Saudi Arabia’s ‘Vision 2030’ is looking a lot less clear

Saudi Arabia’s U-turn to revive oil output quotas is not working and fails to address the changing future of oil demand, as I describe in my latest post for the Financial Times, published on the BeyondBrics blog

Saudi Arabia’s move into recession comes at an unfortunate time for its new Crown Prince, Mohammed bin Salman (known to all as MbS).

Unemployment is continuing to rise, threatening the social contract. In foreign affairs, the war in Yemen and the dispute with Qatar appear to be in stalemate. And then there is the vexed issue of King Salman’s ill health, and the question of who succeeds him.

This was probably not the situation that the then Deputy Crown Prince envisaged 18 months ago when he launched his ambitious “Vision 2030” programme and set out his hopes for a Saudi Arabia that was no longer dependent on oil revenues. “Within 20 years, we will be an economy that doesn’t depend mainly on oil . . . We don’t care about oil prices — $30 or $70, they are all the same to us. This battle is not my battle.”

The problems began a few months later after he abruptly reversed course and overturned former oil minister Ali al-Naimi’s market share policy by signing up to repeat the failed Opec quota policy of the early 1980s.

His hope was that by including Russia, the new deal would “rebalance” oil markets and establish a $50 a barrel floor under prices. In turn, this would boost the prospects for his proposed flotation of a 5 per cent stake in Saudi Aramco, with its world record target valuation of $2tn.

But, as the chart above shows, the volte face also handed a second life to US shale producers, particularly in the Permian basin, which has the potential to become the world’s largest oilfield. Its development had been effectively curtailed by Mr Naimi’s policy.

The number of high-performing horizontal drilling rigs had peaked at 353 in December 2014. By May 2016, the figure had collapsed to just 116. But since then, the rig count has trebled and is close to a new peak, at 336, according to the Baker Hughes Rig Count.

Even worse from the Saudi perspective is that oil production per Permian rig has continued to rise from December 2014’s level of 219 barrels a day. Volume has nearly trebled to 572 b/d, while the number of DUC (drilled but uncompleted) wells has almost doubled from 1,204 to 2,330.

Equally disturbing, as the second chart from Anjli Raval’s recent FT analysis confirms, is that Saudi Arabia has been forced to take the main burden of the promised cutbacks. Its 519,000 b/d cut almost exactly matches Opec’s total 517,000 b/d cutback.

Of course, other Opec members will continue to cheer on Saudi Arabia because they gain the benefit of higher prices from its output curbs.

But we would question whether the quota strategy is really the right policy for the Kingdom itself. A year ago, after all, Opec had forecast that its new quotas would “rebalance the oil market” in the first half of this year. When this proved over-optimistic, it expected rebalancing to have been achieved by March 2018. Now, it is suggesting that rebalancing may take until the end of 2018, and could even require further output cuts.

Producers used to shrug off this development, arguing that demand growth in China, India and other emerging markets would secure oil’s future. But they can no longer ignore rising concerns over pollution from gasoline and diesel-powered cars.

India has already announced that all new cars will be powered by electricity by 2030, while China is studying a similar move. China has a dual incentive for such a policy because it would not only support President Xi Jinping’s anti-pollution strategy, but also create an opportunity for its automakers to take a global lead in electric vehicle production.

It therefore seems timely for Prince Mohammed to revert to his earlier approach to the oil price. The rebalancing strategy has clearly not produced the expected results and, even worse, US shale producers are now enthusiastically ramping up production at Saudi Arabia’s expense.

The kingdom’s exports of crude oil to the US fell to just 795,000 b/d in July, while US oil and product exports last week hit a new record level of more than 7.6m b/d, further reducing Saudi Arabia’s market share in key global markets.

The growing likelihood that oil demand will peak within the next decade highlights how Saudi Arabia is effectively now in a battle to monetise its reserves before demand starts to slip away.

Geopolitics also suggests that a pivot away from Russia to China might be opportune. The Opec deal clearly made sense for Russia in the short term, given its continuing dependence on oil revenues. But Russia is never likely to become a true strategic partner for the kingdom, given its competitive position as a major oil and gas producer, and its longstanding regional alliances with Iran and Syria. China, however, offers the potential for a much more strategic relationship, which would allow Saudi Arabia as the world’s largest oil producer to boost its sales to the world’s second-largest oil market.

China also offers a potential solution to the vexed question of the Saudi Aramco flotation, following the recent offer by an unnamed (but no doubt state-linked) Chinese buyer to purchase the whole 5 per cent stake. This would allow Prince Mohammed to avoid embarrassment by claiming victory in the sale while avoiding the difficulties of a public float.

The Chinese option would also help the kingdom access the One Belt, One Road (OBOR) market for its future non-oil production. This option could be very valuable, given that OBOR may well become the largest free-trade area in the world, as we discussed here in June.

In addition, and perhaps most importantly from Prince Mohammed’s viewpoint, the China pivot might well tip the balance within Saudi Arabia’s Allegiance Council, and smooth his path to the throne as King Salman’s successor.

Paul Hodges and David Hughes publish The pH Report.

The post Saudi Arabia’s ‘Vision 2030’ is looking a lot less clear appeared first on Chemicals & The Economy.

Naimi finally allowed to retire, Saudi oil policy stays the same

Naimi, Falih May16

80-year olds are allowed to retire, even if they have to wait a year for final permission to be given.  But it seems a simple headline saying “Saudi Oil Minister retires after 69 year career” is not “exciting” enough in today’s media world?  So perhaps we can’t be too surprised to find some of the world’s media using headlines such as:

  • “Saudi Arabia just fired its oil minister”
  • “Saudi Arabia Dismisses Its Powerful Oil Minister Ali al-Naimi”

But it is still disappointing that a desire for “clicks” should over-ride the facts, particularly on such a critical issue.

It has, after all, been common knowledge that the 80-year old Naimi wanted to retire a year ago, after the death of Saudi King Abdullah.  He was only persuaded to stay on to provide continuity.  Now, just before Ramadan begins on 7 June, is an ideal moment for the long-planned handover to Saudi Aramco chairman Khalid al-Falih to take place.

One benefit of his year-long lead-in to retirement was that Naimi was able to give a “retirement interview” to Daniel Yergin at the IHS/CERA conference in February.  This was a tour de force of everything that Naimi had seen and learnt during his 69-year career in the oil industry, which began when he joined Saudi Aramco as an office boy in 1947.

The question-and-answer session with Yergin was highly revealing of Naimi’s and Saudi thinking on the outlook for oil prices, particularly when he dismissed suggestions that OPEC production might be cut to rebalance the market.

Arguing that this decision was made in November 2014, he described the freeze concept as being modest in scope, even it it was possible to make it happen, due to the “lack of trust” between the major producers:

A freeze is the beginning of a process and that means if we can get all the biggest producers not to add additional barrels, then this high inventory we have now will probably decline in due time, its going to take time.  It is not like cutting production, that is not  going to happen, because not many countries are going to deliver even if they say they will cut production, they will not deliver.  So there is no sense in wasting our time seeking production cuts, they will not happen.”

Today it is clear that even the freeze concept has been abandoned.  So in terms of oil market developments,now is a sensible moment for Naimi to move into his well-deserved retirement.  But lets be clear. He wasn’t fired or dismissed.

Equally important is that the change of personnel doesn’t mean any change is likely in Saudi oil policy.  This has always been a slow-moving process, controlled at the highest level of the government.  And as Naimi explained to Yergin, the key decisions were made as long ago as November 2014.

The fact that even a freeze has proved impossible to agree, reconfirms the rationale for the decision.

My weekly round-up of Benchmark prices since the Great Unwinding began is below, with ICIS pricing comments:
Brent crude oil, down 57%
Naphtha Europe, down 53%. “Arbitrage window to Asia shut”
Benzene Europe, down 53%. “Market is still facing the structural challenges of limited liquidity”
PTA China, down 40%. “Weaker upstream feedstock prices and diminished buying sentiments dampened discussion levels.”
HDPE US export, down 27%. “Talk of falling values in a few Latin American countries.”
¥:$, down 5%
S&P 500 stock market index, up 5%

Saudi lets ‘market decide’ on oil prices to maximise local jobs

OPEC refining Feb15

I was kindly invited last week to give a keynote address at the annual ME-TECH conference in Dubai.  Naturally, there was intense interest in my argument that oil prices were most unlikely to recover to the $100/bbl level.

Instead, I suggested they would likely return to their long-term historical average of $33/bbl (in $2014).  And I argued that this would be good news for the global and Middle Eastern economies.

The chart above highlights a key issue in my analysis.  Based on official OPEC data, it shows how:

  • OPEC’s own refining output grew 245% between 1980-2013, from 3.3 mbd to 8.1 mbd (blue area)
  • OPEC’s share of world refinery output grew as a result from 5.6% to 9.5% (red line)

This development highlights the change of direction underway in oil policy in key nations such as Saudi Arabia.  They now have a much greater stake in promoting downstream demand, in order to create local jobs in the region.

One key issue is that exports from this new refining capacity effectively increase OPEC’s total oil exports.  Commentators usually only focus on OPEC’s actual oil production.  Yet its exports of refined products are equally important to global oil supply and demand balances.

Even more important is the opportunity that new refining capacity provides to create jobs in downstream industries such as plastics and other value chains.  This is critical for social stability, as the Middle East is one of the few world regions with relatively young populations of median age 25 – 30 years.

Governments who wish to remain in power, know they have to provide jobs for these young people, or risk mounting social unrest.  And so whilst it may be more profitable to ship high-priced oil to markets in the US, Asia and Europe, job creation is becoming a more important priority.

Jubail refiningThus Saudi Arabia is in the middle of a major refinery expansion, as the picture on the right shows of the new Jubail refineries.  These add 0.8 mbd to Saudi capacity, with a further 0.4 mbd capacity planned at Jazan for 2017.  As Oil Minister Ali al-Naimi told the Wall Street Journal yesterday:

We are no longer limited to exporting crude oil.  This will make the kingdom one of the five largest countries in the world in terms of refined crude capacity and the second largest exporter of refined products after the US”.

In turn, this highlights a key rationale for Saudi’s market-driven pricing policy.  Not only does it have the lowest production costs in the world, and the largest oil reserves.  But it needs to maximise its refinery and downstream volumes to create jobs.

High oil prices do the opposite – they destroy demand.  Thus it should be no real surprise that, as I noted back in December’s pH Report, Naimi has made it very clear that in future, “the market sets the price”.

In my view, the various conspiracy theories that have been put forward to explain why Saudi encouraged oil prices to fall are wide of the mark.  Logic suggests that Saudi has little interest in trying to bankrupt Russia, or to close down US shale production.

Instead, it simply needs to maximise demand for its products in order to create as many jobs as possible, as fast as possible.

Saudi warns, again, that oil prices are "too high"

Brent May12.pngBrent oil prices are still within the triangle formed by movements over the past 4 years. As the chart shows, they tried to break-out on the upside last month, based on Iran supply worries. But since then, they have retreated again.

Interestingly, there are now signs that fundamentals rather than sentiment are starting to drive oil markets. For the past 2 years, prices have been driven higher by the investment banks, with their continued forecasts of strong demand growth in China, plus reduced supply.

The only problem is that neither argument has proved correct. China’s demand growth is slowing fast, as it moves to a more domestically-driven economy. Whilst record oil price levels have encouraged new supply to come onstream.

Of course, rising prices helped originally to create the perception of strong demand, as buyers rushed to protect margins by buying forward. But today, this process is reversing as companies try to reduce inventory levels and working capital.

Usually, the end of a triangle formation leads to a major move upwards or downwards, as either the bears or the bulls give up their argument. Back in March, the blog suggested that:

If prices fail to break higher, then the next step might instead be (for companies) to use today’s higher prices as a platform for opening new hedges to guard against the downside risk.

With Saudi Oil Minister Naimi again warning that prices are ‘too high’, the blog sees no reason to change this analysis.

Saudi comments increase oil market uncertainty

WTI v natgas Jan12.pngThe International Energy Agency (IEA) confirmed the blog’s worst fears this week, with its announcement that crude oil demand actually fell by 300kbd in Q4. Not only is this “quite rare” as the IEA noted, but they went on to warn:

“We’re flagging that there are clearly downside risks to the global economy and to oil demand: the world could see zero demand growth if there were further downgrades to global GDP estimates”.

The issue is simple. The world has never before had to live with Brent prices at over $100/bbl ($2012) for so long. Demand destruction is clearly taking place on a wider and wider scale. Even if prices fell sharply tomorrow, demand would now still take a long time to recover.

The IEA data shows that Western demand fell very sharply in Q4, by 700kbd. And Asia, despite all the bullish analyst talk about decoupling and perpetual demand growth, saw just a 400kbd increase. China’s slowing economy meant its demand rose only 1.7% in November versus 2010.

Yet for the moment, prices remain at their record levels. They are supported not only by Iran’s threat to block the Strait of Hormuz, but also by Saudi Arabia’s comment that its “wish and hope is we can stabilize this oil price and keep it at a level around $100/bbl“.

As a former feedstocks and oil product trader, the blog well remembers that the basic rule in oil markets has always been to assume Saudi will achieve its objectives:

• It has the largest reserves, and plenty of spare capacity (Oil Minister Naimi suggested in his interview it could easily produce an extra 2mbd)
• And usually Saudi prefers relatively low prices, as it is keen to be seen as a reliable supplier, helping to promote global growth
• It is equally dangerous to bet against Saudi when it wants higher prices
• It cut production between 1980 – 1985 from 10.3mbd to just 3.6mbd, in its effort to keep prices at ~$30/bbl ($65/bbl in $2012)

But today’s position is less clear-cut. Saudi needs high prices, at least $80/bbl, to balance its budget, following its decision to increase subsidies and handouts following the Arab Spring. But it also (unlike the 1980s) needs high volumes. 3.6mbd at $100/bbl wouldn’t provide enough income.

It is thus hard to see how both its objectives can be achieved:

US demand is down 1.5mbd since 2007, and its domestic production is increasing rapidly, whilst European and Japanese demand is also reducing
• 2012 seems a bad year to try the experiment, with demand growth under threat from European austerity programmes
• Equally, China imports only 5mbd, so even a major new stimulus programme would not really create much extra global oil demand
• The outlook is even less promising. Spare capacity today is 4mbd, and this volume is already set to rise to 8mbd by 2015

And finally, of course, there is the growth of gas supply. The arrival of shale gas has pushed US prices down to $2.35/MMBTU. As the chart shows, this has led to a record ratio for crude oil prices versus gas of 34 today, when the energy equivalent ratio is only ~6.

This will further reduce oil demand in favour of gas, probably permanently. Whilst today’s record prices mean that other major consumers including the UK, Poland and China, are all hurriedly jumping on the bandwagon.

The blog cannot remember a time in the past 30 years when oil markets have been so uncertain.

History suggests it would be extremely unwise to bet against Saudi, at least in the short-term. The Iranian situation makes this doubly risky. Yet building inventory would also be very risky, if prices did begin to fall. And it is also very expensive at today’s prices.

Thus low inventories and increasing nervousness create the potential for continued price volatility, further adding to the uncertainty.