24 January 2019
Since King Salman (L) ascended to power in 2015, his son, Crown Prince Mohammed bin Salman (R), has become the most influential and powerful figure in the oil-rich Saudi kingdom. Photo: Reuters
Since King Salman (L) ascended to power in 2015, his son, Crown Prince Mohammed bin Salman (R), has become the most influential and powerful figure in the oil-rich Saudi kingdom. Photo: Reuters

Saudi purge: The Crown Prince’s motives and market implications

Earlier this month, Saudi Arabia’s newly formed anti-corruption committee detained 201 people in a sweeping purge. Among those held were eleven princes, four ministers and tens of former ministers.

The so-called “anti-corruption” campaigns take on different meanings in different regimes (Think about China). In Saudi Arabia, it is more about consolidation of the power of the Crown Prince, Mohammad Bin Salman, the head of the committee. Since his father became king in 2015, the 32-year-old prince has become the most influential figure in the oil-rich kingdom.

Before going into the Saudi Arabia situation further, here is a short primer to help get you started.

Saudi Arabia is the world’s largest oil exporter with the second largest reserves of oil (behind Venezuela), accounting for 20 percent of the world’s conventional oil reserves. It produces around 10 million barrels of oil daily, second only to Russia.

Founded by Abdulaziz ibn Saud in the 1930s, The Kingdom of Saudi Arabia, an absolute monarchy, is ruled by the House of Saud. The Sunni-led kingdom has long been considered a conservative religious state, but there have been a few winds of change recently. In September, authorities announced that they will lift a long-running national policy that banned women from driving.

Saudi Arabia has a complicated system of succession that does not usually run linearly from father to son; instead, the crown has passed laterally from brother to brother, and then to the eldest son of the eldest brother who had held the throne.

Taking into account that polygamous marriages are legally recognized in Saudi Arabia in accordance with Islamic Sharia law i.e. Muslim men are allowed to take up to four wives, there are many princes waiting in the line of succession to the throne in the royal family.

The current ruler of Saudi Arabia is King Salman, who succeeded King Abdullah on his death on January 23, 2015. On the same day, Prince Muqrin bin Abdulaziz became Crown Prince only to be replaced three months later by Muhammad bin Nayef, at the order of Salman. In July this year, Muhammad bin Nayef was deposed as Crown Prince and Salman’s son Mohammad bin Salman was appointed to the position.

The Crown Prince has been appointed by his father as the First Deputy Prime Minister, and the minister of defense of the Kingdom. He holds the oil price dynamics in his hands, while overseeing the country’s plan to launch a historic initial public offering of shares of Saudi Aramco, the state oil giant.

As the president of the Council for Economic and Development Affairs, Mohammad bin Salman is also the architect of economic reforms designed to help Saudi Arabia escape its dependence on oil exports.

Oil is already facing stiff competition from ever-cheaper and more environmentally-friendly energy sources. The US looks set to establish itself as the leader in crude and gas production thanks to surging growth in shale oil. Consider also that the revolution in electric vehicles has barely begun. The oil price has likely passed its peak and could face more headwinds in the foreseeable future.

In light of that, the Crown Prince has launched “Saudi Vision 2030″, a plan that seeks to broaden the kingdom’s revenue sources and reduce its dependence on oil. The country aims to make huge investments in disruptive technologies such as renewable energy, robotics and artificial intelligence, in order to make the non-oil private sector the new motor of the economy.

The Crown Prince’s extravagant plans require huge money for investment. That is why, I believe, the country is working on the IPO of Saudi Aramco, to raise capital by selling 5 percent of its shares to outsiders.

But as I understood, so far, there has been little actual progress towards the IPO plan. It is looking more doubtful amid debates over Aramco’s valuation and its IPO venues, taking the persistently low oil prices into account. While the Saudi government has put Aramco’s valuation at US$2 trillion, estimates by industry analysts suggested a valuation of merely US$800 billion.

From my point of view, the recent sudden and aggressive move by the Crown Prince was made with Aramco’s IPO in mind – he desperately wants higher oil prices to boost the valuation of the public offering.

Practically, there are three ways that Saudi Arabia may fuel the oil price rally.

1. OPEC supply cuts

Since 2016, Saudi Arabia has sought to push other OPEC producers to agree on production cuts, and established the historic rapprochement with Russia that helped lead to the output limits. The supply limit led by Saudi and Russia has significantly lifted crude from US$38 last year to near US$57 a barrel by now.

2. Saudi political tensions

The surprising arrest of Saudi princes, including the billionaire global investor Prince Alwaleed bin Talal, coupled with a helicopter crash leading to the death of a senior Saudi prince and seven other officials, have stunned the markets worldwide. Oil price rose to a two-year high after Saudi purge.

3. A looming Middle East war

Since King Salman elevated Mohammad bin Salman to a position of greater power, the country has turned to a more hostile and muscular posture toward some neighbors. It sought to isolate Qatar due to the latter’s relations with Iran, Saudi’s regional rival. Saudi Arabia is also directly involved in the Yemen civil war.

Tensions in the region have risen again recently as Saudi Arabia has ordered its citizens to leave Lebanon, a move that some observers interpreted as sign of an impending war on Iran-backed Hezbollah in Lebanon. Middle East conflicts tend to send oil prices in one direction: up.

Now, let’s look at some of the market implications from the recent Saudi shakeup.

I guess most of the investors are underweight on oil stocks. If WTI crude oil price reaches US$70 a barrel in 2018, the stock price of CNOOC (883.HK), China’s biggest offshore oil and gas producer, would likely rebound to HK$14 in Hong Kong, while that of PetroChina (857.HK) can rise to HK$7.

A rising crude price can push the US 10-year Treasury yield higher, reaching 3 percent next year. Besides, inflation is expected to go up with the rise in oil prices, requiring a more hawkish stance from the US Fed, a point worth noting.

This article appeared in the Hong Kong Economic Journal on Nov 14

Translation by Ben Ng

[Chinese version 中文版]

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Eddie Tam is the founder and CEO of Central Asset Investments.

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