“Nice global economy you’ve got there; shame if something should happen to it” is not a great pitch for oil and definitely not for the IPO of Saudi Aramco.
The best that can be said about Saudi Arabia’s gossamer-veiled threat of retaliation for any punishment over the disappearance of journalist Jamal Khashoggi is that it’s probably mere posturing. On Sunday, the foreign ministry put out a statement emphasizing the country “has an influential and vital role in the global economy.” (They’re talking about oil.) But by Monday, the country’s oil minister was making soothing noises about keeping the market stable, and the king had ordered an investigation into Khashoggi’s fate. Because actually using, or even seriously threatening to use, the oil weapon would be a self-own of colossal proportions.
Politically, Crown Prince Mohammed bin Salman, seen as the de facto ruler of Saudi Arabia, is locked in an embrace with President Donald Trump. If Trump’s tweets are anything to go by, he is antsy about rising gasoline prices ahead of midterm elections, now only about three weeks away. His transactional approach to foreign relations means he likely feels he is owed something for pulling the U.S. out of its nuclear deal with Saudi Arabia’s arch rival, Iran. Indeed, speaking of the oil-for-security bargain underpinning Washington-Riyadh relations for decades, the president has said the country wouldn’t last two weeks without U.S. support. And while Saudi Arabia has a warmer relationship with Moscow these days than it once did, outright confrontation with the U.S. is unthinkable.
Saudi Arabia’s success in keeping Iranian barrels off the market — raising prices for its own, higher exports — is another reason not to push things further. Iran has the market spooked already, and even today’s prices are denting oil demand, especially in emerging markets also suffering a slide in the value of their currencies. The International Energy Agency last week cut its forecasts for demand growth this year and next. They are still above 1 million barrels a day in each year, but higher prices would likely spur further reductions.
The world has suffered through two oil price spikes already in just the past decade or so. While they generated windfalls for the likes of Saudi Arabia, they also did wonders for rival producers (especially U.S. frackers) and structural demand destruction (especially electric-vehicle developers).
MBS only just reaffirmed his determination to push through his wide-ranging reform program, including that $2 trillion IPO of Saudi Arabian Oil Co. As I wrote here, the two biggest inputs on that valuation are the oil price and the free cash flow/dividend yield demanded by investors.
An oil price spike offers, superficially, a boost to producer valuations. But the stocks to own in that case are those most leveraged to short-term cash flows, such as U.S. frackers. For oil majors with large resources, the damage done to demand weighs on long-term price assumptions for all those future barrels (Aramco’s proved reserves life extends beyond 60 years).
Meanwhile, turmoil around Saudi Arabia raises its risk premium on all its stocks (look at what happened to the Tadawul on Sunday). That’s doubly so for a company deeply enmeshed in both the oil market and the state — such as Saudi Aramco. According to my calculations, every percentage point increase in the required yield roughly wipes out the benefit of a $10 increase in the long-term oil price assumption.
So a political crisis affecting the oil market via Saudi Arabia itself ultimately hits Aramco on both counts. Any oil producer with a horizon further out than 12 months needs to think about attracting customers, not holding them to ransom.
In all likelihood, both Saudi Arabia and the U.S. will try to find a way to defuse the current situation that preserves the relationship while saving as much face as possible. Trump’s Monday morning tweet certainly suggests as much.
Even so, the scar tissue building up on MBS and his reform plans can’t be ignored. From the Yemeni conflict, to the Qatar blockade, to his Ritz-Carlton reformatory project, the prince has displayed a penchant for headstrong moves. If Riyadh is ultimately implicated in Khashoggi’s disappearance, then it will only further undermine the storyline of Saudi Arabia’s vaunted reformer – and reinforce the risks building at the heart of the oil market.
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Liam Denning is a Bloomberg Opinion columnist covering energy, mining and commodities. He previously was editor of the Wall Street Journal’s Heard on the Street column and wrote for the Financial Times’ Lex column. He was also an investment banker.
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