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Is Saudi Arabia bluffing?

18.05.2015

Judging by last week's interview with a Saudi Arabian official, a change of course is unlikely at the OPEC meeting in three weeks.

Last week Saudi Arabia gave a rarely candid interview to the Financial Times. This stipulates that the strategy to squeeze the high cost producers is working. Investments in shale oil, tar sands and deep-water oil are plunging.

Saudi Arabia is not only talking tough. They also follow up with action. Crude oil production rose in April to 10.3 million barrels per day which is the highest level in a generation.

Developments in drilling activity are even more startling. While there is a crisis in the rig industry worldwide, Saudi Arabia is going full throttle with their oil exploration. The number of active rigs has skyrocketed since the end of last year.

The high drilling activity will probably allow the kingdom to increase the production further.

This year's main event

For the Oslo Stock Exchange and Norway, this year's main event will be OPEC’s meeting on Friday, June 5.

Oil optimists believe that Saudi Arabia is bluffing and that the sheikhs are just trying to scare Russia and other major oil producers to join in on an oil production cut. The reasoning is that Saudi Arabia in reality is no low cost producer.

We can mention that the state budget needs an oil price of 106 to break even in 2015.

Russia’s Key Role

The danger is that Saudi Arabia is not bluffing and instead aims to compensate lower prices through higher volumes. In that case, the oil market can remain weak for a long time.

We doubt that the final decision has been made. Much depends on whether Russia joins the Dutch treat. Putin has so far declined, but we do not exclude the possibility that he will change his mind.

What about demand?

In assessments of oil prices, it is easy to forget the demand. According to official statistics, the oil market is sharply oversupplied and inventories are growing rapidly.

However, it is possible that demand is underestimated. Firstly, inventories in the OECD area have increased less than expected. There are many so-called "missing barrels". Secondly the contango is abnormally small.

The contango for oil futures, the premium for future delivery over the spot price, has shrunk in recent months and is at levels that provide low profitability for oil storage. A small contango is normally not associated with a large oversupply.

No parent company guarantee

The oil company Noreco has recently undergone a complete financial restructuring followed by a consolidation of shares. Such processes often result in good buying opportunities because creditors, who receive shares instead of cash, often dump them in the market shortly thereafter. This pushes the stock price far below its fundamental value.

This also appears to be the case in Noreco, and we therefore include it into the Dovre portfolio. We believe the market has overlooked that nearly two-thirds of the remaining interest-bearing debt of approximately NOK 1.5 billion is in Noreco Norway. Noreco Norway has no production and this debt cannot be demanded from the parent company.

When the debt of Noreco Norway is excluded from the calculations it appears that the share is clearly undervalued at current levels.

Dovre portfolio

  • Kongsberg Automotive
  • Avance Gas
  • Nordic Nanovector
  • Marine Harvest
  • Aqua Bio Technology
  • Noreco

In: Noreco

Out: Aurora LPG