Daily Management Review

Does Saudi Arabia really need expensive oil in 2017?


Saudi Arabia may not be as weakened as one would expect, even though the oil market is vulnerable in the face of reductions carried out by major world oil producers.

The Saudis are playing a longer game, analysts at RBC Capital Markets said. This can be explained by the fact that the key elements of the ambitious plan "Vision 2030" are concentrated in 2018, says Helima Croft, head of the commodity strategy department at RBC. This includes the decisive partial IPO of Saudi Arabian Oil Co, whose capitalization could reach $ 2 trillion.

"The Saudis may fear a scenario in which the oil rally in 2017 will destroy the restoration of 2018, contributing to the flow of production from the US. Therefore, there may be a real advantage in waiting and keeping some moves in the reserve," Croft noted.

The fall in oil in 2017 was a disappointment for the bulls who expected oil to be supported by the oil freeze agreement between OPEC and other major producers concluded last year and extended this spring.

Croft’s colleague, Michael Tran, argued that the Saudis should avoid a situation that occurred in the last six months, when "the flexibility of production in the US was the biggest driver of falling oil prices." The price rally, which will cause another round of hedging by US producers, "is the worst scenario for the kingdom, given that it will open the way for lower prices next year, while the Saudis need significantly higher prices," Tran wrote.

In other words, a large rally would now give the shale miner a chance to block these higher prices and save or increase production next year.

Nevertheless, the Saudis may face these events if the increase in production in Libya and Nigeria, which were exempt from the contract to reduce production, will be more stable in the IV quarter.

This could force Saudi oil minister Khalid al-Falih to fulfill the May promise to cut more and make room for unstable producers, Croft said. She also added that it would be better for the Saudis to find a way to include both countries in the agreement to reduce production, given the lighter oil brands they produce, and a clearer signal that such a step would have to direct "the common responsibility of OPEC."

The cost price of Saudi oil is one of the lowest, according to Rystad Energy and CNN. Nevertheless, the kingdom is making desperate attempts to reduce production, being unable to cope with the current level of prices.

According to the Wall Street Journal, while costs of the 13 major producers are declining, the production of each barrel of oil in Saudi Arabia can cost $ 8.98 - slightly less than in Iran ($ 9.08). For comparison, production of one barrel of shale oil is worth $ 23.35 in the US.

This includes taxes, net manufacturing costs, administrative expenses and capital expenditures. When it comes to the cost of production, Saudi Arabia actually lags behind Iraq, Iran and Russia, but in other areas, taxes, for example, it has an advantage almost to all the others, as its oil production is not taxed.

Taxes in the process of oil shale production should bring $ 6.42 per barrel, for non-oil producers - $ 5.03 per barrel. Thus, based on last year's indicators, Saudi Arabia has a significant advantage compared to its main competitors: oil is on the surface, the weather is not as severe as in Siberia, and Aramco does not pay taxes. So why do some analysts argue that shale miners can break out ahead?

The melting reserves

Saudi Arabia has lost one-third of reserves in less than 3 years.

If Saudi Arabia lost 11% of its reserves in 2014, 11% of reserves in 2015 and 11% in 2016, guess how much reserves it will lose in 2017? Saudi reserves are now $ 493 billion, and it will drop another 11% to $ 438 billion, or even $ 400 billion by the end of 2017.

All other assets, be it long-term investments, oil and other assets abroad, or real estate, are not at all easy to sell. Currency of the Persian Gulf countries pegged to the dollar will be abolished. Perhaps Oman or Bahrain will be the first to bend under pressure. The rest will just have to follow them.

A reasonable explanation is the fall in oil in June 2014. The first two years after, the Council of Cooperation of the Arab States of the Persian Gulf could use reserves.

The next two years until the end of 2017, they will be able to support borrowing by issuing bonds. The pressure will increase significantly when they start to experience a decline due to excessive borrowing (just what happened in Oman and Bahrain).

Oddly enough, the decline in reserves continues even after introduction of sharp austerity measures aimed at reducing the budget deficit, which had an impact on the economy and led to a halt in the growth of the non-oil sector last year. According to Bloomberg, loans, advances and overdrafts in the private sector decreased by 0.6% in April compared to the same month a year earlier.

In addition, the GDP of the world's largest oil exporter will grow by only 0.6% this year, from 1.1% in 2016.

Meanwhile, local authorities say that growth will exceed 1% in part because of a plan to launch a stimulus package for the next four years with a volume of 200 billion riyals.

The measures are primarily aimed at the private sector. Mohammed Al-Jadaan, the Minister of Finance of the Kingdom, said in April that the government did not use the central bank’s reserves during the first quarter.

Last year, Saudi Arabia proved that it was carrying out the largest economic restructuring in the kingdom’s history in order to reduce dependence on oil revenues.

Among other steps, the plan implies cutting subsidies and selling stakes in several companies, including the Saudi oil company Saudi Aramco. The latter was the initiator of the rise in oil prices, even if it meant giving way to the US shale market, drastically changing the strategy from the end of 2014.

source: rbccm.com, reuters.com