Oil and stocks are married, for better or worse. Too bad lately it looks more like for worse.
With the price of Brent Crude around $37 a barrel and West Texas Intermediate (WTI) around $33.50 a barrel, oil producing countries’ budgets are slipping into a deep well.
That’s pretty well known. But here’s the secret.
To keep growing deficits from overwhelming their economies, every oil exporter with a national fund, also known as a sovereign wealth fund (SWF), is selling portfolio assets. There are eight of these countries, and they’re big names.
Unless oil jumps considerably higher, sovereign wealth funds will be forced to sell hundreds of billions of dollars’ worth of equities in 2016.
That constant selling pressure will dampen global equities for all of 2016 if oil stays at depressed levels.
The “Break-Even Price” Is Creating A Death Spiral
Equities are the easiest assets to sell for the SWFs.
According to JPMorgan Chase, out of SWFs’ total assets of $7.4 trillion, 51% are in public equities, 18% is invested in government bonds, 7% in corporate bonds, 18% in alternative investments (private equity funds, hedge funds), and 6% is in cash.
With $3.7 trillion directly in equities, and according to Credit Suisse, another $600 billion in equities held through private equity and hedge funds, SWFs can exert a lot of selling pressure on global equity markets if they have to keep selling assets.
And they will have to keep selling equities.
What’s telling about how much selling will happen in 2016 is the fiscal break-even price, in terms of oil, SWF countries are facing. In other words, how much per barrel they have to sell their oil for to not go further into deficit spending.
- Saudi Arabia‘s fiscal break-even, the price they have to sell their oil at to not run a deficit, is $100 a barrel, according to the International Monetary Fund. While that’s a mile above the estimated $9.90 per barrel it costs the Saudis to produce a barrel of oil, it’s 185% above where oil’s trading today.
- Bahrain‘s fiscal break-even is the same as Saudi Arabia’s ($100 a barrel), and so is its production cost.
- Russia breaks even at $105 a barrel, and their cost to produce is around $17.20.
- The fiscal break-even for UAE (United Arab Emirates) countries is $67.50 a barrel, while their cost is $12.30.
- Qatar‘s fiscal break-even is $57.50.
- Kuwait‘s is $51.80.
- Norway‘s break-even is $47.40.
- And Kazakhstan‘s fiscal break-even is $82.70.
The average fiscal break-even for all oil producing countries with SWFs is $70 a barrel. Obviously that’s a long way off, and almost nobody thinks we’ll get back to that price this year. So these eight countries are running out of options.
Kazakhstan’s central bank recently said in a U.S. News report they plan to sell $28.8 billion out of their $64.2 billion national fund over the next three years to offset budget deficits.
Russia spent $18.1 billion, or 44% of its reserve fund in 2015 supporting its budget.
JPMorgan says oil-based funds sold $160 billion worth of investments in 2015 and they expect them to sell at least $220 billion in fiscal 2016. That’s if oil averages $35 a barrel.
Between $25 and $28 a barrel, where oil traded this past January, SWFs would have to liquidate as much as $500 billion in 2016 to meet the same budget targets in 2015.
That’s one reason oil and stocks seem married and have been moving in almost lock-step for several quarters now. As oil prices rise the heat comes off SWFs to sell assets, which puts pressure on markets.
They’re married for other reasons too.
Oil Impacts Every Market It Touches
Banks are leveraged to oil prices. If oil prices continue to fall banks will end up with bad loans they have to set aside more reserves against. And there’s always a chance a bank somewhere goes belly-up from over exposure to the energy patch.
Also, big oil companies are large capitalization components of all the indexes they reside in. As they cut dividends, which causes investors to sell shares, and post lower earnings and cut capital expenditures to the bone, the impact of their downtrending share prices weighs on benchmark indexes.
The production freeze being talked about is a hopeful sign oil prices will at least stabilize, if not jump higher. But freeze talk has been disappointing recently and there’s no guarantee any agreed to freeze will be honored.
In the meantime, as long as oil hovers around these levels, sovereign wealth funds will continue to sell equities on all the rallies they can find.
Now imagine if oil tanks and the market swoons and SWFs run for the exits while they can. It could get ugly.
That’s what’s worrying me.
And that’s what should be worrying you, too.