EXECUTIVE SUMMARY

Crude oil market is trading in anticipation of OPEC meeting on May 25. There has been so much talking from OPEC about probable extension of the deal that it is possibly already priced in by the market, at least base-case scenario with higher production ceiling. Evidently, if OPEC does not deliver this, the price will collapse.  

It seems that OPEC nations are confident in the extension of the deal. However, Russia will wait until May OPEC meeting before deciding on extension of the deal. Russian oil companies have plans for investments growth and new projects to bring online in the second half of the year. Especially Rosneft has got a strong lobby and has already sent a letter to the Government with its caution on risks of the extension.

Apparently bullish view on crude oil price is mostly based on Saudi Arabia strong intentions to lift the price amid Saudi Aramco, national oil company, IPO road show.  There has been achieved some progress lately:

1.       The tax rate for Saudi Aramco has been reduced to 50% from 85%.

2.       HSBC, JP Morgan and Morgan Stanley have been hired as IPO advisors.  

In May Saudi Aramco's board is supposed to meet in Shanghai with some consortium of Chinese state-owned oil companies, banks and its sovereign wealth fund, which will act as an anchor investor in the IPO. It will be the first meeting in China in seven years.

According to Reuters’ reports, potential IPO value for Saudi Aramco, in spite of tax reduction, are still substantially lower than anticipated initially $2 trillion. Crude oil price dynamic does not help it. Brent crude oil price has been successfully supported above $50 per barrel by OPEC verbal interventions and high compliance level of the deal implementation. However rise in U.S. shale production is so overwhelming that Saudi Arabia needs to cut deeper for higher prices.

Recent news from Saudi Arabia could be interpreted as possible downside risk, the next change in crude oil market strategy:

1.       Saudi Arabia reinstated financial allowances for civil servants and military personnel.

2.       Prince Abdul-Aziz bin Salman was appointed as minister of state for energy affairs. Khalid A. Al-Falih is still minister of energy.

It looks like Saudi made preparations for new price downturn, having eased risks of social tension and political instability. Perhaps, waiting rebalancing in the crude oil market instead of cutting production deeper is preferable scenario for Aramco’s IPO. Excessive regulation for Saudi Aramco can discourage investors, in spite of higher crude oil prices supported temporarily by deeper production cuts. Saudi Arabia might choose not to be haste and postpone IPO to 2020 when significant supply deficit is forecasted due to upstream industry underinvestment.

Possible reasoning for IPO postponement is in lower urgency for all of Mohammed bin Salman Vision-2030 program, which priority aim was likely to establish the young prince in the eyes of Western audience as an impatient reformer and a modernizer. After meeting with Trump in the White House in March the purpose of Mohammed’s program was achieved and the financial allowances for civil servants and military personnel were restored.    

Meanwhile, current weakness in the price is not only negative reaction on market’s fundamentals but lack of talking support from key export countries, like Russia and Saudi Arabia. Perhaps, lower crude oil price ahead of OPEC meeting is more preferable to achieve the same high compliance level in the second half of the year. In November 2016 Brent crude oil price was about $45-48 per barrel.  

Russia announced that on May 1 it produced more than 300 thsd bbl / d less than the reference October level, fulfilling its promise. Surprisingly, it didn’t visibly support the price. There are some doubts in method of conversation tons to barrels by Russian Ministry of Energy, because in tons oil production has declined considerably less. More than that, the market looks bearish due to weak fundamental statistics:

·         Global oil inventories have increased in the first two months of the year by 105 million barrels, according to Morgan Stanley.

·         Exports from OPEC have not fallen as much as production levels:

• Tankers tracking agencies found big boost in shipping movement in April. Saudi Arabia likely exported more than 8 mln bbl /d for the most part of April. 

• Some countries like Iraq increased exports of oil products.

• Global oil shipments by tanker are at a record high in April, according to vessel-tracking data compiled by Thomson Reuters Supply Chain and Commodity forecasts.

• US net imports of crude oil and refined products plunged to 22-year low in February.

·         U.S. oil demand growth is falling and likely to stay subdued this year as gasoline, diesel,  use stay weak, according to  JBC Energy:

• U.S. gasoline station operators have reported at industry conferences that their sales are down 1.5 to 2 percent this year, according to Andy Lipow, president of Lipow Oil Associates.

• The annualized pace of U.S. auto sales, adjusted for seasonal trends, slowed to 16.9 million in April, missing analysts’ average estimate for 17.1 million. A year ago, the selling rate was 17.4 million. The four-month slump reinforces estimates for the U.S. auto market’s first annual contraction since 2009, the year GM and Chrysler reorganized in bankruptcy court.

·         EIA reported oil production for February even higher than in doubtful weekly estimates suggest (9.031mln bbl / d vs weekly 9,017mln bbl / d):

• According to Rystad Energy, U.S. oil production can grow on at 100 thsd bbl / d pace every month.

End-April oil production in the USA was more than 200 thsd bbl / d higher than pre-OPEC meeting in November 2014 (9293 thsd bbl / d vs 9083 thsd bbl / d) when Saudi Arabia chose market share strategy instead of backing crude oil price.

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22 May 2017, Arbat Capital

oil, investment, equity

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