Saudis Budgeting Less Than $53 For 2017 Crude Oil Prices

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Summary

Saudis budgeting a 46% increase in revenues in 2017.

But that increase is not entirely due to a comparable increase in world oil prices.

Most of the increase is due to raising domestic oil prices.

Therefore, Saudi Arabia is budgeting less than a 23% increase in world oil prices, or less than $53.

I recently wrote that the oil market was misinterpreting Saudi Arabia's intentions for oil prices in 2017.

The Saudis have decided to "nudge along" the rebalancing of supplies with demand during 2017. It seems to me that he would like to fine-tune OPEC's market intervention, so as to not create massive hedging opportunities for U.S. shale oil, which would result in a counterpunch to his strategy to firm-up prices… Saudis are looking for $55/b in 2017 and $61 in 2018."

One headline about the budget that raised eyebrows was that the Saudis are budgeting revenues to increase by 46% in 2017. Applying that increase to an oil price average of $43 in 2016 implies an average price of almost $63 in 2017, were the increase due solely to higher world oil prices.

I reviewed the 2017 Budget Kingdom of Saudi Arabia and found that it said (page 21):

Total revenues are expected to reach SAR 692 billion in 2017, a 31% increase compared to initial projections this year. Oil revenues are 20 estimated at SAR 480 billion, 46% higher than the 2016 projections… The increase in projected revenues and expenditure is primarily due to the energy pricing reform program, although this will be partially offset by the allowances for those citizens who need government support." (emphasis added).

Saudi Arabia's energy minister Khalid al-Falih said last Thursday that the kingdom would continue its policy of reforming domestic energy prices from 2017 until 2020, and prices would gradually be linked to international benchmarks. The Saudis had received petrol subsidies, part of the welfare state that forms a social contract with the kingdom's 20M nationals.

Saudi Aramco IPO

The domestic prices of petroleum products within Saudi Arabia also affects Aramco revenues and profits. And the IPO of Saudi Aramco (ARMCO) is the cornerstone of its Vision 2030 transformation plan.

It's important to understand that Saudi Aramco does not own the oil reserves. The government does. Aramco has a monopoly to produce from these reserves. Thus, any valuation will not be based on the value of the reserve base, but most likely on the discounted cash flows into the future, which depends on the profit per barrel and the quantity of oil produced.

The profit per barrel in turn will depend on the level of taxes and royalties Saudi Aramco pays back to the government and the subsidies being provided domestically.

If the taxes and royalties that are transferred to the finance ministry are high, and if the subsidies remain high, then the valuation will be lower-than-otherwise. The fact that the government can increase taxes on Saudi Aramco, and provide subsidies to its citizens, also introduces 'sovereign risk,' and so comparisons with private companies do not hold. The discount rate to Aramco's cash flows must be higher, given the higher level of risk.

Beyond the issue of the subsidies, there is the issue of whether Saudi Aramco would remain a national oil company if it listed in foreign stock exchanges, as will be necessary, given the limited size if Saudi stock exchange or Tadawul (Arabic: تداول‎‎). As stated by the Oxford Institute for Energy Studies in its analysis, "If Saudi Aramco loses the status of a 'national oil company,' it could be subject to anti-trust lawsuits. Any IPO has to ensure that Saudi Aramco is not exposed to such risks."

Conclusions

Most of the increase in 2017 revenues is due to the energy price reform program. Therefore, if most of the 46% increase is not due to gains in world oil prices, the Saudis are budgeting $52.89/b or less (i.e., a 23% or less gain from the $43 average in 2016). The OPEC reference price (ORB) was $52.25 (12/21/16), and so it is near their budget. They have called the budget assumption "conservative," but I don't believe they want to ignite a massive shale oil production response.

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.