We only follow 57 authors on Seeking Alpha, but those 57 are some of the most insightful authors we've come across. One in particular, Open Square Capital, wrote a piece titled, "Saudi Arabia's Peg: The Riyal Deal." The gist of the article talks about WHY we should expect Saudi to NOT devalue the Riyal.
What particularly stood out to us is this part:
When one looks at the economic situation Saudi is currently in, it's easy to make the argument that the correct measure is to devalue. But taking the grand view of things, a devaluation in the Riyal would severely destroy any confidence investors have, and pose a substantial risk to the Saudi Aramco (Private:ARMCO) IPO in 2018.
As we have detailed in past OMDs, if one pays attention to incentives, it's easy to see why Saudi has all the intentions now for higher oil (NYSEARCA:USO) prices. Global upstream capex has been reduced by nearly $1 trillion to 2020, and as oil demand continues to surprise, there are now concerns with whether there will be enough supplies to meet all the demand in the coming years. Saudi has all the tools to temporarily cut production by up to 2 million b/d, and a few years down the road, when the planned projects that were canceled stop providing supply growth, Saudi can ramp up production again. This is the best win-win scenario for Saudi's economic policy and its 2030 vision as detailed in this OMD.
Looking at the bond issuance, investors are paying some very low yields for those bonds. The 10-year bond was sold at a yield of 3.25%. The five-year debt was sold at a yield of 2.375% and the 30-year bonds were sold at 4.5% yield. This recent debt issuance allows Saudi to pay off the contractors that haven't been paid since late last year.
Issues remain for Saudi despite the recent bond issuance as IMF now projects Saudi's fiscal breakeven to be $79.70 per bbl. Recent economic austerities have not resulted in the level of cost savings Saudis expected, and if oil prices continue to languish around $50, the grand 2030 vision might be dead on arrival.
At HFI Research, we think the incentives are lined up for Saudi to make a drastic move. Cutting oil production by up to 2 million b/d will accelerate storage rebalancing from Q4 2017 to mid Q2 2017. As Saudi Aramco's IPO is slated for mid-2018, Saudi needs to build up investor optimism around investing in oil companies. The easiest way to build up optimism is by raising the price of oil.
If Saudi withstands two years of 2 million b/d lower production, the difference between what it will receive from the Saudi Aramco IPO dwarfs any comparison to the revenue loss. We think it's strategically and economically sound for Saudi to cut oil production to boost oil prices.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.