The crude oil market has been following the ongoing saga on trade between the US and China. The trade war that escalated in early August weighed on the price of the energy commodity. The threat of a global recession sent the price of nearby NYMEX futures down to a low at around $50.50 per barrel after President Trump slapped additional tariffs on Chinese exports to the US and China retaliated. Weak economic data out of China and fears that contagion would ripple around the world threatened the demand side of the fundamental equation in the oil market. However, the latest economic news was better than expected from the world’s most populous nation. At the same time, a bit of optimism returned to the market as China and the US continue to negotiate for a resolution to the trade war.
On the bullish side over the past months, US sanctions on Iran have tightened the economic noose around the throat of the theocracy in Teheran. After a series of provocative actions around the Straits of Hormuz that stoked supply concerns, the waters have calmed over the past weeks. Bullish and bearish factors have pulled the price of oil in opposite directions over the past months.
Meanwhile, OPEC’s role in the international oil market has changed dramatically over recent years. Saudi Arabia has always been the most powerful member of the cartel as it produces more of the energy commodity than any other members. In 2016, Russia took an active role when it came to production policy after the price of oil fell to $26.05 per barrel early in the year. Russia has not only advised the cartel on production policy but participated in the output cuts over the past three and one-half years that stabilized the price of oil. At the same time, the United States emerged as the world’s leading producer of crude oil. According to the EIA, US output recently hit a new record high at 12.5 million barrels per day surpassing both Saudi and Russia daily production levels.
Over the recent sessions, the price of oil has worked its way towards the top end of its trading range. Oil-related equities have lagged the price action in both the oil and stock markets throughout 2019. One of the hardest-hit areas of the oil business has been the oil services companies. The VanEck Vectors Oil Services ETF product (OIH) has been under siege in 2019. OIH appears to have found a bottom in August at new lows dating back to the turn of this century.
Stability in the crude oil price – at the bottom end of the sweet spot for the Saudis
The price of October NYMEX crude oil futures has been bouncing around in a range from just below $61 to just above $50 per barrel since late May.
As the daily chart highlights, the price band has contained the price of the energy commodity over the summer months. Since the start of September, the price has been edging towards the upper end of the trading range. On September 10, October futures traded to a high at $58.76 per barrel, the highest level since late July before turning lower. Price momentum and relative strength indicators have risen into overbought territory on the short-term chart. On the longer-term weekly, monthly, and quarterly charts, the metrics display neutral conditions. After a dip in the total number of open long and short positions to under 1.98 million contracts in late August, it returned to 2.077 million contracts as of September 11, which is the level it remained at throughout most of July and August. While the fundamentals in the oil market depend on economic growth or contraction on the demand side and the potential for production or logistical issues on the supply side, the technical picture remains neutral.
The NYMEX crude oil contract is the benchmark pricing mechanism for approximately one-third of the world’s production. The Brent contract reflects the pricing of the other two-thirds, including the oil that comes from the Middle East.
As the chart of nearby November Brent crude oil futures illustrates, the price has traded from around $55 to $65 per barrel since late May. Before the most recent OPEC meeting at the beginning of July, members of the cartel stated that the “sweet spot” for the Brent crude was $60-$70 per barrel. At around the $60 level on September 12, Brent has returned to a level that is in that range, albeit at the very bottom end.
A new oil minister and leader at Aramco
Last weekend, a shakeup in Saudi leadership at OPEC and the state oil company was a sign that there is a new focus on pushing the price of oil higher to diversify away from reliance on the energy commodity. Khalid al-Falih was the Saudi oil minister and the Chairman of Saudi Aramco. King Salman replaced the face of Saudi oil policy with his son, Prince Abdulaziz bin Salman. The new oil minister had held leading posts in the oil industry over the past three decades and was recently the minister of state for energy affairs.
At the same time, the Saudis also named Yasir al-Rumayyan as the chairman of Aramco. The new chairman is a close ally of Crown Prince Mohammed bin Salman and had run the country’s $320 billion sovereign wealth fund over the past three years. The replacement of both the oil minister and head of Aramco is a sign that the Crown Prince could be ready to move to the next step in his plans to diversify the Saudi economy away from what he calls its “dangerous addiction to oil.” With Brent prices at $60 per barrel, the Saudis need oil at least the $80 per barrel level to balance its national budget and fund Crown Prince MbS’s Vision 2030.
The new oil minister and the new leader of Aramco will work towards improving the revenue stream from the energy commodity to allow the nation to proceed with its plans to diversify.
A resurrection of the Aramco IPO
In 2018, the Crown Prince’s plans for an initial public offering of Aramco shares on the world’s leading equity markets fell apart over the valuation. While MbS believes that the company has a valuation of $2 trillion or more, the market and bankers crunching the numbers and risks associated with Aramco shares did not agree.
Saudi Aramco is the world’s most profitable company and would have the world’s leading market cap if it were to go public. However, the political and regulatory risks mean that the valuation would receive a massive haircut compared to companies that operate outside of Saudi Arabia. One year ago, the Saudis became the pariahs of the world after the murder of Saudi national and Washington Post contributor Jamal Khashoggi. Khashoggi had been critical of the monarchy and the Crown Prince.
Meanwhile, on the first anniversary of the murder, the IPO appears to be back on the table. Many analysts put the value at the $1.5 trillion level, while the Crown Prince continues to contend that the $2 trillion level is more appropriate. The Saudis still wish to sell 5% of the state oil company to add to the sovereign wealth fund. At $2 trillion another $100 billion flowing into the fund would allow for investments to diversify the country’s exposure to oil for the future. Meanwhile, if the Crown Prince is successful, the Saudis could increase the percentage of the company offered in an IPO.
A realization that OPEC ain’t all that anymore
The world’s leading oil producers are the US, Russia, and Saudi Arabia. Only the Saudi’s are members of the international oil cartel. However, Russia’s involvement in production policy and participation in output cuts since 2016 could make an argument that the Russians are the leading force within the cartel while remaining a nonmember.
These days, the price of oil reflects policy decisions made in Washington, Moscow, and Riyadh. The 2020 Presidential election could change the balance in the oil market dramatically. Elizabeth Warren, one of the leading candidates who could take on President Trump in his quest for re-election recently said that she would ban fracking “everywhere.” Oil and gas production grew dramatically under the Trump administration as regulatory reforms made the US the world leader in output. If the incumbent President fails in his re-election campaign, we could see the price of oil rise as US production declines. Therefore, the Saudis could be setting the table for an IPO of Aramco in 2020 or 2021 to take advantage of a spike in the price of the energy commodity.
OPEC does not have the power to push the price of oil higher in the current environment. However, new leadership in the US and a dramatic shift in energy policy could hand the power back to the Saudis and Russians on a silver platter.
Oil stocks remain cheap, and oil services are the cheapest
The new rumblings about an Aramco IPO come at a time when all oil-related equities have underperformed both the price of the energy commodity and the overall stock market in the US since the end of 2018. Crude oil fell to a low at $42.36 on NYMEX with Brent at a low at $49.96 in late December 2018. With WTI at the $55 level and Brent at $60 on September 12, the price of the two benchmarks have recovered by 29.8% and 20% respectively.
At the same time, the S&P 500 SPDR, that reflects the price action in the index has increased from $233.76 in late December last year to the $302 level as of September 12, a gain of 29.2%. Meanwhile, the XLE that holds shares in most of the leading oil companies has moved from $53.36 to $60.70 an increase of 13.8% over the same period. Oil equities have lagged both the price of oil and the stock market. Oil services companies have done even worse.
While oil and stocks never fell below the December 2018 low in 2019, the VanEck Vectors Oil Services ETF product fell below the late 2018 low at $13.13 per share to a low at $10.76 in mid-August. At $12.86 on September 12, it was lower than last year’s low even though oil and the stock market are significantly higher.
OIH holds shares in the leading oil services companies including:
Source: Yahoo Finance
OIH has net assets of $597.73 million and trades an average of over 9.6 million shares each day. The ETF charges an expense ratio of 0.35%, but the blended yield from the dividends on the companies help by the product is at the 2.61% level. At under $13 per share, OIH offers investors one of the best values in the oil patch these days.
Time will tell if the Saudis decide to readjust expectations when it comes to the valuation of Aramco that would lead to the world’s biggest IPO. However, the future of the IPO could rely on the 2020 Presidential election in the US. A decline in US oil output would strengthen the Saudis position in the energy commodity in the medium-term as the energy commodity continues to power the world. When it comes to oil services companies, OIH offers value in a stock market that is not far off record highs. Based on the appreciation in both stocks and oil compared to their respective lows in 2018, OIH could recover significantly from its current price level. The Saudis want a high valuation on Aramco, which runs contrary to the valuation of other companies in the oil-patch these days.
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