Despite Low Energy Weight, It's All About Oil For Saudi ETF

The iShares MSCI Saudi Arabia Capped ETF KSA, the first exchange traded fund devoted exclusively to stocks in the largest member of the Organization of Petroleum Exporting Countries (OPEC), debuted in mid-September. Said another way, an ETF tracking stocks in a nation highly dependent on oil production as a driver of government revenue debuted in the midst of a lengthy and still ongoing slide for crude.

While there is talk of an initial public offering for Saudi Arabian Oil, the kingdom's state-controlled oil producer, KSA's direct energy sector exposure is scant. Energy stocks account for less than 1.1 percent of KSA's weight, making that the smallest of the nine sectors represented in the ETF, according to iShares data. 

Materials stocks do account for nearly 29 percent of KSA's weight, but of the 52 stocks held by the ETF, nearly a third are financial services names. Still, KSA has been and will likely to continue to be plagued by lower oil prices. The ETF has lost 13.4 percent since coming to market while the United States Brent Oil Fund BNO has plunged nearly 32 percent over the same period.

“By 2018, if there has not been significant cuts to non-OPEC oil production (and therefore commensurately higher oil prices), Saudi Arabia will admit defeat as access to the international bond markets will become increasingly difficult and its store of assets would be largely dwindled,” said ETF Securities in a recent note. 

Inability to fully access international credit markets could deal a blow to Saudi Arabia's efforts to open its financial markets to foreign investors and those investors' hopes that the kingdom could eventually join the widely followed MSCI Emerging Markets Index. For now, the kingdom is not even included in some of the most popular frontier markets benchmarks. 

KSA is the fourth single-country ETF tracking stocks in an OPEC member state. In 2015, the other three members of that quarter, each of which traded for the entire year, posted an average decline of roughly 18 percent. Each of those countries, including Qatar and United Arab Emirates, is highly dependent on oil for government revenue, but in Saudi Arabia, oil represents 80 percent of government revenue.

“The Saudi Arabian authorities had negligible debts in 2014 and an arsenal of assets coming into the price shock. Saudi Arabia can use these assets to fund current spending. However the accumulation of deficits will see its debts increase substantially. Its net assets will erode by 2018, as debts are increased and assets are run down. By 2018 gross debt to GDP is likely to hit 33% while net debts will rise to 17% and potentially continue to rise beyond this point,” adds ETF Securities.