It has been a topsy-turvy story for the most traded and (politically and economically) significant commodity in the world. Welcome to the world of Crude Oil. Back in 2014 when the war between Sheikhs and Shale begun, Saudi Arabia deliberately balked to play the role of, what has been called, Swing Producer of the world. By refusing to turn off the taps Saudis envisaged a future that will, acting out of the principle of survival of the fittest, drive out high-cost producers (most importantly US Shale).
But the strategy went awry. To their, and everyone surprise, even opposite. After a year in 2015 it was Kingdom burning through their cash reserves at a precarious rate. Subsidies were cut, holidays curtailed, salaries slashed. Government largesse, of which the Saudi masses are acquainted with, were shrunk at an uncomfortable rate. There was an imminent chance of a social unrest, if things had continue to be so. Fortunately, they didn’t. After much ado, OPEC was able to strike a last minute deal with Non-OPEC producers. Oil prices, after touching a nadir of $26, climbed up, gradually smashing through the $50 psychological mark. Articles and opinions were replete with positivity and that the act of rebalancing has begun. But across the pacific matters were quite different.
US Shale boom, Fracking 2.0. It has been called many names. The technological innovations in drilling and fracking coupled with certain softwares rendered the US shale industry a chance to stand in the face of low oil prices. The world saw how costs in US plunged almost 30-40%. In some areas such as Permian Basin it is even low. Instead of ousting the Shale producers, the days after the Vienna oil accord (signed 30th November 2016) saw an utterly different phenomena: rise in Shale production. Let us have a look at fundamentals. Right now the inventories stand at 527.8 million barrels down from the historic high of 535 million-not at all a bullish level, indeed. The rig count is also high: 697, highest since August 2015. The US shale production increased by 17,000 barrels per day this month. Total production has risen from 8 million barrels per day to 9.2 million barrels. Expected to touch 9.7mbpd by 2018. Bearishness spread all over! We are back at square one: oil prices are back to the pre-deal level and there has been a deluge of selling in the markets. Bloomberg reported today (5th May, 2017) “The number of contracts traded in a minute — usually in the hundreds early in the trading day — surged above 7,000 on WTI at 4:28am London time”.
Now coming back to Middle-East. The KSA, after the prices stabilized has become stable as well. Deputy Crown Prince Muhammad Bin Salman is trying to ease things up. In a gerontocracy which doesn’t likes the idea of a young man getting hold of the bridles of the country, it is no doubt an achievement for the young scion that he has been able to kick-start projects that will diversify the Saudi economy disconnecting, to a great extent, its dependence on oil. About 90% of Saudi revenue comes from Oil exports. But now The Saudi Vision 2030 and the National Transformation Plan, attempts to wean itself from oil, calls for a bright future, provided both the plans are implemented in letter and spirit. But why are we talking about these projects and plans? Because they lead us to what is being dubbed as the creation of the largest sovereign fund in the world. Behold, Aramco. According to some estimates it is the largest company on earth big enough to swallow Alphabet Inc., Berkshire Hathaway, Microsoft and still leaving some room for Apple Inc! Albeit its history has been shrouded in controversy due to the absence of any proper documentation and transparency now it is going public. There will be an IPO, late 2018, in which 5% shares of Saudi Aramco will be floated which is supposed to create a $1trillion sovereign fund. Once again, why Aramco? That is because it takes us to the deal. To the question that whether, on 25th May when the OPEC and NOPEC oil producers meet, the deal that was originally decided to be implemented for first six months of the year, will be extended or not? It takes us to the nuances that why KSA in the first place not only convinced OPEC and NOPEC producers to reach an entente but also went an extra mile cutting production more than what it had initially promised. It was because KSA needs oil prices more than $50 not only for the impending IPO but also for maintaining their economic health. It has reduced its tax from 85% to 50% to make Aramco more lucrative. Moreover, other Middle Eastern producers also need a stable oil as their revenue mostly depends upon oil, no surprise! Libya and Nigeria were exempted from the deal but they are in doldrums partially because of security issues and partially, economically. See what is happening in Venezuela. In a single phrase it is ripping apart, all because of low oil prices. With a war engulfed Syria a fuming refugee crisis, Middle East cannot afford another tumult as the consequence of low oil prices. Hence, my guesstimate is that there will be an extension, may be it is not for whole 6 months. Although, Saudi Oil Minister admonished the ‘free-riders’ at CERAweek and recently echoed that it is too early to decide, I think the Kingdom has to succumb to ground realities. This will give a support to oil prices for the remaining year.
I will conclude with a catch-22 situation: Suppose there is an extension and that the oil prices rise. What this augurs for the Shale producers (Read USA)? Euphoria! With cries of hurray their derricks are going to ooze out more black gold as higher prices makes it feasible to do so. Subsequently the rising prices will start to feel downward pressure and either come down or, in the best case, become stagnant.
A question to the readers: What is then the fun in extending the deal? Bitter, yet a reality.