There has been considerable speculation over the most likely consequences for near term oil prices and Saudi Arabia’s oil policy after the ungracious ouster on Saturday of Ali al-Naimi as the Kingdom’s long serving oil minister.
Several points on that front:
*** Al-Naimi’s exit has nothing to do with any change in Saudi oil policy or the collapse of the oil output freeze in Doha last month. Its timing was instead dictated by the need to restructure several ministries, including oil, in advance of the Kingdom’s “National Transformation Plan,” whose centerpiece is the partial privatization of Saudi Aramco. Deputy Crown Prince Mohammed bin Salman has in fact been steering policy, including oil, since at least late last year and is very much the power behind the throne driving what can be described as an emerging “MbS doctrine.” ***
*** Fears the Kingdom is about to “flood” the crude market in ramping up oil exports are however overstated. Saudi Arabia’s current oil strategy is more granular and opportunistic, shaped by its longer term ambitions to partially privatize Saudi Aramco. It will be run on a steady-hand basis, winning customers where possible with the term contracts it prefers, slowly expanding output to its sustainable 11.5 million bpd to meet any customer demand where it can be found, and with a commitment to expanding its capacity to its eventual 12.5 million bpd capacity “as needed.” ***
*** Despite Riyadh’s central role in the Doha debacle, Saudi Arabia is still willing to participate in an oil output freeze agreement if OPEC can find a way to a deal at its June 2 meeting. But the odds of that are extremely low. Riyadh is still demanding an Iranian participation to at least commit to a scheduled staggering of the increases in its oil output through this year and, at least implicitly, to open an early door to OPEC quota negotiations at levels far lower than anything envisioned by Tehran. Unsurprisingly, Iran has shown no interest in doing so. ***
As we noted previously (SGH 4/18/16, “Oil: Doha Aftershocks”), we still believe as much as any oil power can dictate a range to crude oil prices, Saudi oil policy is likely to keep crude oil prices within a $40 to $50 range, with something of a hard cap to oil prices moving above $50 on a sustained basis, while any sharp or sustained slide in prices below $40 is likely to be checked by clearer evidence of higher global demand through the summer and going into the third quarter.
Behind the Weekend Shuffle
A friend of ours characterized the recent evolution of Saudi oil policy as an “Emerging MbS Doctrine,” using the common shorthand for Deputy Crown Prince Mohammed, the powerful son of King Salman bin Abdul Aziz Al Saud, who has quickly consolidated power in Riyadh to an unprecedented degree (SGH 1/15/16, “Saudi Arabia: Riyadh’s Strategic Gambit”).
We tend to like that description, for it captures the linkages between Saudi oil policy and its domestic political and economic drivers as they are being written by Deputy Crown Prince Mohammed and the advisors in his Royal Court or the Public Investment Fund (at least one of whom, Yasser al-Rumayan, the PIF Secretary General, was promoted to Ministerial position in the weekend reshuffle).
First, more than a dozen changes were announced on Saturday in the members of the cabinet of the Prime Minister — Crown Prince Mohammed bin Naif serves as prime minister and chair of the cabinet — with a half dozen of the ministries restructured or eliminated. It is the first key step to make way for the details of the National Transformation Plan due for release in four to six weeks. Key among those changes, of course, were the changes in the oil ministry.
The Oil Ministry is being restructured to include domestic power, renewable energy, water, and some day, nuclear power, effectively making it something of a domestic regulatory agency with oversight of the Kingdom’s public utilities, many of which are due in fact to be privatized.
Saudi Aramco, previously the core of the oil ministry, is to be restructured into a holding company, with an independently elected Board of Directors no less, and the announced 5% of its still to be defined and valued assets to be privatized in a global Initial Public Offering listed in Riyadh and probably New York (maybe Shanghai as well). The Aramco holding company will be transferred to the core holdings of a vastly expanded Public Investment Fund, itself being revamped to become the Kingdom’s Sovereign Wealth Fund.
And while the way in which al-Naimi’s departure was more than a little brutal if not shocking in the way it was handled, his retirement — the former oil minister is still serving as an advisor to the Royal Court — was always intended somewhere between the first unveiling of the prince’s “vision” of the objectives to its far reaching economic reforms, and the more detailed release of the National Transformation Plan to come in around four to six weeks.
Al-Naimi’s successor as Energy Minister, Khaled Al-Falih, who is apparently favored and trusted by MbS, is also serving on the new Council of Economic and Development Affairs that MbS chairs and which oversees all domestic economic, budget, and foreign investment policy as well as oil policy. As well as Oil Minister, al-Falih will remain chairman of Aramco and its Board of Directors. So al-Falih in that sense, will be more powerful than al-Naimi ever was.
The New Aramco
But again, the main takeaway from the weekend is that Saudi oil policy is not changing all that much since the Saudis will be running Saudi Aramco on a steady-hand basis, using spare capacity to compete for customer demand where it can be found, in hopes to make Aramco more attractive to investors looking at market share and output capacity, while it also expands further into higher value downstream markets like refining and petrochemicals, in part through joint ventures.
Indeed, in perhaps something of a parallel to the changes in Federal Reserve monetary policy away from targeting a specific federal funds rate amid an enormous excess of reserves, the Saudis concluded some time ago that targeting crude oil prices has become somewhat pointless in an era of technological advances and new sources of supply like shale that are structural changes rather than temporary changes in the balance of supply to demand.
The shift to a market share strategy is based on producing as much as possible, based on spare production capacity irrespective of prices. Its more blunt turn since November 2014, however, proved something of a disaster in driving down prices far more than ever anticipated. But while the Saudis are in effect competing “barrel for barrel” against the Iranian efforts to get back to its pre-sanction output levels (SGH, 4/19/16, “Oil: Output War”), the Kingdom is competing against all rivals for hydrocarbon products, and not just crude, but importantly, higher value downstream refined and petrochemical products.
The Kingdom, then, is not so much intending to “flood” the market to drive down prices or to undercut shale producers in the US, other high cost oil producers, or even to do a geopolitical hit on the Iranians. Instead, the Saudi oil strategy in its current evolution is a fine tuning of the same market share approach, and beyond a geo-political tit-for-tat production increase to preempt other rivals (i.e., Iran) from coming in to take clients.
Riyadh does face a near term shift in its output of around 300,000 plus bpd to supply the need to meet the summer surge in domestic demand for electricity, so the recent increase in the capacity of the Shaybah field from 750,000 bpd to around 1 million bpd may in fact go to meet the summer needs not being met through a draw down in inventories.
On that front, this is where delays in the Saudi confirmation of the output of 500,000 bpd from the Neutral Zone shared with Kuwait will be important. The Kuwaitis had jumped the gun in announcing in late March a resumption of the Neutral Zone output, which has been shut down in since 2014 over a reported dispute over environmental concerns and the role of Chevron in the sharing agreements.
We understand the Saudis have stopped short of confirming the resumption of what is mostly Heavy Arabian crude output, in part to pressure Kuwait to toe Riyadh’s hard line policy towards Iran, and as an inducement to Tehran to make enough concessions on the oil output freeze to make a deal possible. With the odds of that slim to none, it is our understanding the Neutral Zone will be ramping up again, which will probably take several months.
Eyes on the Prize
Perhaps the key way to frame the current Saudi oil strategy is the way the Saudi planners are keeping an eye on the prize in creating a deep investor demand for Saudi Aramco’s eventual partial privatization — and all that it will do to boosting the Saudi stock exchange and inward capital flows.
Showing a consistent track record of meeting customer demand where it can be found and showing Saudi Aramco has the capacity to produce whatever amounts of crude are required, and that it has access to the sovereign reserves to back it, should dispel any lingering doubts about the Kingdom’s oil output capacity and the level of reserves in the ground that are the world’s largest, and thus should make Saudi Aramco a long-term core holding in most global portfolios.
When it comes to the course of Saudi oil policy, then, the MbS doctrine is best seen as essentially running in a straight line from its current output and market share strategy to the eventual partial privatization of Saudi Aramco. And the depth of the political commitment to those ambitions lies in the larger benefits that is expected to bring in underpinning the transformation of the Saudi economy, and even the social compact between the ruler and ruled in the only country still named after a family.