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The BID

The mystery of the Saudi oil attack

Esta semana presentamos a Amer Bisat, jefe de Mercados Emergentes y Alfa de Fondos Soberanos en BlackRock

El 14 de septiembre, hubo una serie de ataques aéreos a dos instalaciones de energía en Arabia Saudita. Fue el ataque más importante a la infraestructura energética en décadas, pero aparentemente los mercados no piensan lo mismo. ¿Por qué, entonces, casi no hubo reacción?

En este episodio de The BID, Amer Bisat, jefe de Mercados Emergentes y Alfa de Fondos Soberanos, arroja algo de luz sobre el misterio: qué sucedió, por qué sucedió y qué sigue. También da su opinión sobre la invasión militar turca en Siria y las recientes elecciones en Argentina.

Sin Argentina: En este episodio de The BID, Amer Bisat, jefe de Mercados Emergentes y Alfa de Fondos Soberanos, da su opinión del misterio: qué sucedió, por qué sucedió y qué sigue.

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    Catherine Kress: On September 14th, a series of airstrikes hit two Saudi Arabian energy facilities with at least 17 points of impact. Who was behind the attack? In the immediate aftermath, Houthi rebels in Yemen claimed responsibility. Iran denied it and the U.S. and Saudi Arabia both refused to lay blame. But after a series of investigations, it became clear that Iran was responsible.

    This was the most significant attack on energy infrastructure since Iraqi forces set fire to oil fields in Kuwait at the end of the Gulf War in 1991. Ten or twenty years ago, an attack like this would have sent oil prices through the roof for quite a while; and this attack looked like it would follow suit. It caused the largest single day increase in oil prices in history, but within a few days, oil prices came back down to only a few dollars above pre-attack levels.

    On this episode of The BID, we’ll talk to Amer Bisat. Amer leads a team at BlackRock that manages a $20 billion portfolio of sovereign and emerging market bonds. But Amer’s experience goes beyond financial markets. He also taught at Columbia University and spent about 10 years at the International Monetary Fund negotiating the fund’s highest profile programs.

    In today’s episode, Amer will help us unpack the events of September 14th and the days following: what happened, why it happened, and why oil markets didn’t react the way we would’ve expected them to. We’ll also talk about other current events around the world, including Turkey’s military invasion of Syria and elections in Argentina. I’m your host, Catherine Kress, we hope you enjoy.

    Amer, thank you so much for joining us today.

    Amer Bisat: My pleasure, Catherine.

    Catherine Kress: I’d like to zoom in on Iran but before we do so, let’s quickly level set on the region. There’s a lot that we should be thinking about, whether it’s conflicts in Yemen and Syria, economic crisis in Lebanon, protest in Egypt and Iraq, and of course tensions in the Gulf. How should we be thinking about all of this?

    Amer Bisat: Listen, I’ve been watching and looking at the region for more years than I’d like to admit. And I honestly have never seen it as tense and as, dare I say, even dangerous as currently. Anything from the Iran-Saudi, the more recent Turkey-Syria incursion. You have civil wars still in two very important countries in Yemen and Libya, and those civil wars don’t seem to be coming to an end. Street protests that are becoming increasingly tense in Egypt, in Iraq, in Sudan. And they are threatening potentially regimes that are important for us. We have economic crisis looming in Lebanon, in Jordan, a potential implosion is not out of the question in either of these two countries. And finally, importantly as well, you have this perpetual Arab-Israeli conflict that even though it’s simmering right now could, God forbid, potentially trigger a more violent turn in places like Gaza or even Southern Lebanon. Sadly, all of this does matter. It matters for the oil market, it matters for global growth, it also matters because each of these risks could draw in external powers and could move from being regional to something broader than that. So, it’s currently a very delicate and tense moment in the Middle East.

    Catherine Kress: And you mentioned you’ve been covering the region for a long time so it makes sense that these issues are kind of top in mind for you. Do you think markets generally, or investors broadly speaking, are paying enough attention to these risks?

    Amer Bisat: Yes and no. These are risks that are sometimes intractable. They seem to be there in the background. You know they’re important, but you don’t know how to handle them. And every now and then, you get a flare-up, you get a break-out that tends to play out in two markets: the oil market and the energy market in particular, and in U.S. rates as a safe quality, safe haven trade. So, whenever these crises explode in a more dangerous way or a more violent way, you see higher oil prices and lower U.S. rates.

    Catherine Kress: Got it. And so, you mentioned that one of the key risks as you’re kind of surveying the various tensions in the region is that some of them might escalate in such a way as to bring in external actors. So, with that, I’m thinking about some of the events in Saudi Arabia that we’ve seen recently and kind of the role of the U.S. The events we saw in Saudi Arabia in September were truly extraordinary. I’d like you to walk us through your take on how they played out. I know there’s a bunch of a different stories out there, so I’m curious what your views are.

    Amer Bisat: First of all, let me make two very important observations, or larger observations. The first is that the attack on the oil processing field in Saudi Arabia was truly unprecedented. Until now, most of the tensions – even the military tensions between Iran and Saudi Arabia – have tended to happen through proxies. They tend to happen through other cold wars elsewhere. We have not seen a direct attack by the Iranians onto Saudi Arabia before. This is unprecedented. The second important observation to why the event back in September mattered is the magnitude. In one fell swoop, 10% of the oil production of the world disappeared. We never thought that something of the sort could happen, that the magnitude of the shock could be as large. For these two reasons, we started paying significant attention to that event.

    Catherine Kress: So, this event was unprecedented. However, it did follow what seemed to be a summer of escalating hostilities by Iran in the Persian Gulf region. Iranian aggression over the last few months has been largely focused on disrupting shipping, reducing compliance with the nuclear deal. What is driving this escalation of hostilities or kind of increased Iranian aggression in the region?

    Amer Bisat: That’s a great question. The reality is I’m going to be slightly longwinded here if you don’t mind. We need to understand the background to this. The first point is that the tension between Iran – and I’m going to call it the Sunni alliance led by Saudi Arabia – but the Sunni alliance more broadly, is really not new. This is decades old. Some people would go as far as say that this is a centuries-old tension, right. This is a long-term regional struggle for dominance and influence. Second observation is that there was a fleeting moment there during the Obama administration in which we thought that tension was going to recede as a result of the signing of the nuclear deal between the U.S. and Iran. We thought that maybe there’s a rapprochement, some sort of détente, between the West and Iran. The removal or the withdrawal from the Iran deal by President Trump re-awakened that tension one more time. The third observation is that, and as you pointed out, this tension didn’t come out only with the attack on the Saudi oil production. It’s been going on for a year now through a bunch of proxy wars. We saw them in the Yemen War. We saw it in Iraq. We saw it on the taking over of number of oil tankers in the Persian Gulf. So, this is something that has been brewing that eventually led to that explosion or that attack on the Saudi production facility. And finally, we have to keep in mind that the U.S., in the last two years, had been pursuing this so-called maximum pressure campaign on the Iranians by introducing extremely tough and onerous sanctions, arguably putting the Iranians in a corner and providing them with no exit ramp. So, what you end up here is, to sum up, you have a historical tension that got re-awakened by the withdrawal from the nuclear agreement that has been festering through all these proxy wars and eventually was exacerbated by these extreme sanctions that pushed the Iranians into a corner and forced them into, or arguably incentivized them, to do something dramatic along the lines of the attack on the Saudi oil facilities. So, the background matters to understand what’s going to happen in the future.

    Catherine Kress: Right, and you can almost pinpoint the exact moment earlier this spring at which point it seemed like hostilities really started increasing, and that was with the refusal to extend the sanction waivers on Iranian oil exports. So, it almost seemed kind of like a, “We’ll take your exports because you took our oil exports.” That kind of tit for tat maximum pressure campaign.

    Amer Bisat: Absolutely. And this sort of variation of the same theme. There was a political decision that seemed to have been taken by the Iranian regime that there’s a need to escalate the tension and create a painful consequence on the other side in order to maybe incentivize the U.S. and Saudi Arabia to reduce the sanctions. So there was a, dare I say, they took from the playbook of the North Koreans in that they felt that if they can push hard enough, they could maybe release the pressure on them. And the question is, will they succeed? Time will tell.

    Catherine Kress: And on that point, what was really interesting to me is the response after the attack, or rather lack there of a response, by the U.S. and Saudi Arabia. Given the significance of the attack, you mentioned it was unprecedented, of an incredible magnitude. And I’m not an expert in this, but I would have expected some form of retaliation by the two nations, namely U.S. and Saudi Arabia. But that didn’t really happen. Do you have a sense of what’s going on there?

    Amer Bisat: There are a number of factors that I think played into why the reaction by the Saudis and by the Americans ended up being less severe than we thought. The first is from the U.S. side, let’s not forget that the policy of disengaging from military presence in the region is a position that President Trump has taken from day one. This is not new, and this should not be surprising us whatsoever that he wants to avoid military conflict. He has always said that. Also, there are domestic political issues in the U.S. itself, where there are distractions. Clearly, the impeachment effort, the election calendar. This is a distraction that is hard to ignore. From the Iranian side, the Iranians have been quite good at knowing where to draw the line. The absence of a human casualty, and particularly among American personnel, is clearly a choice. So, they’re pushing as far as they can, but they’re not pushing to the point where it makes it inevitable to get an aggressive reaction. So, from both sides, the incentive seems to be that neither side wants to go into a military escalation that becomes violent. The Americans, for ideological and domestic reasons and the Iranians, because clearly, they’re worried. I mean, the military superiority of the U.S. is so clear that they really would prefer not to have a war. So, the incentives for pushing it just far enough, but not too far, seems to be the modus operandi currently.

    Catherine Kress: That makes sense. And so, speaking of things not really responding the way that we would’ve expected them to, oil markets also had a relatively muted reaction, I noticed. We saw prices spike in the first day, but that was a relatively short-lived response. How do we make sense of this?

    Amer Bisat: Three reasons, right, and they’re all equally important. The first reason is, structurally, the oil market has undergone a radical revolution in the last 10 years, and that revolution is the introduction of shale oil in the U.S. Just to give you some numbers. Oil production in the U.S. has gone up from 5 million barrels a day to 12 and a half million barrels a day in less than 10 years. The U.S. has moved from needing more than 10 million barrels a day in imports to currently no more than 3 million barrels a day. We’re not at self-sufficient yet, but we’ve become very close to self-sufficient. The oil market is significantly easier than it used to be because of the introduction of U.S. oil. We’re not going to be able to see the kind of explosively higher oil prices with that kind of new supply, reason number one. Reason number two is that demand for oil is very weak, right? We’ve gone through—and this is independent of what happened in Saudi Arabia—we’ve gone through a significant slowdown in global growth in the last year. Global growth has down shifted by more than a percent and a half in the last year and half, and it’s very much driven by the manufacturing sector. And that’s probably because of the trade tensions between the U.S. and China. But demand is weak, and when demand is weak globally, oil demand is weak as well. So, the attack on Saudi Arabia was happening at a time when U.S. production was very high and when demand for oil was low. But then there’s a third reason which is quite important and to their credit, Aramco, the Saudi oil company, was extremely aggressive in bringing back production and brought back production much faster than most people had thought. Within a few weeks, oil production is back to normality so that was also a surprise. So, weak demand, large supply, and quick recovery of oil production explains why the muted reaction in oil prices.

    Catherine Kress: So, is there, I guess, given those factors at play, is there something that could happen or what would it take to cause a more sustained reaction in the oil market whether it be in the Middle East or elsewhere?

    Amer Bisat: The first thing obviously you need and the most important, you need the markets to become tight again, right. You need inventories to start being drawn down and the way you do that is mainly through if demand picks up. So, if global growth recovers – and there is a question mark on whether growth will recover in the next few months now that the trade tension may have de-escalated – then that could make the oil market more vulnerable to the next shock. The second thing that could lead to a bigger shock than the one that we saw is if the attack obviously was larger, and the ability of Aramco to bring back production ends up being less than the previous time. So, what would take an outsized reaction would be an environment of strong demand and the larger than expected oil supply shock.

    Catherine Kress: So, we’ve been talking about oil primarily because oil prices historically have been sensitive to tensions in the Gulf. We’ve seen that with our BlackRock geopolitical risk indicators tracking some of the relationships between asset prices and the indicators themselves. Are there other areas of global markets that we should be paying attention to in light of all this, kind of beyond the oil market?

    Amer Bisat: Yeah and I would emphasize, too, U.S. interest rates. That asset class has been the most sensitive to global risk aversion that comes from geopolitical shocks. There are two reasons for that. The first is that that’s the safety instrument. That’s the one the people run to whenever there’s uncertainty. So, I would keep an eye on U.S. rates. The second reason is that this is happening at a time when the Federal Reserve has been easing interest rates, so it’s been making the path of least resistance of lower rates that much easier. So, the safety valve—the safe haven status of U.S. duration—as well as the fact that you have a central bank right now that seems comfortable easing interest rates, explains the strength of U.S. rates and the strength of U.S. Treasuries. The second area that I would focus on is what we call, more broadly, risk assets, equity markets. I would throw in equity markets, credit products like bonds, credit bonds of corporate issuers. Those have so far been resilient and, some would even go as far to say, complacent to the geostrategic shocks that we’ve seen recently. So, that’s an area I would watch carefully if there is another shock.

    Catherine Kress: Let’s bring it back to the politics. We’ve seen some de-escalation intentions and small indications of willingness to negotiate. What’s your outlook for how this plays out moving forward?

    Amer Bisat: You have to believe that the baseline right now is of the status quo continuing, which is tensions that are high but neither escalating to a point of violence nor easing to the point of a ceasefire. The baseline right now is we stay where we are for the next year, presumably until the U.S. elections goes through. That seems to be the calendar moment that people are looking at. What are the scenarios around that baseline? There is the negative scenario where those tensions -- there’s an accident. There’s a mistake. There’s something that is unexpected and we move from a cold war to a hot war. Probabilities are low, but one should not fade that as a risk whatsoever, and it could take a number of forms. It could take, God forbid, casualties, actual human casualties, an unprecedented attack that has impact that is not easily recoverable. On the other side, there’s a positive possibility and a positive scenario which is something that particularly the Europeans and within that, particularly the French presidency, President Macron has been emphasizing which is, “Let’s use this opportunity of maximum tension to bring the parties together and have a negotiating discussion.” And he’s trying very hard to bring the U.S. president and the Iranian president to talk to each other. So far, the Iranians have rejected that possibility. They’re asking for prior demands. They want things before that meeting starts. The Americans seem more open to the idea, but that is something that we know that the Europeans are working very hard on. My sense is that that’s also a low probability, but it’s not something that we should dismiss as a possibility.

    Catherine Kress: Two follow-up questions I guess related to each of those scenarios you laid out. In the first one, you mentioned that tensions kind of continue simmering. In that case, is there a risk that markets could potentially become too complacent in response, if they just think of this as business as usual, tensions continue simmering in the Gulf and then, perhaps, underappreciate or are underprepared for a potential accident?

    Amer Bisat: Very much so, and that’s more of a portfolio management, or investing thought here, and we spend a lot of our time thinking about this, when we feel that the risk that is in the market is below our own perception of the risk, we always look for cheap hedges. We always look for assets that we think are inappropriately priced for what we think is a probability of risk emerging. So, let me give you an idea. There are moments in which the price of oil in the forward markets become too low for our own perception of where the risks are, and we end up selling that forward. So, there are ways in which you try to assess the market’s perception of the risk, versus our own views on that risk, and we try to find asymmetric hedges.

    Catherine Kress: On the second scenario you laid out, the potential return to negotiations. Earlier in the conversation, you talked about how these tensions have kind of a long-running, deep-seated backdrop, that the tensions that we’re seeing in the region have been underway and have been building for some time. So, even if we see a return to negotiations, do you actually see these issues as going away, or do you think that they’re likely to stay with us for some time?

    Amer Bisat: The bar for permanent peace in the region is very, very high. Let’s start with that, and it’s for all the reasons that we’ve been talking about, not least of which is how historically deep they are, right. So, thinking slightly away from the Iran-West tension, the Arab-Israeli conflict. I mean, how many times has there been attempts of trying to solve that problem, and it just never seems to work. The bar is very, very high. However, never say never, right? Let’s not forget that Iran used to be an ally of the West until 1979 and was the closest ally of the West, until 1979. It was at the core of the Western alliance in the region. It’s an anomaly that they haven’t been. Now clearly, there are reasons for it, not least of which the Islamic Revolution in ‘79, but could we go back to a world in which Iran gets closer and gets brought back into the fold, in a way that the Obama administration clearly was foreseeing as part of the nuclear agreement. Long story short, the bar is very high. I’m not that optimistic, but it’s happened in the past. Why can’t it happen again?

    Catherine Kress: Amer, in your role as a portfolio manager, you cover a variety of other markets around the world. Staying in the neighborhood of the Middle East, let’s start with Turkey. What’s your view on what’s going on there?

    Amer Bisat: This is one very complicated situation. The first thing you want to keep in mind, Catherine, is that the tension in Northern Syria, Southern Turkey, which is where the conflict is emerging recently, is not a new conflict. And that conflict has been between the Turkish government and the Kurdish population of Northern Syria, that has always had desires for autonomy and independence. That war had been ongoing for decades, often very violent in nature. Over the past five/six years, that war went into a bit of a hiatus, a bit of a detente, and the reason is because an unholy alliance between the Turks, the Kurds, but also with the West, the U.S. that had presence there. There was an alliance to fight a common enemy. And the common enemy in that case was ISIS, that was emerging as a very powerful military presence in the region around the 2014 to 2015 frame period. Two things happened since then, right. The first thing that happened is that ISIS was defeated. So, the need for the alliance became less important. The second thing that changed, as well, is that President Trump, as part of the strategy of disengaging from the region and removing the U.S. military forces in the region, opened up a vacuum that allowed the Turks to come back and re-engage in their fights with the Kurds: (a) they didn’t need them anymore; and (b) now that the U.S. has withdrawn, they felt a vacuum has opened. That strategy of allowing the Turks to incur and even invade Northern Syria, was also a decision that was not uncomfortable for the U.S. administration, because it permitted the Turks to play the role of the policeman of the region (a) to avoid the re-emergence of ISIS, but also to be the buffer between the Assad regime, the president of Syria, which is in the South, and the Turkish government. So, it was important to see the Turks as a buffer, that ensures that ISIS does not come back, but also to ensure that the Assad regime in Syria itself remains quite weak. This, unfortunately, may not be playing out the way the desire of the plan was, right. And it’s not playing out for two important reasons. The first is that ISIS appears to be re-emerging. A lot of the prisoners that were kept in Northern Syria seem to be released, and they seem to be remobilizing again. It’s going to take effort to re-arrest them. The second unintended consequence is that, now, the Kurds have shifted alliance, and now, they are part of an axis with the Syrians, the Iranians, and the Russians as well. So, now you’ve lost an ally and you gained an axis, a more powerful axis, against you as well. It’s a very fluid situation, extremely uncertain. In an ideal world, the Turks act as a buffer, but this could play out into a significantly deteriorating situation, if that means the re-emergence of ISIS and the strengthening of the Assad regime in Damascus.

    Catherine Kress: Shifting hemispheres to another relatively-volatile situation, Argentina. Argentina’s president, Mauricio Macri, was defeated in the presidential election by opposition leader, Alberto Fernandez and his running mate, former president, Cristina Fernandez de Kirchner. Macri had been elected in 2015 with the hope of reforming the economy. What does his defeat mean for the economy and markets in your view?

    Amer Bisat: So, the Macri administration was known and characterized by its very market-friendly approach. There were two things that they wanted. They wanted to tighten the government’s spending, reduce the fiscal deficit, fight inflation—so all these things that we call macro. They wanted to do macro stabilization. But at the same time, they also wanted to do deregulation and allow the business sector to become more potent, and as a result—in their vision, restart the economy growing. Unfortunately, that game did not play out, and instead, the country went into a severe crisis last year of a proportion that is comparable to the U.S. Great Depression in the 1930s. The economic implosion of Argentina is of a very rare magnitude. That opened up the door for the opposition, and the opposition is—you would call it—left leaning. You would call it populist. It certainly has a strong linkages to the previous regime of the Peronists, the Kirchner regime before Macri came. If anything, to be clear, the vice president of President Fernandez now is Cristina Kirchner herself, who used to be the president before Macri. So, it’s a difficult situation, the country has enormous economic challenges that now are being dealt with, or now being governed by a new government that does not have the same market credentials. There are two issues that we’re going to be watching very carefully. They need to do something with the debt. They’re going to have to restructure the debt; the debt is unsustainable. And the second thing we’re going to be watching is their negotiations with IMF. Will they stay with the IMF, or will they go alone by themselves? So, their approach to the debt reprofiling/restructuring and the relationship with IMF is how we’re going to be judging the new administration.

    Catherine Kress: What other markets are you thinking about today? Or what other issues should we be keeping top of mind looking forward?

    AMER BISAT: The things that are interesting us right now are, in Latin America, we’re very interested in what’s happening in Brazil. There’s an important number of reforms that have been recently embarked upon that seems to be putting the country on an improving economic path that we’re excited about, and we’re watching quite carefully. We’re watching South Africa as a country that has significant challenges, and they’re not easy ones whatsoever, especially on the growth side. How can they restart growth? This economy has been in an anemic weak growth for years now, they have a new president who is reform-oriented, the question is will he be able to implement the reforms that he has in mind. We’re watching Indonesia quite carefully and very positively inclined in that this is a country that is very healthy, low debt, strong growth, fiscal prudence, and attractive valuations, so we’re excited and interested in it.

    Catherine Kress: Amer, this has been an incredible tour of the emerging market universe. I’d like to end now with a quick rapid-fire round.

    AMER BISAT: Go for it.

    Catherine Kress: So, first question: to manage such a large portfolio of sovereign and global bonds, you must travel a ton. How much time would you say you spend on the road meeting with government officials?

    AMER BISAT: I spend more time than I would like, at least more than my family would like. But the only way you could do and manage emerging markets is being on the ground, talking to the government officials, getting a good feel for the challenges and the issues. So, on average, I’m on the road at least once a month.

    Catherine Kress: How many countries would you say you’ve visited in your career?

    AMER BISATI have been to 64 countries in my career.

    Catherine Kress: Oh my.

    AMER BISAT: My objective is to get to a hundred, but I think I’m going to die before I get to a hundred, so.

    Catherine Kress: Every continent?

    AMER BISAT: Every continent. Except Antarctica I should say.

    Catherine Kress: Do you need, when you travel, to speak the local language of the countries you visit?

    AMER BISAT: It helps, Catherine, it really does. But it’s not absolutely necessary. Not least because English has become the lingua franca. Most government officials, if not all government officials, we talk to are very fluent in English. Not least because most governments we deal with are countries that have a strong presence in the markets. So, English has become sort of a language where you can carry most of your discussions. Does it help to know the language? Of course it does, but it’s not absolutely necessary.

    Catherine Kress: Final question, moment of truth: how many languages do you speak?

    AMER BISAT: Fluently three of them. And I have spent my life learning the other two. So, I speak English, French, Arabic quite fluently. And I’ve been trying for years, trying to learn Spanish and Russian, unfortunately not that successfully. I can handle them, but that’s not my fluency. However, and that’s important, the team that manages the money we manage, speaks 14 languages. So, we have enough people to speak 14 different languages.

    Catherine Kress: Wow, that’s far more than I can claim. Amer, thank you so much for joining us today, it was a pleasure having you.

    AMER BISAT: Completely mine, thank you very much, Catherine, for the opportunity.