Is oil set to float?

Supply and demand drive daily oil prices, but investors looking for a longer-term trend should be following three other factors which are pointing to a significantly higher oil price by early next year.

They are the market priming ahead of a share float, politics, and a big sale of military equipment.

Admittedly it's an odd assortment of influences on the oil price, but they are connected and they're all positives for the price. Oil has been edging higher since big oil producers banded together to trim supply as a first step in drying up a massive stockpile of surplus oil.

The market priming is perhaps the most important because it is linked to the proposed stock-exchange listing of Saudi Aramco, the oil business of Saudi Arabia and easily the world's biggest single source of oil.

Only 5 per cent of Aramco is expected to be offered to outside investors but it will bring in billions of much-needed dollars for Saudi Arabia. The kingdom has been hit hard by the oil-price crash and a costly war in Yemen, as well as funding rebels in Syria.

When listed, Aramco is forecast to be the world's most valuable company with a market capitalisation approaching $US2 trillion.

But to maximise what investors pay for a tiny slice of a giant business Saudi Arabia needs a high oil price, perhaps in the $US70-to-$US80/bbl range. To get that it needs to ensure that production cuts by members of the OPEC cartel, and Russia, remain in place until the float is priced and Aramco is listed.

Similar pressure can be found in Russia, which is scheduled to start its presidential election process in mid-March, around the same time Aramco lists.

There is little doubt that Russia's president, Vladimir Putin, will be re-elected. But there is equally no doubt that he would like to be able to demonstrate that budget problems caused by the low oil price of the past three years are being overcome with the aid of a rising oil price.

It's for the presidential election as much as the budget needs of its government that Russia is a curious bedfellow with Saudi Arabia and other OPEC members in restricting oil production in an attempt to orchestrate a higher price.

The third factor influencing the oil price, which is not directly linked to supply and demand, is a big arms deals signed by the US President, Donald Trump, with the Saudi government during his recent Middle East visit.

Valued at more than $US100 billion, the Saudis are getting everything they want by way of new equipment. And the US gets a boost to its arms manufacturing sector which, in Trump's words, means “jobs, jobs, jobs”.

The arms deal has put the US in the same boats as the Saudis and Russia, with all three keen to see a higher price for different reasons. And while they might have differences on other issues, they are united by oil and the benefits of a higher price.

In the case of the US there is the added incentive of boosting export income, since it has also become an oil exporter thanks to the development of its shale-oil (and gas) deposits.

Unknown in this complex oil-price equation is the effect of day-to-day market events which have seen the oil price oscillate between $US50/bbl and close to $US60/bbl. This has been driven by daily events and speculative trading, which is not factoring in the longer-term influences such as the Aramco float and the Russian presidential election.

Those daily forces were on display late last week when OPEC, led by the Saudis, and Russia, agreed to persist with a policy of withholding a portion of oil supplies until the end of March next year.

Rather than rise, as had been expected, the oil price initially fell, prompting collective head-scratching as to why given that limiting supply should have the opposite effect.

Explanations for the price fall varied, but the most important factor seems to have been speculators caught by the unexpected extension of the production curtailment into next year.

As investment positions are adjusted to account for a longer period of oil production cutbacks, the longer-term influences will come into play. This will enable the Saudis to start the serious business of pricing the Aramco float, with every dollar added to the price of oil delivering millions of extra dollars to the Saudi Government.

Underlining the importance of a higher oil price to the pricing of the Aramco float are a government and a personal issue.

At the government level it is significant that the Saudis are doing more than their fair share of heavy lifting, cutting daily oil output below the 10 million barrels a day required under the terms of the deal with other OPEC members.

On a personal level there is the reputation of the Deputy Crown Prince of Saudi Arabia, Mohammed bin Salman, who is overseeing his country's negotiations with OPEC as well as being in charge of the Aramco initial public offering (IPO).

A Swedish bank analyst, Bjarne Schieldrop, told the Wall Street Journal last week that Saudi Arabia needed an oil price of as much as $US80/bbl this year and $US75/bbl next year to balance its budget.

“It's hugely important for bin Salman,” Schieldrop said. “He cannot slip now. He needs the (Aramco) IPO to be successful as he has a lot at stake. An oil price of $US50/bbl will not do it in the longer term.”

Indeed!