In my previous piece, I discuss the deteriorating relationship between Washington and Riyadh. The Khashoggi murder, Washington ending support for Saudi Arabia’s brutal assault on Yemen, Washington’s disengagement in the region, and China becoming Saudi Arabia’s top oil customer have totally changed the geopolitics of the region. OPEC has now announced a major geopolitical earthquake.
Per Bloomberg, OPEC+ has announced the biggest production cut since 2020. The cartel is planning to cut its oil production all the way down to 2 million barrels per day. The report further states that the cartel is thinking about cutting oil production down to 1.5 million - 1 million barrels per day. OPEC + includes Russia as a member. The White House is fuming as OPEC and gulf countries are clearly siding with Moscow in Washington’s all-out efforts against Russia during the Ukraine - Russia war. But does OPEC+ (in particular Saudi Arabia) have bigger plans?
The Dollar Index (DXY) vs Oil is a chart that we discussed during our last piece. Ever since the mid-2010s, the US became a net exporter of energy thanks to Shale Oil. Thus the Dollar index and oil prices correlated with each other. But as you can see above on the YTD chart the DXY and oil price index are back to the way they used to be. As the Dollar has gotten extremely stronger oil prices have declined.
As we reported in our last piece, the strong Dollar is breaking everything and anything coming on its way. Emerging market economies with giant account deficits and bad balance sheets are suffering while stronger economies are able to either de-Dollarize or sell large amounts of their FX reserves to defend their currencies. So is OPEC+ defending their economies against the strong Dollar?
As the Dollar is strengthening oil prices are getting affected. Not just that, as interest rates are going up, the Saudis and Gulf countries are seeing their Dollar holdings decline in value. Also, the Saudi Sovereign Wealth Fund has allocated tons of its capital into US stock and venture capital investments. US equity (both public and private) boomed during the 2010s thanks to the Fed’s QE. Now that the Fed is engaging in aggressive rate hiking and QT, financial markets are falling. By cutting oil production oil prices will go up. This is going to create even more inflation. This is going to add an extra burden to the American (and global) consumer. By cutting oil production (which increases oil prices) is OPEC+ making the Fed cut interest rates and go back to QE? This may stimulate the US economy but the Fed can’t do so much given the inflation globally is mainly due to commodity supply. But if the Fed were to pivot, which means to cut rates and increase QE, emerging currencies will strengthen and their economies will start to grow again. This growth will increase the demand for commodities. For example, if the Dollar’s value were to go down against the Chinese Yuan, where China is the largest buyer of Saudi oil, China has to sell less Yuan to access Dollars to buy Saudi oil. Same for any other Asian currency. Also, by doing QE this Fed will start buying US government debt. This will increase the value of Saudi’s Dollar holdings. Last but not least, QE will give a big boost to US markets, which of course will help the Saudi Sovereign Wealth Fund. There Saudis are also trying to please their number one customer, China. It is also worth noting that in a month the US midterm elections are coming and it looks like the election favors the Republican Party. Is OPEC and in particular MBS hoping for a change in the guard in the White House and is a hoping for a Republican administration in 2024?
Of course, prior to the Fed doing QT, the rise of oil prices because of Western sanctions on Russia was an opportunity for the US to rebuild its energy infrastructure. Oil producers in the US have told the White House that without high oil prices US oil producers cannot build energy infrastructure. To give you context the U.S. has not built an oil refinery since 1977. In early 2022, this should have been a priority for the US. Instead, the White House sold off oil from the Strategic Petroleum Reserve to stabilize the price of oil (keep in mind there is an election this November in the U.S. and the White House is doing what it can to reduce oil prices). Also, increasing interest rates will only make it hard for oil producers to borrow money to build energy infrastructure in the U.S. High interest rates are coming right at the time the U.S. is starting to enact infrastructure policy. A desperate White House is now easing sanctions on Venezuela and allowing Chevron to pump oil in the country (one good thing to come out of this crisis is Washington easing sanctions on Venezuela, where the people in the country have suffered immensely due to Washington’s sanctions on the country).
The White House is doubling down on misguided policy. As the Wall Street Journal reports, Washington is looking to retaliate against OPEC+. One such retaliation measure Washington is considering is seizing assets of OPEC+ members owned in the US (where have we seen this playbook before?). It is rather ironic given that the original PetroDollar deal is that oil producers will sell oil in Dollars only to park money in US government securities, financial markets, and real assets. The US has an open capital account and allows countries to park their money in the US so that the US can print Dollars to prop up its reserve status and the bond market. This move will break the PetroDollar and create a Dollar crisis.
Overall, watch for the Gulf nations and the geopolitics happening in the region. As I wrote before Saudi Arabia has shown keen interest in joining the BRICS. Two weeks ago the Shanghai Corporation Organization (SCO) concluded in Samarkand, Uzbekistan. SCO was created by China and Russia to challenge the Western-led NATO alliance. Qatar and Egypt were invited to be observer states of the SCO. Saudi Arabia and UAE have shown interest in being dialogue partners of the SCO. The Gulf oil producers are showing interest in China’s Digital Yuan. The Central Banks of China, Hong Kong, Thailand, and the United Arab Emirates announced that they have come together to create the Multiple Central Bank Digital Currency Bridge or mBridge for short. The partner countries have already done 160 transactions which involve $22 million successfully. mBridge is not just for China’s e-Yuan. The program is built upon Project Aber, a joint initiative created in 2019 by Saudi Arabia and the UAE to test digital currency transactions and cross-border payments between the two nations, showing how even the gulf wants to de-Dollarize between each other. Concerns about Western sanctions and getting cut off from SWIFT and increased trade relations with China are the main reasons why Gulf countries are embracing the digital Yuan. Finally, the UN Human Rights Council had a vote on the motion to debate the treatment of Uyghur Muslims in Xinjiang. As shown below, gulf nations like the UAE and Qatar (where the US has a major military base) voted “No”. It is worth noting that Ukraine and India (which is part of the anti-China QUAD “alliance”) abstained.
The economic war between the West vs. the Rest just got heated up. We are in for some painful and interesting times.
What I write here is not investment advice. I am a curious financial markets analyst and write these for educational purposes. Please do your own research.
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