The coming initial public offering (IPO) for ARAMCO, the Saudi Arabian oil company, has captured the attention of Wall Street regarding just how much the company is worth. On the valuation question, well, we will leave that to the collective wisdom of the marketplace.
We are interested in how ARAMCO will function as a public company and the implications for oil market volatility.
In the past, Saudi Arabia has served as the swing producer for the Organization of Petroleum Exporting Countries (OPEC). That strategy worked exceptionally well in the 1970s when OPEC burst onto the scene and pushed prices four-fold higher.
Supply economics took over in the 1980s and OPEC was a non-factor. OPEC's influence revived in recent decades, until the U.S. shale oil boom.
The story unfolded in November 2014. OPEC decided not to cut production even as oil prices were falling. The idea was to break the profitability of U.S. shale producers. The price of oil hit a low of $27 per barrel in February 2015 and many shale producers were in big financial trouble. Then, the price recovered, as did U.S. shale producers, and now the U.S. is the largest oil producer in the world, standing slightly higher than Russia and Saudi Arabia.
Managing Shares, Not Crude
With the writing on the wall regarding the ability of Saudi Arabia to serve as a swing producer and buffer to oil price volatility, the Saudis are switching gears. As my former professor John Rutledge, the chief investment officer of Safanad, has observed, instead of managing oil production, the Kingdom will manage its holdings of ARAMCO shares.
That is, over time, the Kingdom will exert less and less influence over oil production decisions -- the age of the Saudis as swing producers, not to mention OPEC, may be ending soon. When the Kingdom needs more money to fund its economic revitalization plans, it will simply sell more shares in ARAMCO.
We are in a new world of less OPEC influence, and potentially more oil price volatility as Saudi Arabia cedes the role of swing producer to the market-price influenced U.S. shale producers.
(This article is sponsored and produced by CME Group, which is solely responsible for its content.)