Saudi Arabia Looks Beyond Oil

In the latest edition of the Numbers Report, we’ll take a look at some of the most interesting figures put out this week in the energy sector. Each week we’ll dig into some data and provide a bit of explanation on what drives the numbers.

Let’s take a look.

1. Saudi Arabia eyes post-oil age

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- Saudi Deputy Crown Prince Mohammed bin Salman made headlines when he offered hints into the government’s plan to setup a $2 trillion sovereign wealth fund to diversify the Saudi economy. Part of the plan is to put parts of Saudi Aramco up for an IPO, although less than 5 percent of the company. The IPO will come in 2017 or 2018.
- As Bloomberg notes, that fund would be larger than Apple, Microsoft, Google, and Berkshire Hathaway. By 2020, the fund will invest 50 percent of its $2 trillion in foreign assets. The Prince said that the government is already eyeing two targets for a takeover.
- It is also looking at an overhaul to the economy to bring in non-oil revenue, including its first VAT and other taxes on luxury items. Austerity measures are also bringing about the largest changes to the economy in decades, with cuts to government spending and to an array of subsidies. They are starting up a program of putting fees on some foreign workers, a drastic change for a country that relies on so many non-Saudi nationals for its workforce.
- Non-oil revenues rose to 163.5 billion riyals ($44 billion) in 2015, or a 35 percent increase from the year before.
- The proposed $2 trillion fund will continue to move Saudi Arabia gradually away from oil revenues. “So within 20 years, we will be an economy or state that doesn’t depend mainly on oil,” the Prince said.

2. When oil prices rise, GDP goes…up?

- Goldman Sachs finds that U.S. GDP would rise if oil prices rise, a counterintuitive argument given that the U.S. is the world’s largest consumer of oil. This echoes a recent IMF report, although for different reasons.
- Supply elasticity is greater than demand elasticity, meaning, there is a bigger drop off from the oil industry when prices crash, which outweighs the benefit to the economy from higher consumer demand. Consumers have more money, but the drop in supply will lead to more oil imports, which worsens the U.S. trade deficit.
- Under three scenarios – oil prices rising to $30, $50, or $70 by mid-2017 – Goldman finds that GDP would increase by an extra 0.4 percent under the $70 scenario compared to if oil dropped to $30.
- On the other hand, that changes with time, as the consumer benefit grows and ultimately offsets the loss to the industry. The study finds that while GDP is higher through mid-2017 under the $70 scenario, if you look out to the end of 2018, GDP growth will be virtually the same regardless of the oil price.
- In summary, Goldman finds that the crash in oil prices could weigh on the economy in the short-run, but the consumer benefits start to become more obvious several years down the road.

3. Baltic Dry Index passed the bottom?

- The Baltic Dry Index measures trading activity for dry bulk commodities, such as iron ore, coal, grains, and more. It can be viewed as a sort of proxy for global trade and the health of the economy.
- The index has increased by 62 percent from its low in February, rising to 471 as of April 5. However, over the past five years, the index has average 1,100.
- Part of the reason for the crash in the index is a slowing Chinese economy. China was the major source of dry bulk commodity demand for much of the past decade, but that has slowed remarkably since last year.
- On the other hand, the index has been hit by a glut in shipping capacity. Shipping companies continued to add ships over the past few years expecting robust demand for commodities. But with excess capacity, the rates for dry bulk ships have collapsed.
- Bloomberg says that the daily rate for a vessel is $6,050, or about $1,000 lower than the operating costs. Shipping companies are burning through cash in today’s market, a fact that should steer investors clear of the sector.

4. Energy debt continues to rise

- Investors continue to try to find diamonds in the rough of the U.S. energy sector, hoping to spot companies that will emerge from the financial wreckage with fewer competitors.
- But buyers beware. Debt climbed across the industry even when oil prices were high between 2011 and 2014, as the FT chart shows.
- The markets are still very welcoming to stronger companies. There have been 17 equity offerings from U.S. shale drillers this year, raising $10.6 billion in fresh equity.
- Weaker companies do not have that option. More bankruptcies will be announced from the smaller indebted companies, which Goodrich Petroleum’s latest announcement illustrates.
- Very few drillers can turn a profit at oil prices below $40. Occidental Petroleum, for example, said that 14 percent of its wells are profitable with oil below $50, and 40 percent at oil below $60.
- Rystad Energy estimates that the U.S. will only see the boom times of drilling again when oil prices rise to $80 per barrel.

5. Solar installations surging

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- Michael Liebreich, the head of Bloomberg New Energy Finance, made headlines this week when he criticized Bill Gates’ search for a “miracle” clean energy technology, pointing out that solar power has seen costs declined by a factor of 150 since the 1970s, with installations up 115,000 times. "How much more miracle-y do you need miracles to be?” Liebreich said in a rhetorical question to Gates.
- In 2015, investment in renewable electricity capacity hit $266 billion around the world, more than the $130 billion invested in natural gas- and coal-fired electricity. Shockingly, the developing world accounted for more of the clean energy investment than the developed world.
- The record year for renewable energy also came as oil prices hit decade-plus lows. As BNEF puts it, “the reason solar-power generation will increasingly dominate: It’s a technology, not a fuel. As such, efficiency increases and prices fall as time goes on.”
- Every time wind power doubles in capacity, costs fall 19 percent. Every time solar doubles, costs decline by 24 percent.

6. Natural gas drilling is crashing

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- The oil rig count is closely watched each week as a key determinant of the drilling activity in the oil markets. But natural gas drilling has plummeted as well, with the gas rig count dropping below 100 in March for the first time in recent memory.
- Natural gas prices in the U.S. dipped below $2 per million Btu (MMBtu) in 2016, as the combination of a warm winter, near-record natural gas production, and elevated levels of gas in storage all weigh on the market.
- Prices are too low for companies to deploy rigs. Southwestern Energy (NYSE: SWN), the third-largest U.S. natural gas driller, has ceased drilling. Chesapeake Energy (NYSE: CHK), the second-largest gas producer, has scrapped all of its rigs in the eastern U.S.
- “Companies that do absolutely nothing are going to lose a quarter of their production this year,” Neal Dingmann, managing director for equity research at SunTrust Robinson Humphrey Inc., told Bloomberg. “How is that going to look for them in 2017?”
- Southwestern has $1.7 billion in debt coming due in 2018, and has cut spending by 80 percent. Chesapeake is looking to sell off $500 million to $1 billion in assets to trim its debt.

7. U.S. coal production, demand and exports all in decline

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- The U.S. coal industry, in a rapid and likely permanent decline, had hoped that exporting coal to China would be its saving grace.
- China’s coal consumption has been flat for the past two years, however, which shocked global commodity markets. With no new growth markets for U.S. coal, exports have been in decline since 2013.
- A shrinking domestic market and few options abroad have pushed most major U.S. coal producers into bankruptcy. All eyes are now on Peabody (NYSE: BTU), the largest private-sector coal producer in the world, which is rumored to be considering bankruptcy.
- U.S. coal production dropped by 12.6 percent in the fourth quarter of 2015 from the third, to 207 million short tons. That is also down 18.2 percent year-on-year. Exports dropped by 9.5 percent between the third and fourth quarter.
- Investors should stay far away from practically any player in the coal sector.

That’s it for this week’s Numbers Report. Thanks for reading, and we’ll see you next week.