BP Bids Likely to Be Short-Term Support for Sterling

The British pound has continued to strengthen in the past week, especially against the US dollar. Up till now, with the country’s economic turmoil and rising public concern over divided central bank officials, currency market sentiment sold the sterling short. However, some new speculation regarding one of Britain’s largest companies has helped to at least support the underlying currency in the short term.

On the heels of creating one of the worst oil spills in American history, BP may be accepting funds from one of the world’s largest sovereign wealth funds – Abu Dhabi. On July 13, crown prince and fund board member Sheikh Mohammed bin Zayed Al Nahyan said the fund was “looking across the board” when it came to a potential investment in BP. No confirmation has been given, of course, and authorities stress that the investment is currently one of many opportunities.

Of course, “opportunity” isn’t a word many people associate with BP these days. The beleaguered oil companies now looking to fund a $20 billion promise to help alleviate public distress over its oil spill.

But exceptionally large investments in troubled companies are definitely not all that foreign to Abu Dhabi and its wealthy investors. Back in October 2008, amid the collapse of the global financial system, investors from the region came to the rescue of Barclays PLC. Abu Dhabi’s royal family chipped in 3.5 billion pounds – giving them an outstanding 16% ownership in the UK-based bank.

And the bet paid off. Just nine months later, the royal family sold the shares, ultimately reaping a 2.2 billion-pound gain – a 42% increase in wealth. With BP in such distress – and a double-digit potential for returns – it would be difficult to ignore this new opportunity..

Officials in China recognize the potential opportunity, too. A country that has already spent upwards of about $20 billion in investments in raw commodity producers over the last two years, Beijing is always on the lookout for bargains. (In fact, it also saw a decent return by investing in Barclays shortly before Abu Dhabi jumped in.)

In the second quarter of 2008, Chinese officials made a $2 billion investment in BP. This equated to a small 1% portion of the company, but it kept China’s interests solidified in a key global oil producer. The two-year relationship is now likely to lead to other deals in the short term.

Recently both sides have begun talks for a $9 billion purchase of BP’s stakes in South America – specifically, Argentina. The transaction would involve the state-owned China National Offshore Oil Company, or CNOOC, increasing its already 20% stake in the area. A win-win, the deal would further solidify China’s hold on global commodities while boosting BP’s need for funding.

The enormity of both the Abu Dhabi investment and the CNOOC deal is set to boost British pound prospects in the short term. This is because the pound sterling will be used as a base currency for the transactions – an exchange currency to both the Abu Dhabi dirham and the Chinese yuan. The price of the investments will be quoted in pounds, and therefore will be settled in pounds. As with anything, an increase in the demand for a currency will help strengthen it against its counter currency.

Against the greenback, the sterling will remain supported. But the effects could be even more powerful against the Swiss franc. A 25-basis point investment yield advantage will also help to boost a preference for the British currency against a lower yielding currency like the Swiss franc. Now throw in the fact that the British pound/Swiss franc currency pair has precipitously fallen by about 36% over the last three years. The currency was able to gain some strength in the first half of 2009. But, the move wasn’t sustainable – kicking the currency pair back down to retest decade lows.

Although the current economic condition of the UK warrants a continually bearish outlook for the pound sterling, there may be a silver lining for its currency in the short term. With speculation of cash injections and investments into BP – and smaller interests – likely to surface in coming months, simple demand may be enough to support a short-term rise in the currency against a low yielding Swiss franc.

Richard Lee
for The Daily Reckoning