Global Investing Hot Spots

With big debt deal and rising oil prices, market message is don't 'bet against the Saudis'

Saudi's oil minister says oil markets at end of downturn
Saudi's oil minister says oil markets at end of downturn

It wasn't lost on investors that Saudi Arabia had bullish things to say about oil prices Wednesday, just as it launched its first-ever international bond deal.

The whopping $17.5 billion three-tranche offering Wednesday benefited from strong demand and came in well above the initial expected range of $10 to $15 billion. It priced better than initial market talk indicated and was heavily oversubscribed, with total book orders of about $67 billion.

The deal also priced Wednesday afternoon as oil surged more than 2.5 percent, helped by a big drop in U.S. supply but also bullish comments from Saudi Arabia's oil minister, who said the long decline in oil prices was nearing an end.

Further helping crude were optimistic comments from OPEC's secretary general about the prospects of a production deal in late November.

"The spike in oil prices was notable," said Adrian Helfert, Amundi Smith Breeden head of global fixed income.

The debt offering is a key part of the kingdom's economic reform plan as it would give Saudi Arabia a sovereign benchmark that would help open its capital markets for future offerings, including corporate issues. It also is a necessary boost to cash flow to help the country withstand a long downturn in oil prices.

"Something investors have to consider is this is not the only opportunity they are going to have, because it's expected that Saudi will come back to the market. It may be good for both sides, but what they have shown is there's significant market interest in lending to Saudi Arabia," said Helfert.

Oil price volatility is one thing that bond investors have to consider, and prices have been steadily above $50 since OPEC's meeting in Algiers in September, when it agreed to work on a deal to control production by its late November meeting.

"We're basically going to see the markets rebalancing anyway. I think they're very incentivized to keep the momentum going through November. We still have a lot of skeptics. … If they go dark, people will question whether they can get this done. They have to talk it up. There's still just this residual skepticism that you need to have individual country quotes. No, they don't. Saudi can make it happen with the [Gulf Cooperation Council] countries," said Helima Croft, head of global commodities strategy at RBC.

Croft said she expects oil to hold above $50 per barrel and head to $60 by the end of the quarter. West Texas Intermediate crude futures closed up 2.6 percent at $51.60 per barrel, the best level since July, 2015. Brent crude was up 1.7 percent at $52.57 per barrel Wednesday afternoon.

"From an oil market perspective, there is a wide range of opinions and there's a lot of skepticism, but the bottom line is since that OPEC framework agreement … the takeaway is 'I don't want to bet against the Saudis. I better trim back my short positions. I either want to be neutral or long,'" said Michael Wittner, global head of oil market research at Societe Generale.

Wittner said the message from the Algiers meeting was that OPEC was back in the business of influencing prices, after a near two-year break where it let the market set prices.

"I know the bond sale, they've been planning this for many months. But the fact that they're, as of Algiers, signaling 'we're back in the game of actively managing the market,' it fits together to do that and then sell your bond. The investors of the bond are going to be more comfortable about the financial health of the issuer. To the extent that you're thinking about oil prices, it's 'don't worry, we got it,'" he said.

Final pricing terms were more favorable than anticipated. The $5.5 billion in five-year notes were priced to 135 basis points over the U.S. five-year Treasury; the $5.5 billion 10-year notes were 165 bps over the U.S. 10-year and the $6.5 billion 30-year were 210 bps over the U.S. long bond.

"The pure amount of interest in Saudi debt shows them there is the capability for them to further manage their funding sources in line with their targets. It's positive and it's a positive for investors as well," said Helfert.

Croft said the successful bond deal is a positive for Saudi Arabia as it pursues its economic reform program to diversify away from oil. As part of the plan, which is driven by Deputy Crown Prince Mohammed bin Salman, stock will be issued in state-owned Saudi Aramco next year.

Bin Salman plans to use the stock offering as a way to create a $2 trillion sovereign wealth fund and diversify the economy away from oil towards other industries, such as mining, finance and technology.

"They were talking about this well over a year ago. They made good on what they said they would do. It is a break of past practices. I think the IPO is the next big hurdle for them," said Croft. "I hear a lot of concerns about transparency."

"I think the next big question is will the IPO fly?" Croft said. "The debt is a break with the past of how they used to manage their affairs. They're putting debt in the category of integration with capital markets, but previous regimes took pride in having low debt-to-GDP ratios. It's taking something that could have been seen as a negative a few years ago and making it broadly positive."

The debt deal could be seen as a positive personally for bin Salman, the favored 31-year-old son of King Salman. "I have to give him credit. He is not doing anything by half measures. This is a man of singular ambition and it's at least in terms of this bond deal. It's not clear that it's broadly popular to borrow. The fact he pushed ahead with it and pulled this thing off, you can say this is a win for MBS. I thought he might have gotten more push back for doing this," said Croft.

Oil has certainly been a factor that the bond market has been focused on, because Saudi Arabia generates some 75 percent of its revenues from petroleum. The kingdom disclosed in its prospectus that proven oil reserves are 266.5 billion barrels as of the end of 2015. That is expected to last another 70 years, at the average production level of last year's 10.2 million barrels a day.

Saudi is the biggest oil exporter, and when it comments on the oil market, the remarks carry extra weight. Saudi Energy Minister Khalid al-Falih said on Wednesday that oil markets were at the end of a considerable downturn as fundamentals were improving and supply and demand were rebalancing.

He called on non-OPEC producers to help stabilize the market, saying their role was as critical as the role of OPEC members. Russian Energy Minister Alexander Novak said on Wednesday he was planning to meet al-Falih this weekend to discuss coordination of possible actions.

Mohammed Barkindo, secretary general of the OPEC, gave the market a boost by saying he is confident about the prospects of a planned production cut following an OPEC meeting on Nov. 30. "I am optimistic we will have a decision," he said.

OPEC said it plans to reduce production to 32.5 million to 33 million bpd, compared with record output of 33.6 million bpd in September. Just talk of that deal has supported oil prices and kept them above $50 per barrel since OPEC's Algiers meeting.

Oil also gained as U.S. crude stocks fell 5.2 million barrels last week, when analysts expected a build. Imports also slid 912,000 barrels per day last week, to an unusually low 6.47 million barrels. Gasoline inventories rose 2.5 million barrels, a surprise increase. The drawdown in crude was a surprise as oil demand usually slips at this time of year due to refinery maintenance. Refining fell to 88 percent of capacity.

Platts said top the importers into the U.S. saw volumes drop across the board last week. "...with notables such as Saudi Arabia showing the lowest imports since February, and Colombia showing a drop in imports of some 200 Mb/d as well, its lowest level in a year," it said.

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