Originally published April 28, 20169
Rear View Mirror Thinking in the Energy Industry
It is said that one should buy low and sell high. It is also said that generals tend to fight ‘the last war.’ Yet market participants tend to sell low and buy high; that is the social mood phenomenon known as herding. Generals remember the last battles lost and work to make sure that does not happen a second time, no matter how much things have changed since then.
And so it goes with the energy industry. Firms expand during periods of high oil prices and oil boom towns take on ‘skyscraper’ type projects, as rents soar. Then amid the price collapse, thousands are laid off and boom towns wonder how to pay for what seemed to be ‘sure thing’ projects.
Which brings us to yet another example of such thinking. Saudi Deputy Crown Prince Mohammed bin Salman is the 30 year-old son of King Salman. This past week he announced that the Kingdom, which is more dependent on oil revenue than any other on the planet, will wean itself from oil dependence. The Prince has modestly dubbed the plan ‘Saudi Vision 2030.’ The implicit assumption is that the Kingdom will end its dependence on oil by 2030. The press release is vague on exactly what end its dependence means.
This will be accomplished by selling perhaps 5% of the Arabian American Oil Company known as ARAMCO. The Prince values ARAMCO at between $2 and $3 trillion dollars. No one knows how those numbers were calculated. The Saudi government has always been secretive about the operations of the company and of course there are no public financial statements. Five percent of $2.5 trillion is only $125 billion But no doubt the Prince is focused on a high multiple (price earnings ratio) for the issue.
But enough of bothersome details, let’s stay big picture here. The goal is to create a trillion dollar sovereign wealth fund. Toss in $600 billion of current Saudi fiscal assets along with state owned real estate and industrial areas and bingo, a trillion is on the table.
This would have been a much more shrewd idea when oil was over $100 and even small firms carried uber-optimistic price earnings ratios. Now the news if replete with banks increasing loan losses and firms going bankrupt, unable to pay on the high debt from boom times.
My point is that this is not the ideal time for a shadowy firm to go public. Add in the fact that the Kingdom has at various times both sought and later rejected foreign involvement in the operation of the oil fields, and we have a less than ideal governance structure.
But hey, stock markets are high and let’s assume he pulls off the sale. Then the only remaining obstacle is to continually make money with the fund! Given that the markets world wide are at some of the highest levels ever, and the bull market is now seven years old, that may be harder than the Prince thinks. After all the skyscraper theory holds that massive projects are always planned during periods of wildly positive social mod. The Burj K halifa, the world’s tallest building located in Dubai, opened right after the financial collapse of 2009 , in one of the worst real estate markets ever.
The real problem of course is that the government subsidizes most of the ‘jobs’ in Saudi Arabia and women are mostly excluded from the work force. But, in a burst of social mood, the Prince has proclaimed that “with this plan we can live without oil by 2020.”
Oh and yes there are some structural reforms and efforts to increase efficiency underway.
Thinking that one can replace 56% of the oil economy now supporting thirty million people in a mere four years with a to be formed wealth fund is an example of positive social mood at the top of a market.
We will keep readers posted on the outcome of this plan.
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