cut agreement can absorb this in the short-term but can only slow how quickly storage is being filled. To reduce US shale oil in a meaningful way, WTI prices will need to stay well below USD 25/bbl for the next 12-18 months, which is the break-even at the well, and below USD 50/bbl in the medium to longer run, which represents the break-even at corporate levels. However, due to Chapter 11, production from shale oil producers is unlikely to disappear very quickly. Furthermore, we do not rule out protective measures either (tariffs, outright support from the emergency package).

Lower fiscal break-evens needed, likely to slow the recovery. With the new paradigm, oil producing countries will need to reduce their fiscal break-evens by at least USD 35/bbl for Bahrain, Oman and KSA and USD 5-15/bbl for UAE, Qatar and Kuwait. While Saudi, UAE, Qatar and Kuwait can reduce their spending and improve revenues gradually, a high upfront adjustment is now needed in Bahrain and Oman. Both countries are clear casualties and will need external support, or will face insolvency, in our view.

The impact on the region depends on speed and size of fiscal adjustments and how deficits and current accounts will be financed. The combined fiscal deficit of the GCC will reach USD 267bn at oil at USD 25/bbl in FY 20e, equivalent to 16% of GDP and 11% of the banking system. Bond issuances and selling foreign assets (withdrawing SWF funds as well as tapping into FX reserves) is the preferred way as opposed to deposit withdrawals from the commercial banking system, which would result in sharply higher interbank rates, liquidity squeeze and a credit crunch, as the banks provide the bulk of the credit in the region, with the bond market still in its infancy. While Oman and Bahrain will need a radical reduction in spending, other countries can phase the expected fiscal consolidation (removal of fuel subsidies, introduction or increase in VAT and excise, fast forward corporate tax rates of 10%, adjustments in safety nets for nationals).

Operating earnings and capital buffers of the MENA banks are generally sufficient to weather a situation that is deeper than the GFC of 07/08. GCC banks will be able to take 10% in loan losses over the next two years, with excess capital at 4-5% of gross loans and operating earnings are on average 3.5% of gross loans, despite income drag of lower interest rates, but we expect dividends to be slashed or cancelled.

De-peg only plausible if FX reserves run out. De-pegs from USD do not provide any relief to the current account or fiscal account, given the limited non-oil export base and high dependency on imports. However, central banks in Bahrain and Oman may have to resort to capital controls in absence of quick external support from its neighboring countries. 

We maintain a very defensive investment strategy. We play a combination of being a net beneficiary of COVID-19 outbreak (milk producers, gold), sustainable dividend payouts (telcos, utilities), strong support from a cash position or tangible capital base (HRHO) or ability to bounce quickly once the worst of COVID-19 crisis is behind us (COMI). We replace Emaar with Aldar and MTI with JUFO in our Core portfolio.