Global Asset Management
National Bank of Abu Dhabi
Tel: +971 4 4245795
Abu DHabi – 12 March 2017
Much restructuring has taken place in the MENA region’s oil industry, and markets are rebalancing, helped by the agreement to reduce production by OPEC and some other producers. However, what has happened is unlikely to get oil prices back to over $100/barrel. The tapestry of oil production problems within MENA and elsewhere are complex. Therefore, our outlook forecast for oil to trade in a range of $45-60 - with $65 to be tested towards the end of this year - remains in place.
Last year saw a slow recovery in the price of crude oil after a very savage correction downward toward the end of 2015. The trading range suggested in our 2016 Outlook last year remained intact as the commodity oscillated in the range of $25-$45 a barrel. At the same time much was said about the falling Baker Hughes rig count with the loss of less profitable US oil shale rig production with the drop. This sector of the oil industry while witnessing falling production costs over the years still requires crude to maintain a steady $50 a barrel and above in the longer term to make rigs there commercially viable (see below chart 1).
|Chart 1. Source: Oil Voice|
This comes despite US Shale break-even’s dropping as low as $35 a barrel in some areas of the United States these days (chart 2).
Saudi Arabia’s efforts to reign in any fall in its market share to these new players started ramping up its oil production last year flooding markets with oil. Other theories put the Saudi exercise down to multiple advantages to the strategy. This would include cutting election funding to the Trump Republican campaign (many donors of which came from the US oil industry) under the Democrat administration led by Obama at the time. Secondly, targeting Russia the country with the world’s 5th largest proven reserves of oil and where the commodity makes up 35% of the country’s total exports. Prominent Russian officials linked to the Putin administration remain under US sanctions after the country’s annexation of the Crimea along with transgressions that currently take place in occupied Eastern Ukraine. Thirdly, targeting Venezuela. Nicholas Maduros administration presides over a country that has 90% of revenue coming from crude oil exports (the world’s largest proven oil reserves). Hyperinflation has wreaked havoc in a country following a path of outdated socialist policies under outdated dictatorship. Venezuela too has been the target of US sanctions on prominent officials in the country. Many Venezuelans continue life without basic food stuffs and amenities due to chronic shortages. Multi nationals operating have not being paid by the government there. American corporations make up the majority of these.
The other side of the argument and one most economists have focused on is the US Federal Reserve. At the end of 2015 Fed chair Janet Yellen suggested a more aggressive rate increase path was to follow for 2016. This in turn put severe pressure on the pricing of all commodities globally including crude oil which are all priced in US Dollars. Rising interest rates increase the value of the dollar with respect to other currencies around the world and therefore the net effect makes the commodity price fall. This may have been the trigger for the Saudi’s who saw this move as a chance to propel the decline in oil prices thus protecting Saudi market share at the expense of US shale oil.
Saudi oil reserves remain constant
Surprisingly Saudi oil reserves have been constant around 212 Billion barrels. They consume or export 3.5 Billion barrels annually as an economy. So there are about 60 years of Saudi oil reserves left at current prices! Much has been debated about how much Saudi Reserves really are with other estimates suggesting the figure is closer to 250 Billion barrels. This comes at an interesting time with the possible IPO of Saudi Aramco in the offing. The main thing here is shale producers need anywhere between six to twelve months to ramp up or down production. However, this six to twelve months is still significantly less than conventional fields, which take years to start production. With the sheer scale of Saudi Arabia’s oilfield arsenal when compared to US shale oil, swaths of oil rigs in the Kingdom can be turned off without affecting their overall net reserves of oil. It’s a bit like comparing a sports car driving at a modest speed in 2nd gear (Saudi) to a small 1 litre saloon car with a labouring engine in the highest gear (US shale). John Hess the CEO of Hess corporation one of America’s prominent oil company’s has said that this Saudi ‘swing production’ can be ramped up or down by as much as several hundred thousand barrels of oil production per day. Something that US shale oil is unable to achieve given the scale.
Saudi Arabia while leaning on US competition was also been in acquisition mode in the US last year. Saudi Aramco’s American arm along with Anglo Dutch company Royal Dutch Shell took over the US’s biggest oil refiner Motiva. Motiva also owns Texas’s main oil refineries that were acquired from US chemical company Lyondell basell. In addition, Saudi Aramco Energy Ventures LLC is a fund that was set up to invest in global energy and technology companies while funding and investing in other energy companies. Aramco bought Zahroof Valves that produces valves for gas compressors in the US. Siluria Technologies another U.S. investment they made, develops technologies to convert natural gas to liquid petrochemicals. There are many others out there. Aramco also operates three research centers in Houston, Cambridge, and Detroit. The Cambridge location is next to MIT which attracts top oil talent in the United States. This is all going toward Saudi Arabian capital building in the country. Aramco will have an exclusive license to use the Shell oil brand in Texas, Mississippi, and across the South East United States through its Motiva connection. This equates to revenue from Shell stations in the South going directly to Saudi Aramco. This is very similar to Citgo Petroleum of Venezuela that has garnered support in the past through gas stations in the American North eastern region through places like Connecticut. Saudi Aramco’s Motiva in the Southern states transports Saudi, American and other crude such as Canada to the whole area that is a big revenue source as well as a provider of many American jobs in the region.
OPEC deal won’t bring the heady days back
What’s interesting to note is that much was said in the press about the cost to Saudi Arabia and the GCC region as a whole with the collapse in crude oil. Restructuring has taken place, projects cancelled as the oil price gets into a rebalancing phase. What actually resulted is Saudi market share with the above acquisitions has actually increased by 1% (Source: oilprice.com) since the onset of the correction. This comes at a time where OPEC struck an agreement to curtail oil production to shore up prices after this very difficult period and after what appears to be yet another shrewd move by the Saudi’s the third such move of its kind in as many decades. At an OPEC meeting in Algeria (the less important one for the year), they announced a production cut that can only be tangible with Saudi support. Much was debated about whether they would with regional rivals Iran lobbying for some time to enter the fray after years of crippling sanctions on the country. The Saudis at the peak in 2016 were pumping as much as 10.648 million barrels of crude oil per day. Approximately 230 million barrels have been taken away and they now produce around 10.41 million barrels per day that has been a joint coordination exercise by OPEC members resulting in the more stable environment we have seen for prices as of late. While this is welcome news for oil producers and the sovereign nations that need to rebuild lost revenues it’s by no means the trigger for the heady days of $100 a barrel which we think is some years away. A rising US dollar along with other producers around the world will keep gains in check we think as world economic growth is also expected to recover led by the United States as well as the other big consumer of the commodity China.
As the US rig count fell last year, many lenders to the US energy sector including Wells Fargo (the largest to US oil shale) started to withdraw funding to the US oil shale industry. With dozens of companies going bankrupt, Wells Fargo increased its provisioning for bad and doubtful debts 5-fold last year to USD $2.8 Billion on total lending to the US oil industry of USD $ 42 Billion. Wells Fargo, Citigroup and JP Morgan make up the three biggest domestic lenders to the US oil industry totaling USD $127 Billion which is ‘significant’ on their loan books. It was a worrying factor when oil prices were low and made up a large component of the US high yield bond market. This now looks manageable under the current recovery. This headwind we think will delay any further meaningful rally in oil prices as funding to make these oil rigs pump again is not as readily available as before. To add to this many of the major oil companies around the world have started to write off their amount of commercially available oil reserves on their balance sheets. Royal Dutch Shell in its recent results has taken out of its balance sheet 1.5 Billion barrels of oil, Chevron dropped 900 million barrels with Exxon Mobil of the US removing a staggering 3.3 Billion barrels of its reserves estimates. These all take into account current oil prices but could be added back to the equation if oil prices were to continually rise that we are not expecting in the near future but would also add to prices staying in check. With this and taking into account the effects of recent stunted Libyan, Nigerian as well as Iraqi oil production (that are expected to be dislocated by the advance of the Iraqi military on ‘insurgents’ in the country), as well as staggered payments to the oil majors in neighboring Kurdistan one of the world’s most potentially lucrative oil producing regions, we maintain our Outlook 2017 forecast for crude oil level which is unchanged to range of between $45-$60 a barrel with $65 a barrel to be tested at the end of the year.
Abu Dhabi – 19 January 2017
NBAD has just published its ‘Global Investment Outlook 2017’, the third in the GIO series. The report provides expert insights and guidance as to the risks and opportunities investors will need to consider in order to successfully navigate the evolving macroeconomic landscape.
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