Brent crude has enjoyed a rally this month and is up over 30% from its lows in June, at time of writing. With futures currently trading above $60 per barrel; Brent is up at a two-year high. This comes off the back of recent reports that OPEC (read Saudi Arabia) and Russia are to extend production cuts beyond the first quarter of 2018. A strong message of support for prolonging the deal came from Saudi Crown Prince Mohammed bin Salman over the weekend, ahead of the OPEC gathering in Vienna at the end of November. Recent reports of instability in one of OPEC’s top producing nations, Iraq, coupled with strengthening global growth, thus increasing demand, has also added fuel to Brent price gains. Off the back of the trifecta, a number of market makers have revised their forecasts for Brent in 2018 materially higher; JP Morgan for example revised forecasts for Brent by as much as $11, to $58.
Despite the recent rally and improved sentiment, there is little assurance that crude will continue to trade at these levels going forward; although the IMF forecasts oil to trade around $50-$60pb in the ‘medium term’. Crude at $60 per barrel is still on the lower side, especially if we consider that only five OPEC nations have fiscal breakeven levels in and around $60; these are Kuwait, Iran, Qatar, Iraq and the UAE, according to the IMF. It is important to note that breakeven levels not only take into consideration extraction, capital spending, production, taxes and transportation, but measure the amount of crude required to meet spending plans and balanced budgets.
So leader of OPEC and largest producer, Saudi Arabia - which has suffered a dent in its budget gap - has taken steps to cut its oil expenditure ; despite extractions costs being amongst the lowest globally (only $3 in production costs) due to the location near the surface of the ground (desert) and the enormity of the fields. According to the IMF, Saudi’s break-even oil price is estimated at $70pb this year, down from as much as $96.60pb just last year. In fact, Gulf nations reliant on oil production have moved to slash spending and remove or reduce hydrocarbon subsidies over the past three years or so. Although breakeven levels have moved lower amongst gulf producers, Bahrain, Oman, Saudi Arabia and the UAE are still overspending according to the IMF and Bloomberg; thus balancing their budgets is slightly trickier. On the other hand, Kuwait and Qatar have seen limited impact from the collapse in oil prices since 2014, as 2018 break-even analysis estimates both are comfortably below $50pb. Some nations have also made huge leaps and bounds to diversify their economies, thus less reliant on hydrocarbon revenues; however, there is still a long road ahead.
According to our proprietary Net Foreign Analysis (NFA) the above mentioned Gulf nations are all ‘wealthy’ with positive net foreign assets. Aside from Iraq, Iran and Bahrain, none of which are investment grade, we have holdings in the other nations; all of which offer over 3 notches of credit cushion and a weighted average yield around 4.5%.