Three Ways to Play the Saudi Situation

Keith Fitz-Gerald Sep 18, 2019
1 

The Dow is off 160 points as I write Monday on fears that higher oil prices will stunt global growth.

Right.

The real reason is something far more basic.

Let’s talk about that today and how you can profit.

Here’s what you need to know.

Let’s start with oil itself.

The world has been waiting with bated breath for Aramco’s public offering. Not only could taking the state-owned group (Saudi Aramco) public be the largest in history with a projected market value of $2 trillion, but the Saudi Aramco deal could generate unprecedented fees for the world’s biggest bankers.

JPMorgan Chase & Co. (NYSE:JPM), Goldman Sachs Group (NYSE:GS), Morgan Stanley (NYSE:MS), Bank of America Merrill Lynch (NYSE:BAC), Credit Suisse Group AG (NYSE:CS), HSBC Holdings (NYSE:HSBC), and Citigroup Inc. (NYSE:C) – all stand to make billions, and all have reportedly been in Dubai in recent weeks doing the pre-work needed to secure their stake the game.

The goal is to generate billions of dollars via a public listing, which Crown Prince Mohammed bin Salman will then use for social and economic reforms intended to diversify the kingdom beyond oil and to improve the standard of living in Saudi Arabia.

The IPO is planned in two stages… a domestic listing in Saudi Arabia, then a listing on international exchanges a year or two down the line.

Smell a rat yet?

The Crown Prince has said he expects to list 5% of shares with a corresponding valuation of $2 trillion, give or take. Most valuation reports I’m familiar with put the value at around $1.3-$1.5 trillion, but what’s a few hundred billion between friends?!

He needs oil to be priced as richly as possible to pull this off.

The major banks all made a good show of pulling away from the Kingdom following the murder of prominent journalist Jamal Khashoggi at Saudi Arabia’s consulate last year in Istanbul. And, all are now back, apparently keen to do business.

Overlooking murder seems to have a price.

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I’ll leave the moral compass out of it – you and I may agree, or we may not – because that’s moot. My job as Chief Investment Strategist is to help you make money.

Here’s what I see…

  1. The Saudis need $80-$85 a barrel to balance their budget. Prior to the attack, oil was trading at roughly $54 – $58 a barrel or roughly 32% lower.
  2. Oil prices have moved beyond OPEC now that U.S. production has gotten so strong, which means that cheap crude is a byproduct of forces beyond Saudi control, especially when it comes to the link to global growth, which is now viewed ironically as a function ongoing U.S. and Chinese trade talks.
  3. Investors are no longer enamored by oil which has largely underperformed major stock market averages for nearly five years. It’s not a growth market despite what the Saudis would like to believe. Unless Aramco steps up with an extremely generous dividend policy that puts it on par with the competition – and companies like Exxon Mobil (NYSE:XOM), BP plc (NYSE:BP), or Chevron Corp. (NYSE:CVX) – Aramco is unlikely to attract long term investment capital, just quick-buck artists.
  4. And from the “Department of You Knew This Was Coming,” China just announced a $280 billion investment program in Iran’s oil, gas, and petrochemical sectors (despite U.S. sanctions). The deal apparently contemplates the deployment of as many as 5,000 Chinese security officers in Iranian territories to secure Chinese projects including exports from Iran to China across the Gulf.

Not surprisingly, this isn’t being widely reported in the West.

Now what?

I expect the hype machine to go into overdrive because Saudi officials will be keen to portray the kingdom as a bastion of stability ahead of the public offering. Especially if they have to square off against a Chinese-centric Iran when it comes to oil.

Simultaneously, I envision the banking syndicate engaging in a dog-and-pony show leading up to the IPO, conveying what a great opportunity the offering will be. Everything to date is just a warmup.

There will also be gobs of related media coverage to ensure the “story” gets out there.

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Here’s where things get murky.

I don’t think it’s beyond the realm of possibility that there will be more attacks; in fact, I’d be on it.

Here’s the twist, though.

I also believe that a number of them – perhaps even all of ’em – will ultimately be determined years from now to be “false flag” operations intended to raise oil prices ahead of the IPO while deflecting blame to other parties who either knowingly or innocently are held out as patsies.

This isn’t as far-fetched as you’d think.

There are already widespread doubts, for example, that Yemen’s Houthi rebels – a group the Saudis have dealt with for years – suddenly have the means to launch highly coordinated missile attacks using sophisticated technology they’ve never produced without help from a region that’s 500 miles outside Houthi controlled territory.

This is gamesmanship of the highest order.

And, not surprisingly, that’s how you have to think about the situation if you’re going to play it.

So….

First, rising oil prices typically benefit exploration companies, not refiners. Think about an opportunity like Halliburton Co. (NYSE:HAL) versus Exxon Mobile (NYSE:XOM) for example. The former is likely to do better than the latter as traders make a pre-emptive bet that traditional oil supplies get “pinched” in the event of additional supply interruption.

Second, there’s a lot of discussion about delaying the Aramco IPO now that the attack has apparently taken nearly 50% of Saudi production capacity offline. But – and this is important – not one word of that changes the need for higher prices as a function of Saudi budgets.

Normally I’m not into conspiracy theories but in this case I think caution is warranted that additional attacks are carried out by vested interests, including potentially the Chinese, or even the Saudis themselves. Manipulating evidence to justify an attack is a very old game indeed.

Buying a long-term call options on Brent Crude (BZ:NMX) may be the simplest way to go here; just be prepared for some staggering volatility along the way. As such, you’ll want to treat these as purely speculative choices.

Third, buy the fear and sell the greed, particularly with regard to the IPO itself. The hype machine I’ve just mentioned is going to pull out all the stops to ensure as “rich” an IPO as possible because that will generate the biggest paychecks for those involved. This means a media cycle in overdrive that’ll make Silicon Valley’s latest tech-darling pale by comparison.

Longer term though, I think the IPO fails pretty quickly after listing, which means you’ll want to short shares as soon as the lockup period ends (assuming there is one), or buy puts. Selling bearish spreads of some sort could also be a terrific move shortly before Aramco’s first public quarterly report.

In closing, we’ve obviously just scratched the surface today.

The Aramco situation will be at once one of the single largest opportunities and risks you’ll ever see. I have no doubt that we will return to the “trade” many times over.

What we’ve talked about today, though, should get you started!

Until next time,

Keith

One Response to Three Ways to Play the Saudi Situation

  1. Craig A Smith says:

    What would you suggest the parameters should be on buying a call for Brent as well as a put or shorting.
    Thank you for your assistance.

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