Saudi Arabia switches OPEC tack with eye on world’s top IPO

By Anthony DiPaola on 12/6/2016

RIYADH (Bloomberg) -- To understand why Saudi Arabia changed course and decided OPEC should go back to managing supply, look at two of the kingdom’s biggest policy challenges: the urgent need to plug holes in its budget and the plan to sell a stake in the state-owned oil monopoly.

Two years after the world’s biggest exporter backed the Organization of Petroleum Exporting Countries’ switch to a pump-at-will strategy to defend market share, Saudi Arabia’s oil minister promised to bear the biggest burden in curbing global supply. The market response suggests it may have been the prudent thing to do. By promising to cut production by just 4.7%, the country gained an 18% jump in oil prices.

The pain of prices below $50 had become too much for the Arab world’s largest economy. Saddled with budget deficits, the country cut spending and burned through more than a quarter of its foreign financial reserves in two years. The persistent price slump also threatened the centerpiece of the reforms sketched out by the country’s powerful deputy crown prince, Mohammed bin Salman: privatizing what could become the world’s biggest publicly traded oil company, Saudi Arabian Oil Co.

“Even $60 oil isn’t enough to solve all the country’s fiscal issues,’’ Apostolos Bantis, a credit analyst at Commerzbank AG in Dubai, said in an interview. “It’s more a question of building confidence in the economy. If crude stabilizes at higher prices, that will give more certainty and provide a stronger basis for the Aramco IPO.’’

Brent crude has jumped to about $55/bbl since OPEC’s Nov. 30 decision to cut about 1.2 MMbopd from its collective output. Saudi officials will meet counterparts from Russia and other independent producers on Dec. 10 to arrange a reduction of 600,000 bopd in non-OPEC supply.

“For the Saudis, success would look like oil prices where they are now or a bit higher,” said Robin Mills, chief executive of Dubai-based consultant Qamar Energy. “The best outcome would be fighting shale to a draw and maintaining market share.”

The kingdom’s cabinet said Monday that the OPEC accord will stabilize oil markets and lead to greater investment in the industry, according to the official Saudi Press Agency.

When OPEC met in November 2014, Saudi Arabia refused to cut output in the face of oversupply, leading Brent crude to collapse from its peak that year of more than $115/bbl. The country has since sold its first international bonds, raising $17.5 billion in the biggest-ever issue from an emerging-market nation, and is taking steps to make the Middle East’s largest stock market more accessible to foreign investors.

It’s also preparing to sell as much as 5% of the state oil company, the crown jewel known as Saudi Aramco.

OPEC’s output deal won’t undo the fiscal damage wrought by three years of falling oil prices. For the Saudis, the agreement isn’t so much about getting the country back in the black as it is about underpinning an ambition to wean the economy off oil, Bantis said.

Bantis and Qamar’s Mills both see oil staying above $50/bbl next year, with Mills forecasting Brent at between $55 to $60 for the six months that the deal is in place. OPEC can extend the deal for another six months. Brent was 0.3% lower at $54.76/bbl at 12:08 p.m. in Dubai.

Break-Even Price

Prices are “still far below break-even levels” for Saudi Arabia, said Edward Bell, an analyst at Dubai-based bank Emirates NBD PJSC. The country’s fiscal break-even price will drop to $79.70/bbl this year from $92.90 in 2015, the International Monetary Fund said in October.

Saudi Arabia agreed to pare its production by 486,000 bopd, to 10.058 MMbopd, according to OPEC. Iran, which the Saudis oppose in proxy wars from Syria to Yemen, is authorized to boost its output under last week’s accord. 

Saudi Arabia is taking “a big risk” by reversing the pump-at-will strategy it had pursued to win market share, Mills said. If prices fall or if too much non-OPEC oil floods the market, the Saudis could come under pressure to make deeper cuts, he said.

The architect of Saudi Arabia’s pump-at-will policy, former oil minister Ali al-Naimi, said last week the new approach could work, if OPEC members hold to it.

His caveat: “The unfortunate part is we tend to cheat.”

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