The Saudis have floated their first sovereign bonds, a $17.5 billion dollar offering that was more than 6 times oversubscribed. This bond issuance gives us tremendous insight into the largest OPEC member, their thoughts on the trajectory of oil and where we probably should look for investments in the coming years.
Saudi Arabia, besides being the largest and strongest member of OPEC, has begun a major effort to change itself. Earlier this year, it launched the ‘vision 2030’ program to much fanfare, designed to move the Saudi economy away from its singular focus on oil. The death of King Abdullah and succession of King Salman prompted the development of ‘Vision 2030’ which includes social and educational reforms. In charge of this new policy is young Prince bin Salman, who has risen quickly to power ahead of much older and more senior princes like al Nayef, who was thought to be the likely successor to King Salman, now more than 80 years old.
But outside of these family politics there remains an oil question that the Saudis are trying to answer – how long can they depend solely on the revenues from their lone oil commodity?
The aggressive bond offering just completed gives us an indication that the Saudis, alongside their family turmoil, are feeling economically panicked as well.
Otherwise, why would they begin their capitalization of oil assets now, when oil prices are still only hovering at a relatively low $50 a barrel? There’s been a very fast capital burn in Saudi Arabia, sometimes as much as $10 billion a month, cutting their foreign reserves close to the frightening $200 billion level. And while the Saudis are well aware that sub-$50 oil is ultimately unsustainable, they must be worried about a current low price that they assumed would already be rising swiftly by now.
By making a preliminary production agreement with other OPEC members and Russia last month after avoiding production agreements three times in the past, the Saudis are admitting their failure to grind U.S. shale producers into the dust as they had hoped. The important, price controlling swing barrel capacity will not rest solely with the kingdom going forward. They can no longer afford to extend their wait much beyond the two years they’ve already invested for their U.S. competition to fold.
What does all this mean for us? By agreeing in Algiers and Istanbul to a production cap and by beginning the process of raising capital through sovereign bonds and ultimately an IPO of state oil company Saudi Aramco, the Saudis are insuring a slower recovery for the oil markets than both they or I predicted. While I was looking for a blowout of weak production throughout this year, followed by a spike rally lasting more than two years, I now see a much more controlled and slow increase in prices as a likely scenario.
That means that our long term oil investing need not be panicked – we’ll have lots of time to slowly and correctly position ourselves in quality oil stocks.
And as for the Saudi offerings? I think their panic is another opportunity. Saudi bond basis prices are more than 2.3 percent above U.S. benchmarks and on par with UAE sovereigns – who certainly have far weaker oil revenues than Saudi Arabia. These are terrific bonds to hold.
And a coming IPO from Saudi Aramco, if it is offered at the same cut-rate price as the bonds, will be one to look forward to.