File this under “buses you don’t see coming.” I’ve been giving the Dubai/UAE situtation some thought, trying to map out scenarios and possible second and third order effects. So far, I’ve been thinking mostly of the credit problems, but in an effort to keep an open mind about the relationships between asset classes and their risks, I’ve been trying to piece together an entirely different scenario… and I think I’ve got it.
Looking at the newsflow out of the Persian Gulf region, things don’t seem all that cheery on the Arabian peninsula. The folks at the Financial Times and FT Alphaville have been talking a lot about the problems with investments by Dubai/UAE (nothing new, but read this and this), and now Kuwait. Apparently, Kuwait has been guilty of the using the same tragic investment strategy as Dubai: real estate, private equity, and stocks.
Funny, but I’ve heard that before… I think it was in Larry McDonald’s book, where he talked about how much risk the company was taking. How much risk they were oblivious to…
But let’s get back on point. To talk about scenarios we need some data, some plausible linkages between the data, add in the current situation and the options available to respond, and voila you have a scenario.
So first, let’s look at some data. I’m going to throw in a few charts I have that show the incomes of these government sponsored enterprises in Kuwait and the UAE:
Here’s a Y-o-Y chart of the same data from the UAE:
At the same time, oil/hydrocarbon exports have literally been fueling growth:
So while these GSEs are starting to rack up losses on their investments, dependence on oil exports has only gotten stronger.
All the while, the “cheap” credit they used to buy all of those assets is getting more and more expensive. So now if we think about the possible ramifications of asset deflation in the real estate, private equity & stock holdings these government-backed enterprises have, we arrive at some real stark choices really fast. There’s defaulting on the debt, liquidating the assets, extending and pretending, or selling oil.
Default prospects are rather fuzzy at the moment, since there is some debt that might be defaulted on while other debts will not be. Liquidating the assets? In this market? Extending and pretending won’t work in this case either because a number of the projects are unfinished and won’t cash flow as projected.
So that leaves us with the possibility of selling oil to pay off the debt. And these won’t be small bite-sized sales, but rather large oil sales to cover the debt that needs to be rolled/paid off. Next is the weekly chart of the nearby crude oil contract (hat tip: CME Group):
There’s no point in looking at a 15 minute chart, a release of oil reserves the size these two countries need to execute for debt payoffs would put a lot of supply in the market. And looking at the weekly chart, crude has been drifting higher. Price action is more like dawdling, actually, but after bouncing off of last year’s lows it has meandered higher. Based on this, I don’t think the market could easily absorb that kind of supply.
And as I alluded to in weeks past, a drop in oil prices would hurt some countries, just not the ones you’d think.