Saudi Arabia might not be ready to fold just yet

There have been a few whispers of a coordinated cut between OPEC and non-OPEC over the last few weeks.

Most recently, on Thursday, the Wall Street Journal’s OPEC correspondent Summer Said tweeted: “OPEC is ready to cooperate on a cut, but current prices are already forcing non-opec producers to at least cap output, says UAE Energy min.”

But the Kingdom might not be ready to fold just yet.

“Possible ongoing talks on coordinated OPEC and non-OPEC crude oil production cuts are unlikely to be successful in the near-term, in our view,” argued BAML’s MENA economist Jean-Michel Saliba in a recent note to clients.

“Saudi Arabia appears to be continuing in the meantime to position its energy and fiscal policies for a lower for longer oil price environment, if need be, as suggested by the possible flotation of Saudi Aramco or parts thereof.”

Saudi Aramco, the Kingdom’s state-owned oil company and the world’s largest oil producer, could be going public, as The Economist previously reported. Muhammad bin Salman, Saudi Arabia’s deputy crown prince and de facto leader said that a decision by the kingdom regarding an offering of Aramco would happen in the next few months.

And Saliba writes that if the oil behemoth
does go public, it “would be a landmark event.”

“We believe that a potential IPO of Saudi Aramco … could assuage key macro concerns regarding unsustainable debt accumulation and Fx reserves drawdown,” he wrote.

It also would confirm the economic reform credentials of the current Saudi administration and its financial preparedness for a potentially prolonged period of low prices, in our view.

Saliba also argues that the conservative oil price assumption in the Saudi’s 2016 budget also suggests that the Kingdom is “unlikely to capitulate on its energy policy as the adjustment is being carried on the fiscal front.”

Moreover, he writes that it may not even be that compelling for the Saudis to cut in the short/medium term (emphasis ours):

We have suggested that, in the short-term, a unilateral cut from Saudi Arabia appears a marginally revenue-positive move. This could leave it indifferent between a unilateral cut and no cut, partly as other oil producers would free-ride and encroach on Saudi
‘s market share.

This “indifference” arises because a 1mn bpd cut would increase the fiscal breakeven oil price by US$10/bbl and, concurrently, broad elasticity measures would suggest a US$10-12/bbl move upwards in oil prices. However, the elevated starting level for the fiscal breakeven oil price restricts such a policy, given the budgetary flexibility required of a swing oil producer. In the medium-term, unilateral cuts would likely be unambiguously revenue-negative as both the supply and demand curves would respond to higher oil prices.

And, finally, another interesting idea to consider is what the “signalling impact” of such a coordinated cut could be — and how the Saudis may interpret this.

“Headlines on joint cut discussions have already managed to talk up oil prices. Elasticities may likely be non-linear, suggesting a more marked impact on prices from output cuts at low oil prices,” he writes.

“This suggests difficulty to control the extent of the oil price rebound, which could be used by non-OPEC producers as a lifeline to initiate hedges or obtain additional financing,” he adds.

In any case, ultimately, Saliba believes that the Saudis are “best placed” to sit through the lower oil prices if there won’t be coordinated policy action.

And all of this could have interesting implications going forward.

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