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Bad news for Riyadh as an oil rebound seems unlikely

With US shale production expected to result in the US becoming the world’s largest oil producer, the oil price is likely to move lower as the Saudis prepare to float Aramco, the world’s largest oil company.

Garry white employee

Garry White

in Features


The recent correction in oil prices must have got the Saudis worried. The oil-rich Middle Eastern nation is planning the world’s largest floatation – and this may be scuppered by the US and its drive for energy independence.

Saudi Arabia’s rulers have been reducing output to try and boost the oil price – risking its long-term market share. However, fracking technology has resulted in the US pumping so much oil that it’s expected to become the largest crude producer in the world, increasing concerns that the world’s glut of oil will continue. Riyadh needs a buoyant oil price so it gets the maximum valuation possible in the flotation of Aramco, its state-owned oil company. Reformist Crown Prince Mohammad bin Salman plans to list the company before the end of 2018, generating funds to diversify and modernise the country’s economy. A sliding oil price could therefore derail the crown prince’s long-term strategic plans.

Since hitting a three year high in the last week of January, Brent crude futures fell 11% to close on Tuesday at $62.72. Investors were getting very bullish on the oil price, with hedge funds and other money managers building up record net-long bets on oil futures, a run-up that only started to fall back recently. While the Saudis have been policing its allies to ensure compliance with lower output quotas, which were first agreed in November 2016, the US has taken the Republican’s “drill baby drill” phrase to its heart.

The US is now expected to become the world’s largest oil producer in 2019, the International Energy Agency said this week, as soaring output from shale fields offsets Saudi prudence. US crude output is now 1.3m barrels a day higher than at this point last year and the IEA expects US output will surpass Saudi Arabia and could overtake Russia by the end of the year. “US producers are enjoying a second wave of growth so extraordinary that in 2018 their increase in liquids production could equal global demand growth,” the IEA said.

This should not have been a surprise. The market has been aware of the “fracklog” for quite some time, as US companies have a large amount of drilled but uncompleted wells that could be turned on when the oil price made it profitable to do so. Data from the US Energy Information Administration in January showed that the number of uncompleted wells hit a record 7,493, indicating that the potential fracklog remains high.

When this is coupled with concerns about overheating in the US economy, following recent jobs data and a very loose fiscal budget proposed by President Trump, the outlook for oil could look bearish. Although the Saudis continue to insist that all is on track for the flotation of Aramco this year, a move which could raise $100bn and value the company between $1 trillion and $2 trillion, a sustained fall in the oil price because of soaring US production may mean Riyadh has to rethink its plans. Indeed, the company is still to decide on where the potential floatation will take place.

Of course, an international stock market listing in London, New York or Hong Kong is not the only option. The international IPO could be shelved in favour of a private stake sale to strategic investors, possibly from China, alongside a domestic listing on the Tadawul exchange. It could also be abandoned entirely, although this would be a setback to the country’s modernisation plans.

However, there are some potential bright spots for Riyadh. Demand remains robust and the synchronised global economic recovery looks set to gather pace. On Monday, Opec increased its forecast of oil demand this year, with the cartel now expecting growth of 1.59 million barrels per day (bpd) this year, an increase of 60,000 bpd from last month’s forecast.

“Recently, healthy and steady economic development in major global oil demand centres was the key driver behind strong oil demand growth,” Opec said. “This close linkage between economic growth and oil demand is foreseen to continue, at least for the short term.”

Also this week, the IEA upped its demand forecasts too. The Paris-based organisation raised its forecast for oil demand growth in 2018 to 1.4m bpd, from 1.3m bpd previously, after the International Monetary Fund upped its estimate of global economic growth for this year and next.

Of course, making predictions about the future direction of the oil price is often a fool’s errand. There are many unpredictable moving parts, any one of which could wreck a forecast. These include hurricanes in the Atlantic, instability in a major Middle Eastern producer, disagreements in the Opec cartel and new technological developments. Movements in the dollar are also important for the oil price.

The dollar and commodities typically have an inverse relationship, as a stronger dollar makes dollar-denominated assets more expensive to buy in other currencies. The US currency has been surprisingly weak against other currencies, despite the fact that US interest rates are expected to rise more rapidly than elsewhere. This expected interest rate differential has to start having some impact on the dollar, with the greenback likely to strengthen over the year. This would also be a negative for the oil price.  So, with US shale production potentially rising faster than demand growth and possible dollar strength, Riyadh may have to make some difficult decisions about the world’s largest ever floatation in coming months. 

A version of this article appeared in Friday’s Daily Telegraph.

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