Saudi Arabia says “forget OPEC strategy, Aramco IPO more important!”

The dust of the OPEC meeting in Vienna decision has not yet settled. Analysts are falling over each other by analyzing the impact of the unexpected production freeze agreement on oil prices and US shale.  Looking however at the machinations inside of the Saudi ruling elite and politics, Saudi Arabia’s change of tactics is not caused by a lack of power but mainly on the need to stabilize the market for the next 1-1.5 years to gain the expected returns of its widely published Saudi Aramco 5 percent IPO. 

6 December 2016

The dust of the OPEC meeting in Vienna decision has not yet settled. Analysts are falling over each other by analyzing the impact of the unexpected production freeze agreement on oil prices and US shale. Skepticism is very high, as OPEC’s decisions on production levels or cuts always have been cheated by most members. A majority of the financials are expecting this to happen again, so possible downward pressure on oil prices according to them still exists. Other groups are looking again at the end of OPEC, and the change in strategy of Saudi Arabia, but mainly assessing the results and not the underlying main issue, which is Riyadh’s change of heart about a market share strategy. Some have been indicating that Saudi Arabia’s 180 degrees turn is an acknowledgement of its failure to destroy US shale or non-OPEC production. Looking however at the machinations inside of the Saudi ruling elite and politics, Saudi Arabia’s change of tactics is not caused by a lack of power but mainly on the need to stabilize the market for the next 1-1.5 years to gain the expected returns of its widely published Saudi Aramco 5 percent IPO. The future not only of the Kingdom depends on the outcome and success of the IPO but also of its main backer, Deputy Crown Prince Mohammed Bin Salman.

Markets sceptical about OPEC decision impact

Looking at the normal demand-supply factors of Saudi Arabia’s yearlong OPEC strategy, the overall assessments have been slightly negative. The targeted market share strategy has been only for some degrees successful. Yes, Saudi’s dream to regain its market power has been reached, but it has underestimated the willingness of its main opponents, Iran, Iraq and non-OPEC players, such as Russia or US shale, to bight the bullet and increase production against all odds. The acknowledgement of this situation has come to the surface after that Saudi Arabia, and some other Arab producers, showed surprising willingness to take some of the pain of a production cut, while leaving other OPEC producers out of the whole conundrum. Riyadh also was even willing to agree to a production cut of its own oil volumes without a real hard agreement with non-OPEC producer Russia and the danger of a resurging US shale sector. The risk of a crude oil price plunge however was higher for Saudi Arabia if no deal was reached than the costs of a cutback of its own volumes and market share.

Aramco producing at top levels

Some analysts and inside sources within Saudi Aramco and the Saudi Ministry of Energy and Mineral Resources even indicated the last weeks that Aramco’s production was at its peak. To flood the market, as some Arab rulers indicated if no deal was reached with Iran, would not even have been possible, looking at the technical capabilities of the oil giant’s infrastructure and production capacity. The old adagio of Saudi Aramco being a swing producer, shaping the market at its own will, was not anymore available.

MBS and Vision 2030 Impact

At the same time, oil and financial analysts have not been taking into account the extreme changes currently being put in place within the Kingdom. The emergence of a new young elite, with as its main proponent the very young Deputy Crown Prince Mohammed Bin Salman, has been dramatic. The impact of his ideas, shown in the very ambitious Saudi Vision 2030 Strategy, while forging a new alliance with the Saudi business elite, such as the Minister of Energy and Mineral Resources Al Falih, Aramco’s CEO Nasser and others, is still underestimated. The Kingdom is heading towards a major restructuring. The latter ideas are not all being taken for granted by the existing royal elite. After a long period of low media coverage of the Saudi Crown Prince Mohammed bin Nayef suddenly re-emerged the last couple of months. Analysts have largely overlooked this, as their main focus with regards to the Saudi royalty was the Deputy Crown Prince Mohammed bin Salman (MBS). Insiders however indicated that due to MBS’s difficulties of bringing the Yemen War (which he is one of the main strategists off) to a closure and the slow progress of the economic reforms, Mohammed bin Nayef (MBN) has taken the opportunity to revamp his own position. A direct confrontation still is not in the making, but MBN has made clear that he is still vying for the post of being Saudi Arabia’s next king. To promote his own position, Bin Nayef has been very visibly representing Saudi Arabia as its representative at the UN General Assembly and holding talks with Turkish president Erdogan on Syria and Iran. Insiders in the Kingdom have already stated, even that there is no real direct infighting going on, Bin Nayef has re-emerged and is threatening the future of MBS. Both are still in place to be Saudi King, the main question is in which order.

Young Lions under pressure

The stellar rise of power of MBS the last years, in which he has become the favorite of many in the West and some Arab countries, has not all been taken positively in the very conservative and traditional Saudi society. The rise of MBS has been too rapid for most of the ruling and ‘old’ elites. The 31-year old prince has still to prove that his ideas and strategies are feasible. The bogged down war in Yemen is now taken as a blemish, even as a negative issue as long as Yemeni Houthi rebels are firing long-range missiles into the Kingdom. His other priority, Vision 2030, which is an ambitious economic program, is meant to reduce the Kingdom’s oil dependence, while diversifying the total economy. The need for the latter is understood by all, however, changing the economic fabric of Saudi Arabia, including forcing Saudi youth to work for their money, also has threatened old social structures and power politics. At present, there is still a majority of people supporting MBS’s strategies and economic ideas, but some are waiting to see weaknesses to propone their own ideas and power structures.

MBS, even at his young age, has understood the political – economic challenges at present. As Deputy Crown Prince and Minister of Defense, MBS holds vast powers. He also is very active in the restructuring of Saudi’s energy sectors, which are mainly financed and supported by Saudi Aramco’s operations and revenues. Bin Salman understood that part of his future will depend on restructuring the economy, plugging the holes in the government budget, while supporting anything needed to make the Aramco IPO to a success.

Low oil prices necessitate economic political change

As negative repercussions of low oil prices were building up for the Saudi economy, change of strategy was needed. The assessment that a low oil price would be destroying quicker non-OPEC production or holding Iran back was based on a very dubious assessment it became clear. Geopolitics also were playing their role, as the lifting of UN backed sanctions on Iran, and Iran’s aggressive power play in Iraq, Syria and Lebanon, showed that Saudi-led OPEC members were not able to confine their adversaries any longer. The results of its new oil price strategy, by cutting or in reality freezing OPEC production, have been very promising already. By promising to cut production by just 4.7 percent, Saudi Arabia at present already has gained an 18 percent jump in oil prices.
The need for higher prices was clear. As US analysts stated “the persistent price slump also threatened the centerpiece of the reforms sketched out by the country’s powerful deputy crown prince, Mohammed bin Salman: privatizing what could become the world’s biggest publicly traded oil company, Aramco”.  Still the verdict on oil prices is still out. OPEC’s success will partly be decided in the coming days, as the cartel will be meeting with a wide-range of non-OPEC producers on December 10 in Vienna. At that meeting, non-OPEC producers should agree to a 600,000bpd production cut.

Government burning international reserves

Saudi Arabia was until now burning around -18bn per month from its international reserves to cover overall government budget deficits. Sources stated that the Kingdom was hitting rock bottom in around 4-5 years if no real change in income would be generated, based on current oil prices. In an unexpected but very successful move, the Kingdom also reentered the international financial markets, selling its first international bonds, and raising .5 billion in the biggest-ever issue from an emerging-market nation. The latter has been assessed as a very big support for Saudi Arabia’s overall standing, as it shows not only the Kingdom as being stable and attractive but has also supported a move to make the Middle East’s largest stock market more accessible to foreign investors.

Saudi Aramco IPO earlier than expected! 

These preparations should also be seen as preparing the ground for the world’s largest IPO ever, the Aramco IPO. Most financial analysts have indicated that the IPO will be hitting the market in the next 12-24 months. However, insider movements in the Kingdom give some inclination that it could be happen even within the next 6-12 months. Rumors about key people and advisors preparing to set up own shop are only one of these signs.

The IPO of the 21st Century is in the making, no doubts exist with key persons that it will either be delayed or not even be put in place. The market will have to adjust to the fact that the main oil producing giant, Saudi Aramco, the King of King’s in the National Oil Companies league, dwarfing all other International Oil Companies (IOCs) by far. At present, most analysts will be hitting on transparancy issues related to this IPO, mainly focusing on the information to be received from Aramco regarding its 260 billion barrels of reserves, 10 X more than ExxonMobil. Financial figures, reserves data and political inroads will be only partly be supplied, the market knows this and is able to cope with this situation without any doubt. The possible oil reserves, in combination with the very low marginal costs of Saudi crude oil barrels, will a honey pot that nobody wants to be left out of.

Future of MBS under pressure?

What has not been understood and assessed at present is the intricate role Aramco’s IPO is playing in the current OPEC production freeze strategy of Saudi Arabia, its enormous consequences for the stability and future of the Deputy Crown Prince Mohammed Bin Salman, and how to absorb the possible div-3 trillion (for only 5% stakes) into the Saudi economy. All, without any doubt, is on the mind of the young MBS. His future depends on the total combination. A successful IPO introduction, bringing in the hard needed cash, will be not only changing his overall national standing, Saudi Arabia’s regional power position, but also its geopolitical influence. OPEC’s grand strategy, currently focusing on getting crude oil prices up or stabilizing the market, is a necessary instrument for MBS to get his army rolling. Change in Saudi Arabia is more pressing and important for him than a global power position of Saudi Arabia based on a market share strategy. Aramco’s political power is clear, the vast reserve base is there, even if it is maybe lower than official figures indicate.

The last months, a possible crisis within Saudi Arabia’s royal family is showing its ugly face, but can be cured by a successful IPO and diversification of the economy, as indicated in Vision 2030. If MBS is not able to structure this, building on a stable OPEC, but focusing on regional and national issues, Vision 2030 (or MBS position) is in danger. The plans to accumulate a div-3 trillion wealth fund in order to become an investment superpower, is not a dream but a necessity for MBS. Even that sources in Vienna last week indicated that Saudi Arabia was prepared to walk away from the negotiating table, MBS will have put his total weight and links to Al Falih at work, to get a deal done to bolster prices.

Financials leading not oil 

The next months, analysts should understand that any Saudi remarks or statements with regards to OPEC or global oil market, needs to be assessed in the light of the Aramco IPO. The future of the young guards in the Royal Palace in Riyadh is at stake. They understand that an oil based future for Saudi Arabia is still feasible, but will increasingly need to be supported by other economic sectors. Youth unemployment rates and regional power is also at stake. The current MBS Vision 2030 will be key in all. Assessments of international crude oil prices or volumes should take this into account. Saudi Arabia (aka MBS and Al Falih) are not anymore concerned by a pure market share approach. Their new market focus will be not oil markets but financials in New York, London, Shanghai, Hong Kong or Delhi. The future of the new King will be decided there, but also new geopolitical alliances. Until now all in the hands of the young Kingmaker.