Sell-Off in GCC Stocks Creates an Opportunity for Equity Investors

by: Irfan Chaudhry
As unrest in Middle East has increased the risk premium of riskier assets, the markets have taken a strong hit as investors sold these assets indiscriminately. A recent report puts around 6% of global oil supply at risk from spread of political unrest. Safer GCC countries stand to gain massively from higher crude oil price.
Increase in crude oil serves as a hedge against increase in political risk for countries like UAE, Qatar and also for Saudi Arabia. Total value of ME crude oil resources is at $18.3 trillion and present value of $11.2 trillion, assuming a 3% rate of return (and discount rate) and a price of $50 per barrel, while GCC natural gas reserves would be $7.1 trillion, assuming a discount rate of 3% and a price of $8 per million BTU. Value of oil reserves is calculated at US$37 trillion assuming crude oil price at US$80 / barrel with a 3% discount rate and value of natural gas reserves at US$5 trillion at natural gas price of US$5 / MMBTU and 3% discount rate. Please find below the chart showing global oil reserves;

GCC countries are primary contributors to global oil output.
Together, the GCC states accounted for 23 per cent worldwide oil production in 2008 which came down to 17% by the end of 2009 and rose back up to 18.5% in 2010. Undoubtedly, Saudi Arabia is the world’s largest oil producer and exporter and contributed an average of 8 million barrels per day, accounting for 11% of global production, down from 10.8 million per day to global oil output of 82 million barrels per day in 2008, representing 13 per cent of the total. Still, other GCC countries are notable oil producers, with the UAE, Kuwait and Qatar accounting for 3.1 per cent, 3.0 per cent and 1.2 per cent of global production in 2009.

We expected crude oil to rise towards $100/barrel by the mid of 2011. Oil prices were already on the rise even before the turmoil in Egypt, increasing by $20 a barrel since the summer as the global economic recovery pushed up demand for crude. The Brent Crude oil rose to $120 per barrel as Libyan protest escalated and is expected to remain elevated till political risk stays high.
Simple analysis of support and resistance levels over the past few years give some clues as to key levels. A strong support lies at $70 per barrel and a resistance is at $100 dollars. As the crude oil price breaks this level, this will become a new floor of support. To put the things in perspective, every US$10 per barrel increase in crude oil price results in incremental annual earnings of US$ 0.5 billion for GCC countries (output of 16 million barrels per day). At crude oil price of US$100 per barrel, value of GCC oil production can reach US$584 billion. GCC is the only oil producing region in the world with a material spare production capacity at around 5 million barrels per day. If crude oil supply from North Africa and Iraq is interrupted, the call on GCC oil production will be higher. An additional output of around 5 million barrels per day will result in a further addition of US$182 billion to the GCC countries earnings. On the other hand, most of the GCC countries have budgeted their expenses very conservatively.

Breakeven crude oil price for GCC countries 2011/12 budget ranges from US$54 per barrel (
Qatar) to US$78 per barrel (Oman). This provides these countries fiscal muscle to subsidize the effects of inflation to stave off social unrest. A recently announced Saudi mega spending plan of US$36 billion, with an expansive budget, requires crude oil to be at US$85 per barrel to breakeven.

Debt as % of GDP is lowest for GCC

Besides, most of these countries have massive forex reserves (estimated at US$1.79 trillion – second only to China & HK), which can be used to finance deficit spending.

Recent turmoil highlights the importance of pumping the oil money through local economies, which should be positive for domestic consumption and fixed capital investment and for the companies operating in these sectors (the banks and consumer sectors comprise 55% of the market capitalization of GCC indices). The petrochemical sector, which is second largest segment by market capitalization (23% of market capitalization), stands to gain from an increase in crude oil prices as prices of most of the sold products are closely related to the crude oil price. Recent indiscriminate selloff in GCC equity markets creates a rare interesting opportunities for medium to long term equity investors.

Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in GULF over the next 72 hours.