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Why are the breakeven oil prices coming down for GCC countries?

Date : 15/01/2018
Author:  Marmore MENA Intelligence




Fiscal breakeven oil prices (in USD/bbl)



Source: IMF

Fiscal break-even oil price is the minimum oil price needed to meet the spending commitments of oil-exporting country while balancing its budgets [BEP = {(Government Expenditure minus Non-oil revenue)/Oil quantity produced} + per barrel cost of production] (Fiscal Breakeven Oil Price). Prior to the collapse of oil prices, fiscal break-even oil prices were rising rapidly in GCC countries, reflecting the substantial increase in government spending by an annual average of 11 per cent in real terms in 2003-2014 (Gulf News). Moreover, the increasing government expenditures were largely due to rising salaries, wages and subsidies; expenses that were hard to control given the welfare economic model that is prevalent which subsequently made it difficult for the government to lower the breakeven oil prices. This led many analysts to think that lowering of BEP would be hard. However, the new realities due to low oil price environment had led to dramatic changes including curbing of subsidies and introduction of new non-oil revenue sources.

There are three main factors which drive the movement in fiscal GCC break-even oil prices. First is the value of hydrocarbon exports, second changes in non-hydrocarbon government revenues (accounted for 30 per cent of total government revenues in the past five years) and finally change in government spending. An increase in the value of oil exports, improving non-hydrocarbon revenues and a decline in spending will all contribute to lower fiscal breakeven oil prices.

Fiscal consolidation efforts by the government including restrained spending and growth in oil revenues (compared to the previous year) due to gradual rise in oil prices led to a decline in fiscal breakeven oil prices in 2017. Whereas in 2018, improving non-oil revenues is expected to be the main factor in reducing the breakeven prices. Unlike other oil-exporting countries, GCC currencies are pegged to the dollar, and thus most of the adjustment to lower oil prices has been on the fiscal side. Reduced government spending has so far been the most prevalent measure to lower break-even oil prices in the GCC countries after crude oil prices shed by more than half in the last two years.


Source: IMF
Additional adjustment in 2018 will focus on mobilization of non-hydrocarbon revenues, including higher fees and charges, introduction of value-added tax in early 2018 and privatization moves (IIF). As a first step, countries are introducing a VAT and other consumption taxes — for example on tobacco and sugar-sweetened beverages. Over time, governments may also consider deriving additional revenues from income and property taxation. These efforts are expected to raise revenues by 1-2 per cent of GDP, assuming a VAT rate of 5 per cent (IMF).

In Saudi Arabia, this would lead to much lower fiscal break-even oil prices, a decline of 24 percent from USD 96.6 to USD 73.1 per barrel of crude oil in 2017. Kuwait and Qatar will have break-evens below the oil price, more than enough to balance the budget in 2018. Overall, the weighted average fiscal breakeven oil price for the GCC has declined steadily since it peaked at USD 87/bbl in 2014 to USD 69/bbl in 2016 and USD 66/bbl in 2017.


Source: IMF, IIF

Tags:  Economy, GCC, Oil, Price

Ratings:
 Current rating: 2.5 (3 ratings)

How do you mimic the price performance of spot oil market? - The answer is its nearly impossible

Date : 11/01/2018
Author:  Marmore MENA Intelligence




Crude oil by a wide margin is the most traded commodity in the world and arguably the most important. Having hit lows of less than USD 43 a barrel in the summer, WTI crude has spent the second half of the year on a steadily rising trend and looks set to end 2017 somewhere close to USD 60. The main driving force behind the oil price rise has been OPEC’s decision to maintain oil production cuts that started in December 2016. The degree of compliance by members of the oil cartel has also improved as the year progressed

The last few years indicate that calling the direction of oil prices with any degree of accuracy is very difficult. However as the oil prices show a recovery trend many will be tempted to gain from the surging oil prices. The spot price is relatively unimportant in global oil markets. Most refiners purchase oil with the help of long-term contracts, either one-off privately negotiated contracts or standard contracts from an exchange. But the idea of spot price is one that fascinates investors - everyone is intent on trying to invest in something that tracks "the price of oil" as closely as possible. In 2016, WTI oil price return was a remarkable 46% which further extended by 9.4% YTD as of 15th December.

WTI Spot price (Dollars per Barrel)



Source: EIA; Data as of December 15, 2017

Crude Oil ETFs track the price changes of crude oil, allowing investors to gain exposure to this market without the need for a futures account. There are many exchange-traded funds (ETFs) that focus solely on oil. Each ETF is structured slightly differently depending on the futures contract it holds, but all aim to give investors an easy way to invest in oil. The oil ETFs are all highly correlated with the spot price of benchmark it tracks. However, it is important to understand the reason behind the variation in the returns of these investable alternatives as none exactly tracks the spot's return. In fact, against the near double digit returns of spot oil this year 90% of the top performing oil ETFs have lost the money.

Top performing Oil ETFs vs WTI Crude oil




Source: ETFdb; Data as of December 15, 2017

The simple reason for wide variance between ETFs and spot oil price performance is that the ETFs rely on future contracts to get exposure to oil, and futures prices, by definition, are not spot oil. As a futures contract comes close to its due date, its price can approach (or converge) to spot. But the futures price starts either higher or lower than spot, meaning that the market values futures oil more or less than spot oil it can take delivery today. One of the key reasons behind the mismatch in ETF returns and spot oil price is due to a phenomenon termed ‘contango’ which has a huge impact on investors return in oil futures contracts. Contango is the situation where the ‘out-month’ contracts are more expensive than the ‘near-month’ contract. When that's the case, there are real costs to allowing a contract to roll forward into the next month's contract. Thus there is a roll cost or yield involved in buying next month’s futures which lower the profit margins. In fact, contango can turn rising oil prices into a loss if it is steep enough.

As opposed to this when markets are in backwardation a situation where long-dated contracts are cheaper than next month futures, futures-based products will generally outperform spot prices. The oil ETFs actually outperformed spot WTI when crude prices plummeted in 2008 (ETFdb). While contango destroys value for oil ETF investors, backwardation creates it.

Conclusion
Ultimately, there may be no possible solution or financial instrument to accurately capture the price performance of spot oil. However, it is of utmost importance to understand clearly what it is we are really trying to capture. It's natural to think about the spot price of oil. But including oil as a commodity play within an asset allocation framework could add substantial risk in an investor’s portfolio. The front-month contract may simply be the best economic proxy available, since the roll yield inherent in the futures market can severely affect the return performance of ETF which is significantly influenced by factors other than just the movement in the price of oil. Thus while an investor can watch the daily movement in oil price, they cannot hold it and realize returns identical to the spot price movements.
 

This article is published in "Marmore Blog"

Tags:  Commodities, Oil, Price

Ratings:
 Current rating: 0 (3 ratings)

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