Yesterday, at the 172nd OPEC meeting in Vienna, OPEC and some key non-OPEC countries announced the extension of production cuts for 9 months through to 31 March 2018. The earlier agreement had looked for a 1.8 mb/d reduction in production. Khalid Al-Falih, the Saudi Energy Minister, noted that oil inventories are expected to fall below five-year averages before the end of the year but as Q1 is seasonally weak it made sense to push the cuts out until the end of March. Little was said in terms of an exit strategy other than the situation will be reviewed at the end of November and into 2018. Brent crude sold off on the back of this news trading around USD51.75 per barrel the time of writing but oil had rallied strongly ahead of the meeting already factoring in a lot of upside and the announcement did not exceed expectations.
Increased supply from US shale producers remains an issue and makes OPEC expectations for inventory drawdown look a little bit on the optimistic side, although there is probably still a sufficient enough tightening to support the oil price above $50/bbl. US production is estimated to have risen by 600,000 bpd since the November’s production cuts were first announced. The EIA estimates that US crude oil production will average 9.3m b/d in 2017 up from an average of 8.9mb/d in 2016 but could increase further to 10 mb/d in 2018.
A stronger oil price environment is credit positive for the oil producing nations, particularly those in the GCC with currency pegs to the US dollar, where a lower oil price has pushed the fiscal balances into deficit territory and weakened current account positions. Fiscal breakeven oil prices vary across the region but at $50 it is only Kuwait that is breaking even and Qatar is not far behind at $55. In contrast, Bahrain and Oman require oil prices at $98 and $79 respectively explaining their weaker credit ratings. Saudi Arabia requires an oil prices at USD74 but its financial position is altogether much stronger. Bahrain, rated sub-investment grade (Ba2 by Moody’s), remains the weakest sovereign within the GCC region as not only are its deficits under pressure but Moody’s estimate that its FX reserves and sovereign wealth fund assets amount to only 4.2 years of current account deficits versus 30.5 years for Saudi Arabia. They also calculate that Bahrain’s external debt to GDP is 146.6% putting it in a vulnerable position versus much healthier figures of 24.8% for Saudi Arabia and 29.5% for Kuwait. Qatar (Aa2), Kuwait (Aa2) and Saudi Arabia (A1) remain insulated by their strong asset buffers and net foreign asset positions.
Russia has been one of the key non OPEC members to sign up to the production cuts also benefits as its state budget uses a USD40 forecast oil price for this year. But Russia has been more insulated from lower oil prices with greater exchange rate flexibility allowing rouble weakness to cushion some of the hit.
What is interesting is that even with the stellar performance of the quasi and sovereign Eurobond issues from Qatar, Saudi and Russia over the past couple of years they still represent some of the more attractive opportunities within our investment universe. For example, the State of Qatar 6.4% 2040 trades on a yield of 4.2% and 4.7 notches cheap (Aa2 best rating) while Saudi Electricity 5.5% 2044 even with a recent ratings downgrade to A2 still trades on a yield of 5.07% and is trading 3.7 notches cheap.