By Ambrose Evans-Pritchard at The Telegraph
Saudi Arabia faces a vicious liquidity squeeze as capital continues to leak out the country, with a sharp contraction of the money supply and mounting stress in the banking system.
Three-month interbank offered rates in Riyadh have suddenly begun to spiral upwards, reaching the highest since the Lehman crisis in 2008.
Reports that the Saudi government is to pay contractors with tradable IOUs show how acute the situation is becoming. The debt-crippled bin Laden group is laying off 50,000 construction workers as austerity bites in earnest.
Societe Generale’s currency team has advised clients to short the Saudi riyal, betting that the country will be forced to ditch its long-standing dollar peg, a move that could set off a cut-throat battle for global share in the oil markets.
Francisco Blanch, from Bank of America, said a rupture of the peg is this year’s number one “black swan event” and would cause oil prices to collapse to $25 a barrel. Saudi Arabia’s foreign reserves are still falling by $10bn (£6.9bn) a month, despite a switch to bond sales and syndicated loans to help plug the huge budget deficit.
The country’s remaining reserves of $582bn are in theory ample – if they are really liquid – but that is not the immediate issue. The problem for the Saudi central bank (SAMA) is that reserve depletion automatically tightens monetary policy.
Bank deposits are contracting. So is the M2 money supply. Domestic bond sales do not help because they crowd out Saudi Arabia’s wafer-thin capital markets and squeeze liquidity. Riyadh now plans a global bond issue.
While crude prices have rallied 80pc to almost $50 a barrel since mid-February, this has not yet been enough to ease Saudi Arabia’s financial crunch.
The rebound in crude is increasingly fragile in any case as tough talk from the US Federal Reserve sends the dollar soaring, and Canada prepares to restore 1.2m barrels a day (b/d) of lost output. “We feel that markets have moved too high, too far, too soon. We still face a large inventory overhang and supply outages are reversible,” said BNP Paribas.
Total chief Patrick Pouyanne told the French senate last week that prices could deflate as fast as they rose. “The market won’t come back into balance until the end of the year,” he said.
Mr Pouyanne said the collapse in annual oil and gas investment to $400bn – from $700bn in 2014 – would lead to a global shortage of 5m barrels by 2020 and another wild spike in prices, but first the glut has to be cleared.
The oil rally is now at a make-or-break juncture. A growing number of oil traders warn that speculative purchases of “paper barrels” by hedge funds have decoupled from fundamentals. There is usually a seasonal slide in demand over the late summer.
Adam Longson, from Morgan Stanley, said “quant” funds have taken out big positions on Brent crude. "If trends reverse, it could be a catalyst for liquidation," he warned.
Mr Longson said supply outages – chiefly in Nigeria and Canada – have held back 2m b/d and temporarily balanced the market, but this may not last. Canada should be back on stream by June.
US inventories are still hovering at record levels. Data from the US Energy Department showed a rise of 1.31 million barrels in the week to May 13. “The supply glut seems persistent. Oil could well fall to a new low for the year,” said Ben Combes from Llewellyn Consulting.
Eventually the next cyclical oil spike will come to the rescue. The question is whether the Saudis can batten down the hatches and make it through the financial storm in a very leaky ship.