The imposition this week by the EU of an oil embargo on Iran as well as financial sanctions on Iran’s central bank is likely to keep geopolitical tensions elevated in the GCC, especially as Arab unrest aftershocks linger on, according to BofA Merrill Lynch Global Research.
The report titled “BofA ML Emerging Markets: GEMs Daily – MENA: geopolitical risk weighs on GCC assets” authored by the BofA Merrill Lynch Global Research team.
This is being increasingly priced into regional fixed income markets, with five-year CDS in Saudi Arabia moving above its Arab unrest peak of 2011. That being said, we see limited direct impact on the GCC from Iran international sanctions, except in the unlikely event of tail risks materializing, and thus reiterate our overweight recommendation on high-quality Abu Dhabi and Qatar sovereigns.
Existing international sanctions on Iran may adversely impact bilateral trade with UAE, though the overall drag on growth is likely to be small and manageable, in our view. Iran accounts for 6% of total and 12% of non-hydrocarbon UAE exports, though over 90% of it represents re-exports (sanctions do not directly ban merchandise trade through the UAE, except in cases related to Iran’s nuclear program). There is little evidence that UAE exports to Iran have been materially affected by sanctions imposed in June 2010 as these appear to have held up well in 1H11. Financial sanctions have been further tightened in 2011/12. It is difficult to quantify the impact of financial restrictions and obstacles in obtaining trade finance on existing Iranian businesses operating in Dubai. We estimate that, in the worst case scenario where all exports to Iran stopped,
UAE GDP would be reduced by just 1.4% (assuming 20% added value for re-exports), though the impact would be felt most in Dubai. Hormuz strait closure, still a tail risk… The threat of closure of the Hormuz strait is a clear negative to the GCC, though we believe it is unlikely to materialize for now, in our view. This would be because first, it is the main conduit of Iranian crude oil and would also hit Iran hard; secondly, American military bases in the GCC would allow an effective response and consequently the strait might not be closed for long; three it would risk escalation into a broader military conflict; four among the main customers of Iranian oil who would suffer from oil disruptions are China and India, who provide Iran with a degree of international diplomatic support and, five so far, Western powers (excluding potentially Israel) seem to be preferring the route of tougher sanctions to bring back Iran to the negotiating table, which potentially buys time.
Conversely, the Hormuz closure threat keeps the bid on oil prices, at a time where financial sanctions, particularly against the Iranian Central Bank, may have forced Iran to sell its oil at a discount, while also attempt to push Western powers to back off from applying further pressure. Lastly, the elevated costs of maintaining its defense system secure and operating for a prolonged period of time may dissuade Israel to use military force in the ongoing Iranian nuclear standoff given the potential for retaliation by Iranian proxies, in our view. …but one with clear negative impact on the GCC Should the Hormuz strait be closed however for a period of time, the GCC would suffer due to its geographical location. All of Qatar’s hydrocarbon exports including LNG pass through the strait (apart from the Dolphin pipeline, but it represents less than 5% of its gas exports). The UAE is in a similar situation, as the pipeline it is building to bypass Hormuz would only be operational in the
Saudi Arabia is in a “relatively” better shape, as it has in place the Yanbu terminal on the Red Sea with capacity of 4.5mn bpd compared to crude oil production of c9.6mn bpd in December. An EU ban on Iranian oil exports could allow Saudi Arabia to maintain its crude production at elevated levels, to the extent shipping through Hormuz remains an open route. Dubai would likely be most hit by ensuing liquidity squeeze While sovereign wealth cushions, this tail risk has led to decent demand for CDS protection and hedging for exposure to external sovereign debt of GCC hydrocarbon producers. In our view, however, and unlike current market pricing, a squeeze on oil income in the GCC would most harshly (indirectly) affect Dubai given its low level of savings, a leveraged banking sector and the resultant lower liquidity complicating the refinancing of the large maturities coming due in 2012. Limited direct impact of lower spot gas prices on Qatar While our commodities team has sharply lowered its 2012 forecast for US natural gas prices and Henry Hub spot prices made new lows this month; we believe the impact on Qatar would be limited at this stage. This has nevertheless taken place along the concurrent rise of geopolitical tensions, compounding the poor market sentiment. It is however important to note that a very small amount of Qatari LNG is actually sold on spot. LNG pricing for Qatar comes from LT contracts (c55-60% of all contracts with duration of 20+ years) and the rest from ST contracts (1-3 years). Each contract is different and pricing varies. The LT sale and purchase agreements provide some certainty of volume off take. Regarding pricing, the price agreements with Asian and European markets are generally linked to oil-hydrocarbon price index, allowing some fluctuations, while contracts for US markets are generally spot-based (thus potentially more volatile pricing). As such, export revenues over the past few years have thus been resilient. This also reflects the fact that less than 5% of LNG exports from Qatar are destined to US markets, vast bulk is for Europe and Asia. Should spot price weakness however persist for a long time, this could impact the rollover contract pricing terms Qatar would negotiate, as well as industry-wide contract benchmarks.