Saudi Arabia is courting investors for what could be a whopping $15 billion-plus bond share deal. It’s a massive offering that’s likely to see good demand, and possibly more so if OPEC and global oil producers strike a deal that would stabilise oil prices.
The offering is an important step forward for the country, which has big plans to make over its economy and diversify away from its dependence on crude revenue. The debt offering also comes at a time when Saudi needs to shore up its finances. The kingdom has been hit hard by the long period of low oil prices and the costly war in Yemen. With about three-quarters of its revenues coming from petroleum, Saudi Arabia has been running high deficits — $100 billion last year alone as oil prices plummeted 30 percent.
The debt offering will be the kingdom’s first international bond issuance, and it should become the clear sovereign benchmark, allowing for broader development of debt capital markets in the country, according to Standard and Poor’s.
“There is a fair amount of demand for Middle Eastern debt,” said Adrian Helfert, head of global fixed income at Amundi Smith Breeden. “You are getting a little bit of a premium for the oil downtrend and instability, and you should also get some compensation in that this is a maiden voyage for this issuer, and they want to ensure they have open market access.”
The deal is estimated at anywhere from $10 billion to $20 billion, a huge offering to bring to the multi-trillion-dollar emerging market debt market.
Following offerings from Qatar and Abu Dhabi, the Saudi bonds are expected to be easily placed. Qatar in May issued $9 billion in debt, double the amount it initially planned to sell. At the time, Qatar’s 5-year was priced to yield 120 basis points over the U.S. 5-year Treasury note, and it was yielding about 2.3 percent on Thursday.
Saudi Arabia is holding a call to discuss the bonds with U.S. investors on Monday. The kingdom is telling investors that it is targeting a balanced budget by 2020, and expects that if oil prices stay in the current range, it could reach that target. A road show for the deal has been underway this past week.
At the same time as it markets the bond sale, Saudi Arabia is busily trying to reach an agreement with OPEC and other oil producers to reduce oil output. The Organization for Petroleum Exporting Countries adopted a policy of letting the market set prices in 2014, but the plan backfired as producers actually increased their drilling and oil prices tanked.
Any deal to stabilise or boost oil prices would help maintain Saudi Arabia’s S&P sovereign debt ratings of A-/A-2 over the longer term, analysts said.
While OPEC has tried to reach an output deal before, recent talks appear to be in earnest this time, and analysts say some kind of deal could be struck even if it’s loosely adhered to. Oil prices, meanwhile, have risen on just the promise of an accord to about $51 Friday. The oil price helps all producers who were bracing for another downdraft in crude during the autumn refinery maintenance season.
If there is an output deal, Saudi Arabia will be giving up its goal of maintaining market share at all costs, but it will be alleviating shorter-term pain that has resulted in budget cuts and a slowdown in its non-oil industries. Ministers and public sector workers have been forced to take pay cuts, and huge subsidies for electricity, water and fuel are being curtailed.
“They’re in a period of economic contraction, so when you do the calculation, the short-term gains of a $5 to $10 higher oil price may be better in a one- to two-year time frame than capturing additional market share,” said Michael Cohen, head of energy commodities research at Barclays. Cohen said Saudi Arabia could cut back by 400,000 to 500,000 barrels a day to a production level of about 10.2 million barrels, a move it might have made anyway. “It’s not abnormal for them to reduce output after the summer months,” he said.
Market rebalancing act
The oil market is already in the process of rebalancing and analysts mostly expect higher prices next year.
“There’s a significant chance that next year we’ll have a global oil market balance that is in deficit for the first time in two years, so there’s a natural rebalancing taking place irrespective of what happens with this plan,” Cohen said. He said producers would likely agree to what’s in their interest, and a deal may ultimately be a modest cut with producers paying lip service to it. “The best we can expect from Russian output next year is a freeze or a stable output at end of year levels, and that’s not different from what they would otherwise do.”
“I think the debt deal is a key policy priority,” said Helima Croft, head of global commodities strategy at RBC. “Borrowing gives them a little more breathing room on their foreign exchange reserves. If they keep draining their FX reserves, people will question the Saudis ability to maintain the currency peg.”
The sovereign offering also comes at an important time for Saudi Arabia, which has embarked on an economic reform program, dubbed “Vision 2030.” Under the direction of 31-year-old Deputy Crown Prince Mohammed bin Salman, Saudi Arabia is looking to also issue stock in its state-owned oil giant Saudi Aramco, and establish a $2 trillion sovereign wealth fund. The hope is that Saudi Arabia can expand in mining, the financial sector, entertainment and technology. Just this week, Saudi Arabia’s sovereign wealth fund was reported to be joining with SoftBank to start a $100 billion tech fund. Saudi Arabia would reportedly contribute up to $45 billion in the fund over the next five years.
Bin Salman, son of King Salman, has the dual role of overseeing the economy and also the military. Military spending makes up about 25 percent of 2016 Saudi budget expenditures.
“The demand (for bonds) will be there, provided the price is right,” said Jorge Mariscal, emerging markets chief investment officer at UBS Wealth Management. “They can get a little bit better pricing as a result of a (oil) deal with Russia and Iran, and more response from OPEC members in general but it will not be materially different. I think there is still quite a bit of uncertainty in the oil market, even if a deal is reached. There are other issues … it will make a marginal difference.”
Helfert also said an oil deal would help on the margin, if it steadies the price.
“As a debt investor, I want clarity on volatility,” he said. He said the choice for Saudi Arabia and OPEC was to continue the strategy of attempting to drive shale and other producers out of the market, hoping for an ultimate higher price, or accepting a lower price threshold in the future with less volatility. “I think stability in market pricing definitely helps reduce the risk premia. That’s a positive.”
In the prospectus for its offering, Saudi Arabia reported that its proven oil reserves are 266.5 billion barrels, as of the end of 2015. They are expected to last another 70 years, at the average production level of last year’s 10.2 million barrels a day, according to reports. Proven gas reserves were 303.3 trillion cubic feet.
“Foreign exchange assets at the central bank are six times the level of external debt, so the Kingdom’s net equity position is very comfortable, even excluding the estimated $14 trillion value of oil reserves in the ground,” Mariscal said.
But Saudi Arabia has certainly felt the short term pinch of low prices. It recently slashed government worker pay and it’s already trimmed subsidies. In affirming it’s A-/A-2 rating on the country last week, S&P pointed out that government budget cuts have hurt the private sector.
“In particular, there have been reports of a rise in public arrears to private sector construction companies. As a result, companies have been cutting their workforce and withholding salaries. We expect banking sector asset quality to deteriorate but not sufficiently to endanger system solvency, owing to counter cyclical buffers the regulator has imposed in recent years,” S&P said in its rating note.
S&P said that it expects the external and government balance sheet to remain strong and says it expects Saudi authorities to take measures to prevent any deterioration in its fiscal position over the next two years.
S&P also is not counting on an OPEC deal to boost oil prices dramatically.
“A sharp increase in the oil price would be supportive of Saudi Arabia’s sovereign ratings. However, such an event is not our base case. We have assigned a stable outlook to Saudi Arabia’s ‘A-‘ rating and so do not expect to change it over the next one-to-two years,” according to Trevor Cullinan, S&P director of sovereign ratings.
Mariscal said even with the deficit, the Saudis have sufficient resources even without borrowing.
“When you look at asset to liabilities, they’re a net creditor by a long shot. This issuance could be looked at as a temporary measure to fund a shortfall,” Mariscal said. The fact that Saudi Arabia is tapping debt markets for the first time is a break from tradition for the conservative country. “It just tells you about the wealth of these guys and they still arguably don’t need it, but they want to diversify their source of revenues.”
Mariscal said UBS expects oil to rebound to a level above $60 per barrel next year, and that should help the outlook.
He also said he does not believe the recent Congressional vote to allow 9/11 families to sue Saudi Arabia is a risk to the kingdom’s fiscal standing. He said the law has a safety valve in that it can be stayed if there is a meaningful dialogue toward settlement underway.
“These sorts of litigations can take years and years and yield nothing,” he said.