As Brent oil prices threaten $70/bbl, we start to observe President Trump's disapproval by his angry tweets demanding OPEC (really only Saudi Arabia) start "opening their taps" and raise production. President Trump has just one incentive, keep oil prices at a reasonable level so that shale is comfortable -- but low enough to show to the American public how "great" America is. OPEC, on the other hand, has a different agenda altogether. They strike a tough balance between pleasing their key ally, the U.S., and their domestic needs.
OPEC and Russia, which has come to be known as the new OPEC+, really puts Saudi Arabia and Russia as the main swing producers, given the constraints of the other OPEC members. In December, OPEC+ agreed to cut oil production by 1.2 million barrels per day (mbpd) with a plan to discuss their strategy in April. A few weeks ago, OPEC cancelled the April meeting.
The Joint Ministerial Monitoring Committee (JMMC) will meet in May with a full group meeting on June 25 to decide whether to extend cuts through the rest of 2019. For now, it was too early to put their foot on the gas (no pun intended!). The group has delayed the decision, as they feel the market remains oversupplied, according to Saudi Energy Minister Khalid-al-Falih.
Most of the above-mentioned production cuts have come from Saudi Arabia. Russia has only met their target cuts by half, with a promise to be at their target rate over the next few weeks. According to the International Monetary Fund (IMF), Saudi Arabia would need oil prices closer to $80-85/bbl in order to balance its 2019 budget.
Government officials will never discuss "targeted oil prices," so this is just estimated based on FX reserves, budget and spending plans proposed. For this year, the Kingdom announced its highest-ever budget of $295 billion, even higher than the record budget set in 2018 for $261 billion. There is no doubt that they would like, or rather need, higher oil prices. But they must rise slowly and gradually -- not shooting higher, as that can curb consumer demand.
Saudi Aramco, the state-controlled giant that is responsible for roughly 10% of world oil production, for the first time opened its book to the outside world as it recently embarked on a $10 billion bond offering. We all knew the company was hugely profitable, but just how much was anyone's guess. Studying the last three years of financial records, Saudi Aramco's profits have beaten profits of tech behemoths like Apple (AAPL) , Exxon-Mobil (XOM) , and even Royal Dutch Shell (RDS.B) , making it the world's most profitable company.
Aramco produces about 13.6 mbpd vs. Exxon's 3.8 mbpd. In 2018, it recorded profits in excess of $110 billion on $360 billion of revenue. To put it in perspective, that is almost double Apple's profit of $60 billion and five times Royal Dutch Shell's $24 billion. The fact of the matter is that in 2018, when oil prices averaged closer to $70/bbl, Aramco's net income rose by 50%, from $76 billion in 2017.
In 2016, when oil prices were at the lowest in a decade (~ $45/bbl), their net profit was just $13.6 billion. That is how leveraged, or dependant, Aramco is -- and by default the State is -- to the oil price. Hence, the delicate balance they need to strike to keep their ally happy and also be able to grow sustainably.
This bond offering will be used to finance its planned acquisition for Sabic, the Saudi state-held industrial chemicals company. The Kingdom had in the past intended to float 5% off Aramco, or some $100 billion depending on the right valuation, but these plans have been put on hold until further notice. Following this latest $10 billion bond offering, perhaps investors see the company in a new light as to how lucrative it is, especially vs. the usual suspects -- the FAANG stocks that they have been throwing money at all these years.
One thing is clear: Despite political agenda and conflicts of interest, the oil market will settle where it needs to be based on its physical market balances. The timing can be altered a bit due to seasonality, but end of the day, it is just about inventories. The market excess has been cleaned up over the past few months, demand is stable, so oil seems stable around $70/bbl. Winter heating demand has been stable.
The risk is if we actually see a slowdown in global trade as we enter the second quarter. If so, the oil price will sell off along with other assets. There seems to be a floor around $45-50/bbl, as that is when producing member states start getting vocal. It is not a tight market, just a more balanced one. The question is how demand and global GDP will be going into Q2, as that will dictate the fate of the oil price more than sensationalist angry tweets by Trump.
Oil stocks have been underperforming the rise in oil price, but they generally tend to underperform the commodity, given their longer-duration stance. If oil is at the top end of its range, despite how cheap oil stocks are, they can still get cheaper if the oil price falls.
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