The price of oil is widely followed because oil is critical to economic growth. But, it’s also a chicken and egg type of question. Economic growth drives demand for oil. That raises the price of oil. But, high oil prices choke off economic growth.
When oil is priced “just right” we have economic growth. Just right pricing also helps to maintain stability in one of the most volatile regions in the world, the Middle East.
Right now, prices are higher than they were a year ago, but they seem to be just right. However, it seems unlikely prices will remain near their current level.
The price of oil has been climbing steadily, an indicator of demand.
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However, the price rise coincides with a cutback in production from OPEC. This was led by Saudi Arabia which wanted to increase the price of oil to help make an initial public offering (IPO) of the country’s oil company more attractive to investors.
Saudi Arabia’s IPO Could Be Stalled
But now, according to The Wall Street Journal, “Doubts Grow Aramco IPO Will Ever Happen.”
The paper notes, “The initial public offering of Saudi Arabian Oil Co., better known as Aramco, was meant to be the cornerstone of the kingdom’s plan to be less reliant on oil. It would create the largest public company in the history of capital markets, an opportunity coveted by Wall Street’s biggest names.”
Yet doubts have crystallized in recent months, after two years of work to prepare Aramco for its debut. Saudi officials and people close to the process say the company and the country simply aren’t ready for an IPO that could raise $100 billion but also bring unprecedented scrutiny to the kingdom’s crown jewel.
“Everyone is almost certain it is not going to happen,” said a senior executive at Aramco, speaking of the IPO.”
One problem is that listing on a large stock exchange in New York, London or Hong Kong carries a number of legal risks, exposing Aramco to shareholder lawsuits, for example.
Trying to list the company, which is estimated to be worth up to $2 trillion on the Saudi stock exchange, known as the Tadawul, could overwhelm the $500 billion exchange.
Plus, Saudi Arabia might not need the money any longer. Oil prices have more than doubled to nearly $80 a barrel since the idea of an IPO was proposed. That provided significant cash to the kingdom. The Saudis also raised $17.5 billion by selling government bonds to foreign investors in 2016 and have since done several more.
Plus, the government has raised money from hundreds of prominent Saudis who were arrested and released after agreeing to make payments. The Journal reports that Saudi officials say these payments totaled more than $100 billion.
Saudi Arabia could also benefit from renewed sanction on Iran.
Iran Adds Uncertainty to the Market
President Donald Trump withdrew the United States from the Iran nuclear deal in May to pursue a maximum pressure campaign. This removes Iran as a potential source of supply for the oil market, just as Iran was increasing exports.
“Companies that buy Iranian crude oil must completely cut those exports by the start of November or else they will face powerful U.S. sanctions, a senior State Department official told reporters on Tuesday.
The State Department has conveyed that message to European diplomats in recent talks, the official said. The Trump administration has not yet held talks with China, India or Turkey about their purchases of Iranian crude, but it intends to pressure them to entirely cut their imports under threat of sanctions, the official added.”
Iran is OPEC’s third largest producer. The country produced 3.82 million barrels per day in May, according to the latest available data. Total spare capacity in OPEC, excluding Iran, is just 3.39 million barrels per day.
This data shows how difficult it will be to replace the loss of Iran’s production. And OPEC’s production could actually drop if Venezuela is unable to maintain its current levels of production, an outcome that seems to be likely.
Venezuela has been in an economic tailspin for several years and the conditions in that country are collapsing, at an accelerated pace. Production appears to be likely to continue to fall, which will constrain supply even more.
Political Unrest Is Another Wildcard
All of these factors show that supply is constrained while global demand, according to the IEA is expected to grow. The Agency notes, in its latest report, that,
“Our demand growth estimate for 2018 has been left largely unchanged, at 1.4 mb/d. Recent data confirms strong growth in 1Q18 and in early 2Q18, partly due to colder weather in the northern hemisphere. A slowdown is expected in 2H18.
For 2019, our first estimate of demand anticipates growth of 1.4 mb/d. A solid economic background and an assumption of more stable prices are key factors. Risks include possibly higher prices and trade disruptions. Some governments are considering measures to ease price pressures on consumers.”
Meanwhile, “seven months after the widest protest in the history of the Islamic Republic (December 2017), the Iranians are once again on the streets. They are protesting against the bad performance of the economy in general and the devaluation of the national currency (rial) in particular.
Over the last couple of months, the rial has lost more than 50 percent of its value. It has become one the most hyperinflated currencies in the world. A few weeks ago, the Iranian central bank pegged the rial to the dollar, but in the black market the dollar and other top currencies are still being exchanged two times higher than the official rate.
The current wave of protests can be considered as part of the overall anger against the mismanagement of the country; yet, it is significant in many ways.”
Some analysts believe, “the most likely scenario for the Islamic Republic is to turn into the Venezuela of the Middle East. So far, the regime’s strategy has been to frighten Iranians about the Syrianization of the country; but, the situation of Venezuela is not less frightening for Iranians, given their luxurious lifestyle.
In such a situation, the unrest will continue. Even if the regime succeeds in quelling it, it will reemerge more powerfully, and sooner or later it will spiral out of control.”
This all points to higher oil prices as Saudi Arabia would likely foster instability in Iran, its regional rival. Investors should consider small positions in oil ETFs or other energy investments to hedge their portfolios.
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