Energy

Liam Denning is a Bloomberg Gadfly columnist covering energy, mining and commodities. He previously was the editor of the Wall Street Journal's "Heard on the Street" column. Before that, he wrote for the Financial Times' Lex column. He has also worked as an investment banker and consultant.

First question for Saudi Arabia's proposed sovereign "megafund": Will it be buying a stake in Tesla Motors?

Bloomberg published an interview with Deputy Crown Prince Mohammed bin Salman hot on the heels of Elon Musk's unveiling of Tesla's bid for mass-market mastery in electric vehicles, the Model 3. Like Musk -- "We don't make slow cars" -- there was more than a touch of braggadocio in the prince's delivery. Plans to list Saudi Aramco and embed it in a supposedly multi-trillion dollar Public Investment Fund -- "Undoubtedly, it will be the largest fund on Earth" -- amount to nothing less than a transformation of the economy of OPEC's de facto leader.

Upending the global car industry actually looks like an easier task than that. Yet both efforts are intertwined and paint a picture for oil that is ultimately bearish -- albeit with a potentially bullish twist in the near term.

A good rule of thumb when it comes to public announcements of reform from opaque autocracies is that opaque autocracies generally only do this when they really have to. Saudi Arabia has more money stashed away from the oil boom than many of its peers; but, since peaking in August 2014, its foreign-exchange reserves have dropped by more than a fifth. As this chart from RBC Capital Markets shows, it is nowhere close to living within its current means:

We Don't Do Austerity
Estimated fiscal break-even oil prices for selected OPEC members
Source: RBC Capital Markets, Bloomberg
Note: Brent crude oil price is the average year-to-date.

Saudi Arabia, like many other commodity-reliant countries, periodically talks reform whenever the market turns south. But Prince Mohammed's proposals go much further than anything said before; even a partial domestic listing of Aramco would be crossing a Rubicon. And listing shares after your company's main product has crashed is something generally not advised on Wall Street. If the plan bears fruit, then Riyadh is effectively signaling to its fellow OPEC members and the world that, while oil prices may still fluctuate up and down from here, the game is up.

The last oil boom brought in a lot of dollars for oil producers but also unleashed two forces. One is shale production. Even if it is in retreat now -- as Friday's jobs report confirmed -- the U.S. shale boom has opened up a potentially vast source of rival supply run by companies rather than politicians.

Saudi Arabia's own policy of maximizing production is itself an acknowledgement that competition trumps cartels in today's oil market. It is also notable that the prince spoke of expanding Aramco's refining capacity, adding to another, less obvious glut in the global oil market. As if to confirm the new deal, the prince also said a vaunted supply freeze will only happen if chief geopolitical rival Iran goes against its own interest and joins it. His words pushed oil prices back into negative territory for the year.

Troubling Crude
Source: Bloomberg

On the demand side, the last boom revivified efforts to limit oil consumption, including investment in electric cars such as those made by Tesla. While Gadfly's advice to the prince would be to wait before buying shares in Musk's company, it should not be lost on him that Tesla secured $1,000 deposits on 180,000 Model 3s in 24 hours, more than all the cars it has sold to date. With Chinese oil demand growth looking questionable, and Saudi Arabia seeking with good reason to hedge its long-term risk, buying into electric vehicles might not be a bad place to start.

How much actual firepower Riyadh's proposed fund would actually have is very much open to question. The prince's assertion that it would be a multi-trillion dollar fund as soon as Aramco is listed is suspect on two counts. First, while Aramco is highly respected in the oil industry, it is still a quasi-ministry; like other national oil companies, it will warrant a discount valuation, especially if its listing is confined to a few percentage points on the Tadawul. Second, while the unlisted bit of Aramco would provide firepower to deploy in theory, actually using it for acquisitions would inevitably dilute the government's ownership. How much control would the royal family really be willing to cede?

Nevertheless, Prince Mohammed's proposals represent a sea change in the global oil market. The old certainties of ever-rising oil demand and prices are being questioned by a regime at the heart of the market.

The one bullish aspect to all this isn't a pleasant one to consider. Saudi Arabia's sudden desire to reform is borne of pressure on economic, political and military fronts. Besides the shifts in global oil supply and demand, Riyadh is confronted with a young, restless population in a dangerous neighborhood. It is also witnessing the fragmentation of governments and alliances in that neighborhood that have held, more or less, for roughly the past four decades -- with Washington's agreement with Tehran over nuclear weapons the most unnerving example.

It is when ossified regimes are suddenly forced to find religion on reform that they are most vulnerable to unleashing forces from below they can't control. The former Soviet Union's experience with perestroika and glasnost is a prime example, also linked in part to an oil-price crash.

Any crisis of similar proportions in Saudi Arabia would undoubtedly usher in an oil-supply shock, and price spike, of global proportions. It could also be the final nail in oil's coffin.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Liam Denning in San Francisco at ldenning1@bloomberg.net

To contact the editor responsible for this story:
Mark Gongloff at mgongloff1@bloomberg.net