Year in review: How Saudis reclaimed energy’s centre stage

The Kingdom’s Aramco IPO plan and agreement to production cuts came as a welcome surprise. But the implementation of its ambitions remains a concern, while the oil cut deal is dependent on wholehearted commitment.

Deputy crown prince Mohammed bin Salman first floated the Aramco IPO idea in January in a media interview. Nicolas Asfouri / Getty Images

This was the year Saudi Arabia reasserted its leadership on the world oil stage.

It wasn’t just the end-of-year deal between Opec and non-Opec producers, the success of which depended on the kingdom agreeing to bear the heaviest load of production cuts.

Saudi Arabia had also dominated the conversation from the start of the year, when deputy crown prince Mohammed bin Salman set out a vision of radical change for the kingdom, at the heart of which is a plan to privatise a part of the state oil company, Saudi Aramco, in what could be the world’s largest ever initial public offering.

But for both these monumental moves, big questions remain as the year comes to a close.

The production deal was met with polite applause from market participants, who generally see it as a necessary stop-gap measure to speed up a process that already was balancing the market, albeit slowly.

Benchmark North Sea Brent crude futures, which had recovered from a January low below US$27 a barrel to a range between mid-$40s and $50 for most of the summer/autumn, bounced up to the low $50s by late December.

Some widely-watched oil prognosticators expect a modest recovery, assuming the producers deliver on their promises.

Goldman Sachs – which was the most profitable commodities trading firm this year, according to data firm Coalition – raised its forecast for Brent to $59 a barrel, from a previous $56.50, for the second quarter next year.

As Jeff Currie, head of Goldman commodities research, says, Saudi Arabia and even producers outside of Opec – especially Russia – appear to be committed to the cuts.

Still, Goldman says the market will be waiting to see if it is effective and predicts 84 per cent compliance to the pledged cuts of 1.6 million barrels per day (bpd).

“There will be little evidence of production cuts until mid to late January which we believe will be the next catalyst for the next large move in prices,” Goldman says.

The key Gulf Opec players, including the UAE, Kuwait and Qatar, as well as Saudi Arabia, told their clients that crude allotments in January will be lower.

But their cuts will be partially offset by higher output from Libya, which is exempt from cuts. This month, it restarted key oilfields after lifting a blockade of a pipeline and its main export terminal in the Mediterranean. The Libyan oil minister reckoned that they could add 400,000 bpd within three months.

Other exempt members include Iran, Nigeria and Venezuela, where production is unpredictable.

The contribution from non-Opec, which is officially a cut of 558,000 bpd in total, is also something of a wild card given that no previous Opec/non-Opec deals have stuck.

Russian president Vladimir Putin said last week that his country is committed to do its part and even continue the deal past its initial six-month term if needed. He forecast oil prices would stabilise in the mid-$50s next year.

A couple of days later, though, on December 26, Russia’s deputy energy minister, Kirill Molodtsov, said he expects Russia’s crude oil exports to rise by 5 per cent next year, to 253.5 million tonnes.

The International Energy Agency, the Paris-based consumer countries’ energy watchdog, captured the market mood: “The deal is for six months and we should allow time for it to be implemented before reassessing,” the IEA counselled. “Success means the reinforcement of prices and revenue stability for producers after two difficult years; failure risks starting a fourth year of stock builds and a possible return to lower prices.”

In any case, Saudi’s policy prior to the deal has had its greatest effect in the US, where production declined from a peak in the spring of around 9.6 million bpd to 8.4 million bpd late summer, before recovering some ground in the last few months.

The US Energy Information Administration (EIA) this month confirmed a worry that has dogged the Saudis and their allies as they debated whether or not to cut.

“If the agreement contributes to prices rising above $50 a barrel in the coming months, it could encourage a return to supply growth in US tight oil more quickly than currently expected,” the EIA says.

“Oil production, particularly in the United States, has been more resilient in the current oil price environment than had been expected, as reflected in improving financial conditions at oil companies,” it added.

“Most [US] oil and gas companies will start 2017 on a firmer footing, having halved cash flow break-evens to survive the past two years,” said Tom Ellacott, an oil analyst at Wood Mackenzie, a consultancy.

But while Mr Ellacott expects US independent producers to increase their investment by 25 per cent if oil prices stay above $50, he expects the big oil majors to continue to spend less on their mega-projects, with investment declining by another 8 per cent.

That underscores the dilemma at the heart of plans for an Aramco IPO.

In his interview with The Economist in January, when the deputy crown prince first floated the IPO idea, it was clear he saw this as a potential catalyst for the rest of the economy and the grand plans for a national economic transformation.

But Aramco isn’t like a private oil company in many ways, as this year has made it clear. Its officials have tried to subtly manage expectations.

This week, The Economist made its prediction for the coming year: “The Aram­co elite will resist lifting the veil of secrecy that shrouds the company.

Other Saudi royals will object to any threat to the oil income that pours into their pockets. Prince Muhammad will seek to forge ahead nonetheless, and the size and scope of the IPO will be a good indicator of how much clout he has.”

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