Rebalancing supply and demand in the global oil market

Oil prices more than halved in 18 months after Saudi Arabia raised output steeply in 2014 an attempt to drive higher-cost producers such as U.S. shale firms out of the market.
After two years of low prices that over-stretched many budgets and spurred unrest in some countries, in December 2016 OPEC and non-OPEC producers agreed for the first time in 15 years to reverse that strategy and jointly cut production. (See Fig 1)

MitonOptimal Chart

Fig 1

Compliance in the oil market

The market’s focus then switched to compliance with this new agreement, something that producers have been notoriously bad at in the past. Surprisingly, compliance has been good this time around. The best ever, probably. Over 100% in fact. Why? What’s different this time? And, will it last? (See Fig 2)

The heavy lifting in this compliance has been done by Saudi Arabia. Most of this has consisted of cutting export volumes to the U.S. – where Saudi Aramco has significant refining capacity – in favour of growing market share in China. The answers all relate to the looming IPO of Aramco.

MitonOptimal Chart

Fig 2

The World’s Biggest IPO is en route

The markets are awaiting what is expected to be the biggest public offering in history. An IPO so big it will likely make any Silicon Valley unicorn look like a blip in the market. The Saudi’s plan to offer up to 5% of Aramco in the flotation at a currently predicted price of USD100 billion. This would give Aramco a valuation of USD2 trillion, making it the largest IPO ever. Initially, the sale was expected to take place in early 2018, but the anticipated date is now late 2018 or early 2019.

Aramco was originally an American company, originally founded by Standard Oil of California (now Chevron) and was originally named the California Arabian Standard Oil Company (CASOC). It secured a concession from the King of Saudi Arabia in 1933 to look for oil, which it duly discovered in 1938 on the country’s eastern coast. By 1948, it had been renamed the Arabian American Oil Company (Aramco) and was co-owned by Standard Oil of California, Texaco, Standard Oil of New Jersey (now ExxonMobil) and Standard Oil of New York. Unlike other national oil companies in the Middle East and Latin America, the Saudis did not nationalise the company by force or fiat; the government began purchasing shares of the American-owned Aramco in 1972, until, in 1980, it acquired the entire company. Aramco remained an American company until 1988 when the Saudis formally transferred ownership to Saudi Arabia and renamed the company Saudi Aramco.

The company is responsible for all upstream, midstream and downstream oil and gas operations in the Kingdom. This includes vast oil exploration, production operations (onshore and offshore), pipelines, processing plants, refineries, tankers, marketing, sales and research and development. In addition to its oil production (upstream), the company also has an extensive network of downstream operations at refineries and holding facilities worldwide. Aramco has also participated in a variety of joint ventures in refining and petrochemical operations, both in Saudi Arabia and across the globe. Saudi Arabia’s overall oil strategy, including oil production rates, is managed by the Minister of Energy, Industry and Mineral Resources; Khalid al-Falih. Al-Falih’s position is part of the government, but he is the immediate past CEO and, also, the current chairman of Aramco.

As a company, Aramco is not active in OPEC, because OPEC is a cartel of countries that export petroleum. Saudi Arabia, on the other hand, is the most powerful single country in OPEC, because it controls the largest and most easily recoverable oil reserves in the world.

Because Saudi Arabia is the single most powerful country in OPEC, markets expect Aramco, through Saudi Arabia and OPEC, will seek to increase the price of oil before the IPO to increase the proceeds from the IPO.

And that is the reason that Saudi Arabia is doing everything it can to convince the world markets that supply and demand for crude oil are coming back into balance. So the extension of the current supply cuts are a foregone conclusion at the end of this month.

Week 47 – 2017 – Weekly Comment – AP

 

Sources:
Ellen R. Wald Ph.D. – Forbes.Com – Feb 26, 2017
CSIS.org – Center for Strategic and International Studies – October 2017
Bloomberg – November 2017

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MitonOptimal International Limited is registered in Guernsey (Registration No. 51561) and is the overlying holding company of the companies that make up the MitonOptimal Group.

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