The Asian markets will open up over the next couple of hours and oil prices are expected to jump by as much as 16% ($10). The attacks on Saudi Aramco over the weekend have impacted 5.7m barrels per day of production. This accounts for 5% of global supply and almost half of the production from Saudi Arabia. Aramco can use its stock of inventories to cover up for the lost production, which means that we do not know how long this disruption to the market will last.
Besides the impact of high oil prices, the bigger risk is that the attack could trigger a wider geopolitical confrontation between Saudi Arabia and Iran. The Saudi government is now stating that Aramco was hit by more than 10 missiles. This probably makes it the biggest attack in the region since the Iran -Kuwait war.
In the case of Pakistan, the market generally goes up with oil prices, at least in the short term, since the index is overweight on the oil and gas sector. However, there could be a hit on the supply side. Pakistan imports oil worth $3.2bn per annum from Saudi Arabia. It has a deferred oil payment facility for 12 months which could provide a cash flow buffer. However, if the production issue extends for a week, it could lead to supply issues domestically.
The attacks could also lead to a wider risk-off trade in the global markets, which could extend the bull run in gold and strengthen the US dollar.
Tomorrow, the State Bank of Pakistan will also announce its Monetary Policy. Last week, there were some expectations of a rate cut. I think this new risk of an oil shock removes any possibility of an early rate cut. This could put pressure on the market next week, especially if there is some selling from global funds.
There are three other issues. Firstly, a higher oil price messes up with the balance of payments (increases the import bill) and also with the fiscal deficit (unless the government passes on all the price increase). Since the price shock is exogenous, I don’t think raising interest rates will deal with the inflationary impact but nevertheless, it will keep the pressure on the interest rates. Secondly, there could be a rise in the risk spreads, especially for emerging market bonds. This could hurt the plans of the State Bank in raising capital from global funds both through the domestic bond issue and privatization proceeds.
Lastly, the bigger issue is how will Pakistan navigate through a potential Saudi-Iran confrontation. Over the past two to three years, Pakistan has managed to maintain a rare balance in its foreign policy between these two. Imran Khan also spoke about this during his meeting with President Trump. If the situation turns into a conflict, Pakistan will have to eventually support Saudi Arabia, also due to the financial assistance, it has received from the Middle Eastern countries. Such an alignment might also help in appeasing the US government in the near term, due to their aggressive positioning on Iran. This could provide Pakistan with another policy angle with the US besides Afghanistan. Of course, longer-term, geopolitical instability in the region will be massively damaging.
In other news, I am very excited to announce that Arsalan Soomro has joined our team. Arsalan was previously a Senior Advisor to Tundra Fonder, a Sweden based frontier market fund. He has over 12 years of experience of investments in Pakistan. I think his experience in investment management and stock picking, through multiple cycles, will be highly insightful to our clients. I am sure a lot of the readers of my blogs would already be following Arsalan’s insightful LinkedIn posts on the market. I returned from Islamabad and Lahore to London yesterday. I am planning to be back in Pakistan on the 22nd for a week before going to the US for marketing. Please ping me if you want to meet.
I am, yours truly,
Ali Farid Khwaja
Khadim Ali Shah Bukhari Securities
* This is not research material and there is no investment recommendation in this blog. These are my personal views.