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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

 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.

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

 Current rating: 0 (3 ratings)

How much more can KSA cut production

Date : 16/11/2017
Author:  Marmore MENA Intelligence

Saudi Arabia relies heavily on the oil revenue to support is fiscal expenditure and also support its ambitious economic growth plans. Due to this prominence, when the oil prices declined in 2014, Saudi Arabia’s initial stand was to increase market share by increasing the production thereby driving higher-cost US shale drillers out of the oil game.  However, this strategy did not pay off and two years later, the OPEC members including Saudi Arabia have agreed to reverse their stance and instead cut production.

Saudi Arabia plans to pump about 9.77mbpd in November, which would be its lowest output since January 2015. According to the Saudi energy ministry, the decrease in allocations for November includes a full 290,000-bpd reduction over and above the 486,000 bpd that Saudi Arabia pledged to cut as part of its commitment.

Table: Saudi Arabia Oil Supply (Jan-2015 to Sep-2017)

Source: Reuters, Marmore Research

Considering Saudi Arabia’s commitment to do whatever it takes to end the oil glut, it is pertinent to understand how far Saudi Arabia can actually go to cut its output. Some of the prominent factors that would influence Saudi Arabia’s production cuts are its market share, global demand for oil and most importantly Aramco’s valuation.

Market Share
One bright spot for Saudi Arabia as an outcome of its initial decision of not cutting the production, is that it gained market share by 1% over the last two years. However, with the OPEC proposal to freeze or cut production, the gain receded to some extent. Saudi Arabia’s exports declined from 7.4 mbpd during October-2016 to 6.7 mbpd during September-2017.

Considering that Saudi Arabia’s supply is still in excess compared to that at the end of 2014, it appears there is still some room to cut output albeit at the cost of losing market share by a few more basis points.

Table: Saudi Arabia Oil Supply

Source: Reuters, Marmore Research

Table: Saudi Arabia Production Cut Target and Compliance

Source: Reuters, Marmore Research

Global Demand
The oil price woe started with the shrinking gap between demand and supply and eventually leading to the current scenario of excess supply. Consumption was affected due to slowdown in the phase of growth in demand for oil globally and in particular China- the second largest oil buyer. This led to increased gap between supply and demand. The demand of crude is beyond the vicinity of control for the crude suppliers and hence they can only rely on the supply to influence the price. Excess supply at a lower price is not likely to result in increased consumption, though the oil importers might use this opportunity to stockpile crude. However, considering the long-term storage costs, the increase in the level of consumption is going to be limited unless real demand kicks in.

Source: Reuters, Marmore Research
Saudi which relies heavily on the oil revenue, is better off with higher oil price. Despite increased production levels, Saudi will not be able to push the required additional barrels of oil to compensate for the loss of revenue due to the lower oil price. For instance, Saudi would have to increase the exports volume by 1.5X @ USD 65 per barrel and 2X @ USD 50 per barrel to match export revenue of oil price @ USD 100 per barrel. Now that the gap between supply and demand appears to be diminishing, Saudi would it’s supply cut to further reduce this gap. However, Saudi will also ensure through its dominance in OPEC that all the members to contribute to plug this gap.
Aramco Valuation
 The significance of oil prices on the Aramco IPO cannot be emphasized enough. Higher price of oil would help the Aramco report stronger realized sales in the financial performance details that it must release ahead of the IPO. According to Sanford C. Bernstein estimates, Aramco would make a net profit of USD 13.3 a barrel on its upstream production with oil @ USD 50, on the contrary its profit would increase to USD 16.90 with oil @ USD 60. This suggested that a USD 10 swing in the oil price could effectively translate into hundreds of millions of dollars to Aramco’s IPO valuation. Considering the coveted USD 2 trillion valuation of Aramco that the Saudi Government is aiming towards, marginal receding of market share is relatively a smaller sacrifice.
 The Saudi Arabia-led OPEC initiative to control the oil prices have started to yield result with the global oil market improving and stabilizing. The oil price has recovered considerably and global oversupply has nearly halved since the beginning of the year. Saudi Arabia would aim to keep the oil prices around USD 60 per barrel by cutting production, for now as this would help Saudi Arabia maneuver its economy comfortably and at the same time not offer much incentive to US shale producers to increase output drastically.
 For Saudi Arabia it may appear that oil price recovery has come at a cost of giving up market share. However, it has two very strong reasons – reducing budget deficit and highest possible valuation for the Aramco, to stick to the cuts. Considering these priorities, historic production and market share levels of Saudi Arabia and global oil demand in the near future, it can be argued that Saudi Arabia production levels haven’t reach the maximum floor levels. We believe that Saudi Arabia wouldn’t hesitate to cut its production by another half a million barrels to achieve its target price.
This article is published in "Marmore Blog"

Tags:  Arabia, Economy, Oil, Saudi

 Current rating: 0 (3 ratings)

Real Estate Market and New Electricity & Water Regulations

Date : 09/03/2017
Author:  Abdulrahman Al-Sanad

Since 2014 oil prices witnessed a huge fall due to many factors including geopolitical issues. This in return made all sectors to slowdown, which had impacted the consumer purchasing power to be more cautious. Real estate was one of the main sectors affected by the oil prices fall, prices of real estate properties went down as well as the demand. Government, in return, has de-subsidized diesel and gas, which raised the cost of living. Vacancies increased, especially for investment sector, in return rents decreased due to the decrease in demand and high supply.

In 2016, the value of investment, industrial and retail properties have witnessed slight decrease after a decline of 5-7% in 2015 due to the fall in oil prices, and the value of offices has remained stable with a slight increase in rental rates and sales price through 2015 and 2016.

Recently, a new bill (20/2016) was passed to increase utilities expenses for electricity and water consumption. This new law is set to be effective in May 2017 for the commercial sector, August 2017 for the investment sector, and February 2018 for the industrial sector.

The following graphs show visualizes the set increases:

In Kuwait, the non-Kuwaitis represent 70% of the population. As per Kuwait law, non-GCC nationalities cannot purchase any property leading the expatriates to the option of renting. Therefore, the investment sector is one of the dominant sectors in Kuwait’s real estate market. The new law will negatively affect this sector leading to an escalation in cost of living, which makes Kuwait less appealing to expatiates. This will lead to higher occupancy and lower rental rates. 

Regarding the commercial and industrial sectors, these increases will have a high impact as well due to the poor economy conditions effects on the purchasing powers of consumers. This will lead to huge decrease in sales that will have negative impact on current businesses and upcoming businesses affecting all sectors including real-estate. Therefore, it is also expected that the supply will surpass the demand, which leads to high number of vacancies. 


This article is published in "Engage Q4, 2016" - click to view the publication


Tags:  Business, Oil, Real Estate

 Current rating: 0 (3 ratings)

Kuwait Price Index up by 19% in Jan 2017

Date : 09/02/2017
Author:  Marmore MENA

According to Marmore’s recently released Monthly Market Review, MENA bourses had a positive start to the year 2017, with nearly all markets ending the first month in green. Kuwaiti Price and Weighted indices led the charge, rising by 18.9% and 12.4%, respectively, followed by Bahrain (6.8%). Saudi Arabia and Oman were the only markets to register a fall in January, falling by 1.5% and 0.1%, respectively. Various reasons are being touted for the 14-day consecutive rally in the Kuwait bourses, but a look at the top five stocks by value traded suggest that main activities are largely in large cap companies. The appointment of the new chairman and a series of market reforms may have led to investors hoping that steps might be taken to boost foreign inflows, following the regional peers UAE, Qatar and Saudi Arabia. Also, with Pakistan upgraded to MSCI Emerging Markets Index, Kuwait and other countries could see increased representation in the MSCI Frontier Markets Index.


With the fall in oil output, in line with the OPEC agreement, many of the Saudi sectors were affected, with losses posted in Banking, Retail, Hotels & Tourism and Transport sectors. Corporate earnings across all sectors rose by 2% in 2016, but earnings in Banks and Materials companies fell by 5% and 8%, respectively. S&P GCC grew by 1.6% in January, to close the month at 101 points.

MENA markets witnessed an upswing in momentum in January, with volumes rising 53% and value traded 3.7%. All MENA markets, barring Saudi Arabia, witnessed a rise in market liquidity in December, with Kuwait, Bahrain and Abu Dhabi leading the charge. Value traded in Kuwait stood at USD 3.9bn in January, compared to USD 9.5bn for the whole of 2016. In terms of valuation, P/E of Morocco (20.7x), Kuwait (17.9x), and Qatar (15.4x) markets were the premium markets in the MENA region, while the markets of Egypt (7.7x), Dubai (9.9x), and Bahrain (10.0x) were the discount markets.

Blue Chips also had a positive month, with Kuwaiti large caps dominating the best GCC performers in January. Shares of Zain, Kuwait Finance House, National Bank of Kuwait and Kuwait Projects posted double-digit growth, at 20.7%, 14.8%, 12.3% and 12%, respectively. Saudi Telecom (-7.6%) and Emirates Telecom (-4.8%) lagged behind the rest. Kuwait Finance House and National Bank of Kuwait also posted positive growth in 2016 earnings, as revenues grew, while Saudi Telecom witnessed an 8% fall in profits. Q4 profits for SABIC were positive for the first time in ten quarters, which indicated that  the worst might be over for Saudi Arabia's petrochemical sector, since the fall in oil price and government austerity measures raised the cost of gas feedstock. Qatar National Bank has reported a 10% jump year-on-year in net profit to USD 3.4bn for the year ended 2016, helped by stronger core earnings.

New Year Reforms and Bond Issuances
Saudi Stock Exchange is set to introduce settlement of trades within two working days of execution (T+2) during the second quarter of 2017. Tadawul also published draft rules for short-selling, and the borrowing and lending of securities. Presently, trades must be settled on the same day, which has inconvenienced foreign investors in particular, as they must have large amounts of money on hand before trading.

The Saudi cabinet approved an IMF-backed value-added tax (VAT) to be imposed across the Gulf, following the slump in oil prices. A 5% VAT will be levied on certain goods, following an agreement with the GCC in Jun’16. The move is in line with the IMF recommendation for Gulf States, to impose revenue-raising measures including excise and value-added taxes to help adjust to the low oil price environment that has slowed regional growth. The GCC countries have also agreed to implement selective taxes on tobacco, and soft and energy drinks this year.

The government of Oman has approached banks for an international bond issue with tranches of 5- and 10-years as the country plugs a budget deficit caused by lower oil prices. Oman's budget deficit is forecast to be USD 7.8bn in 2017, and the finance ministry has stated that it would cover this year's deficit with USD 5.5bn of international borrowing, USD 1bn of domestic borrowing and the drawdown of USD 1.3bn from financial reserves. Last year, the government raised a USD 1bn international syndicated loan in January, and issued tranches of 5- and 10-years international bonds worth USD 2.5bn in June, followed by another issue of USD 1.5bn in September.

Oil Market Review
Brent crude fell by 2 per cent to close the month at USD 55.7 per barrel, having maintained the price level at above USD 50 per barrel for all of January. OPEC nations Saudi Arabia, Kuwait, Algeria cut production in January more than they had originally committed to, while Russia followed suit and trimmed production faster than was initially agreed. However, rising US rig count and output put a cap on any oil price growth, as the US President had vowed to increase production.

Tags:  Bonds, Capital Markets, GCC, Oil, Stock Market

 Current rating: 0 (3 ratings)
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