Price stability vital for some time to come

Price stability vital for some time to come

Energy Outlook

By Syed Rashid Husain

FEW major developments kept oil analysts on heels the entire last week.

Markets remained busy keeping an eye on OPEC’s next move, attempting to comprehend if the group would extend the output cut arrangement beyond June this year or not? End-November the OPEC had agreed, with Russia and others, to cut output by 1.8 million barrels a day initially for six months. The question now was - would the arrangement be extended or not?

In the wake of global stocks remaining high, despite strong OPEC compliance, this move remained crucially important to the markets. “OPEC is now facing the prospect of falling short of its objective,” Stephen Brennock of oil broker PVM was quoted as saying. “Bulging global oil stockpiles will not draw down to the five-year average unless OPEC-led cuts are extended.”

OPEC seems alive to the issue. Last Wednesday, the Qatar’s energy minister and its chief OPEC envoy Mohammed Saleh Al-Sada told the Qatar-UK Business and Investment Forum in London that the agreement should be extended “beyond the third quarter of 2017” for the crude market stockpile overhang to ease. “OPEC and non-OPEC producers are trying to stabilize both the supply and demand balance, as well as the stockpile overhang. OPEC has complied by up to 96% of the cuts it promised, while non-OPEC compliance is almost at 65%; this is unprecedented,” he emphasized.

Al-Sada clarified that he would “like OPEC cuts to continue” so that the market can be rebalanced. “If the cuts are extended, we should get that sense of balance around the third quarter of 2017.”

And it was in this perspective that markets looked closely at the announcement last Sunday by a committee of ministers, from OPEC and outside, agreeing to look at prolonging the output cut deal. However, with the ministerial group stopping short of the earlier draft statement, recommending to keep the measure in place, generated ripples in the market too. The earlier draft of the statement had said the committee “reports a high level of conformity and recommends six-month extension”. But the final version said that the committee had requested a technical group and the OPEC Secretariat to “review the oil market conditions and revert ... in April 2017 regarding the extension of the voluntary production adjustments”.

And this created a furor in the market. Many looked at it as a negative sign. Analysts felt the lack of an immediate, firm, extension announcement, could drag the crude prices down. “The dropping of the recommendation to extend cuts in favor of technical review committee, is likely to lead to a lot of disappointment and potential further liquidation of long positions by money managers that will put downward pressure on oil prices,” Harry Tchilinguirian, head of commodities strategy at BNP Paribas in London, was quoted as saying by news agencies.

Although it is difficult to say why the wording was changed, but a senior industry source told the press that the committee lacked the legal mandate to recommend an extension, hence it was dropped.

And, the source definitely had a point.

Yet, the very news of the OPEC reviewing its strategy and the possibility of extending the cut beyond the initial period helped the market gain some strength and firmness. Fundamentals for oil are “improving as product inventories are drawn down, pulled back into their five-year ranges, while refinery runs are back to year-ago levels,” Matt Smith, the director of commodity research at ClipperData, was quoted as saying. “Lower oil imports, robust oil exports and higher refinery runs in the coming weeks should halt oil inventories from their continued ascent.”

And all this is taking place amidst growing OPEC compliance with output cut agreement. OPEC output is likely to fall for a third straight month in March, a Reuters survey said, as the United Arab Emirates made progress in trimming supplies while maintenance and unrest cut production in exempt nations Nigeria and Libya.

The reduction by the UAE helped boost OPEC compliance with output cut deal to 95 percent, up from an initial February estimate of 94 percent. Now, this is higher than OPEC achieved in its last cut in 2009. Analysts including those at the International Energy Agency have put adherence in 2017 even higher, calling it a record.

Oil prices also climbed following news that an armed group in Libya shut pipelines because of a dispute over wage issues, disrupting production of 250,000 barrels a day.

However, OPEC continues to keep an eye on growing shale output and its future trends. As per Bloomberg News, OPEC members met with shale producers in Houston discussing the emerging market scenario. Saudi Oil Minister Khaled Al-Falih was quoted as emphasizing in Houston during the CeraWeek that Saudi Arabia refuses to be “used” by others. Clearly, the message was targeted both at the shale producers and other oil producers, both within and outside the OPEC. The message was clear – Riyadh and a few others cannot be expected to shoulder the entire responsibility of balancing the markets and all the stakeholders need to contribute.

On the other hand, with Saudi Aramco IPO drawing closer, and the tax rates presenting a dilemma to authorities in Riyadh, Saudi Arabia announced a very interesting move, resetting the range of income tax rates for producers of oil and hydrocarbons. The tax rate for investments exceeding 375 billion riyals ($100 billion) will be 50 percent, SPA said. It also announced rates for producers with smaller investments.

Authorities in Riyadh have been considering if and when to cut the effective tax rate on Saudi Aramco in view of the upcoming IPO. Aramco CEO has specifically hinted in recent past in one of his talks. As per the current rate, Saudi Aramco pays 85 percent tax to the government. Many felt this could make the IPO unattractive to major global investors. Hence, cutting the tax rate was very much in order.

Analysts now believe that the proposed tax cut will increase Aramco’s after-tax income by 300 percent - propelling its valuation considerably higher. This would also help increase the appetite for the Aramco IPO among major global investors. As per Matt Smith, Saudi Aramco’s market value could now be over $1 trillion, courtesy the taxation tweak by the Saudi government. Some others feel it could go even further higher, approaching the $2 trillion mark. And this very much matches the initial figure stated by Prince Muhammad Bin Salman on the issue of Saudi Aramco valuation.

OPEC and its kingpin Saudi Arabia definitely understand the importance of the prices staying stable - at least for some time to come. The OPEC move to possibly increase the output cut agreement for at least another six months and  the Saudi move to cut the taxes on the oil sector - need to be seen in this very perspective.