Brent oil could fall to $25-$30 per barrel in 2016, BofA-Merrill Lynch says

Downward pressure on oil prices as China’s currency weakens could force Saudi Arabia to de-peg its currency from the US dollar and in turn weigh further on emerging market growth next year, analysts said on Friday.

Bank of America-Merrill Lynch said it expected the Chinese yuan to depreciate next year to reach 6.90 versus the Greenback, adding to the selling pressure on the commodity space.

In parallel, if Brent crude oil prices dropped to $30 per barrel the rate at which the Oil Kingdom’s FX reserves were drained could accelerate to $18bn a month, weighing on the currency.

“In our view, it is unlikely that Saudi leaders would want to exacerbate the on-going reserve drain by pushing Brent prices below $40/bbl. After all, pressure will quickly build on the riyal's 30-year peg to the USD if oil prices keep falling below the current levels.

“Frankly, it is a lot easier politically at first to deliver a modest crude oil supply cut than to implement a full-blown currency devaluation.”

Saudi devaluation is BofA Merrill Lynch’s ‘number one’ Black Swan event for 2016

Be that as it may, a “sharp” move in the yuan could force Riyadh’s hand, BofA-Merrill Lynch said.

The upshot is that if Saudi Arabia cuts oil output in a bid to push Brent crude prices back above $50 then emerging market growth could stabilise at these lower levels and eventually recover, the broker said.

However, if Saudi Arabia is forced to untie its currency and it weakens, following the Brazilian and Russian currencies lower, then oil could collapse to $25 per barrel.

“Thus, even if micro oil supply and demand dynamics continue to improve, the path for oil prices in 2016 will be closely linked to moves in the USD, CNY and SAR. Or to a last minute Saudi oil supply cut.”

“Our analysis suggests that: (1) the USD is far from historical highs and (2) the USD may continue to appreciate long after an initial contraction in US monetary policy. Put otherwise, too many commodities could keep chasing too few USDs.”