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Has Saudi Arabia Shot Itself in the Foot?

by | published November 3rd, 2015

On Saturday, Foreign Minister Adel al-Jubeir became the latest Saudi official to downplay the kingdom’s expanding deficit. Speaking at a conference in Manama, the capital of neighboring Bahrain, the minister maintained that the current situation was manageable.

The situation, of course, has been sparked by two Saudi-led decisions within OPEC. The first was to defend global market share by keeping production high (a move made last year while Americans were sitting down to their Thanksgiving turkeys). That started a downward slide in global oil prices, accentuated by a second action.

The next move involved Riyadh opening the spigots on production, thereby further exacerbating the pricing decline. At the time, I noted here in Oil & Energy Investor that the Saudis had no choice, given what was unfolding elsewhere in OPEC.

A country like Saudi Arabia, even with its vast raw material and hard currency wealth, has its hard currency revenues exposed in trade taking place outside its borders. In a low price environment it will consistently generate reduced revenue in foreign sales while its required foreign product purchases will disproportionately increase in cost.

Why is the wealthiest OPEC nation having these problems, and how much worse can it get?

All OPEC Members Have Taken a Hit

Because the cartel members are all dependent upon oil sales and run undiversified economies, the almost 60% collapse in crude prices hit every one of them hard. Defending market share is one thing, but rendering budgets inoperable is something else altogether.

These countries may be selling 40% of the world’s oil requirements. But they also must import just about everything else they need domestically. That requires an increasing amount of hard currency since populations are rising fast (while average ages are declining to the low 20s or even beyond).

As a result, those least able to withstand the lowering revenues from crude sales simply sold more of it into the international market, further depressing prices and extenuating a downward pricing cycle.

OPEC members like Venezuela, Nigeria, Libya, Ecuador, and Iran are experiencing significant financial constriction. Each of these nations requires a crude price of well more than $120 a barrel to arrest a spreading fiscal paralysis.

But crude closed Friday in London at less than $50.

Saudi Arabia Is Losing Billions on a Weekly Basis

Having lost effective control over the pricing mechanism within OPEC, Saudi Arabia has taken a lesson from the pages of the “if you can’t beat them, join them” book club.

While Saudi Arabia, Kuwait, and the United Arab Emirates (UAE) are the most solvent OPEC producers, even they are experiencing budget deficits. Remember, they must import the bulk of their consumer products. The Saudis are rumored to be losing billions in hard currency exchange weekly.

Now, they are nowhere close to “bake sale” territory. As officials are wont to declare, they can run a deficit for decades.

But not at projected rates.

A deficit run by a rentier state (which takes profits from raw materials but provides little in the way of value-added development) tends to accelerate regardless of whether the country has the means to offset it with forex moves. A vicious cycle emerges well in advance of any threatened default or currency collapse.

Saudi Arabia Withdraws Foreign Investments

Two recent decisions made by Riyadh accentuate the kingdom’s quandary.

First, Riyadh began withdrawing investment from foreign asset funds.

Global oil sales are denominated in dollars. A producer like Saudi Arabia must stabilize what otherwise would be too much hard currency from flowing back into the domestic economy, thereby subjecting the local currency to bouts of debilitating inflation. This is accomplished by investing the money outside the country and then repatriating investment proceeds over time or using it to purchase equipment or other essential imports outside the country (capping the circulation of hard currency within the country limits the inflationary impact).

On the other hand, withdrawing outside funds means only one thing. The hard currency is required to address foreign exchange concerns.

The S&P Cuts Riyadh’s Rating

Second, Riyadh has returned to the global capital markets by issuing sovereign paper after years of staying away. The Saudis used to tout the strength of their economy by refusing to draw from debt markets. Not anymore.

Another indication that even the normally revenue-heavy OPEC leader has to watch its exchange balance. This has hardly gone unnoticed in the market.

Standard & Poor’s cut the Saudi credit rating from “AA-”  “A+” last week, saying in addition that it was retaining a negative outlook. As expected, the Saudi Finance Ministry was quick to issue a strongly worded reaction, maintaining that the S&P move was “reactionary,” driven by “fluid market conditions rather than economic fundamentals.”

Nobody in the business really buys that view. The Saudi “economic” perspective has little going for it other than the global selling of oil. Little else is produced there, and the service industry is largely provided by foreign nationals.

The Saudi Problem Is Long Term

Until a higher (and more resilient) pricing floor can be commanded for crude, the Saudi situation will not be improving.

Now, the environment is hardly better in non-OPEC major produces like Russia, where many of the same problems earlier on pummeled the ruble. In the U.S., where increasing shale and tight oil volume has profoundly changed assumptions about worldwide available reserves, the situation is different. The American market is populated by private producers, not state-controlled companies. There, a market really can develop and regulate the trade.

The Saudis are certainly not a basket case, and their access to oil sale revenues will continue unabated. But the attempt to diversify the economy is still languishing, and that will become more problematic the longer low oil prices remain.

Crude below $50 a barrel is a short-term consideration. The more fundamental Saudi economic problem is not. I’ll be monitoring the situation and keeping you informed as this situation plays out.

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  1. Oil Investor
    November 3rd, 2015 at 20:47 | #1

    Saudi Arabia just a matter of time will soon awake to find its ruling clan deposed. Russia, Iran, Venezuela, Nigeria, et al will be all ecstatitc when this soon come to light and become breaking news around the world. This scenario must be in Saudi monarchs mind that will eventually alter their plan of glutting the world with oil.

  2. swarna latha
    November 3rd, 2015 at 22:41 | #2

    How about Central Asia? that’s the hot bed of oil politics .am i correct?
    China has built a pipeline (1000 mile long) straight to kazagsthan or one of its neigbhours and now most of the chinese homes -about 1 in 3 -have gas at home to light fire. In return these central asian countries are buying chinese products/utensils just like how Americans are also obliged to do. I think modern life for the millions in this world is a race to the bottom!
    I hope oil prices bounce back to $80 lvls atleast.
    recently there was a news that israel struck oil in Golan heights after years of drilling! will this change geo politics of oil-gas war?

  3. Ed Marinelli
    November 10th, 2015 at 01:10 | #3

    A thought experiment: What would happen if the US decided to ban IMPORTING foreign oil, or at least oil from Saudi Arabia, Iran and Iraq? Oil for non US countries would become very cheap while in the US oil prices would be artificially high. This would benefit the US oil industry at least temporarily and perhaps lead to a production increase and an equilibrium price of perhaps 80-90 per barrel. As oil would be less expensive for the EU and other net importers due to oversupply they would enjoy an energy cost advantage vs US industry. However it is likely that OPEC would be forced to reduce production to attempt to establish an optimal price . But what is interesting is that the OPEC leverage on the US would no longer exist. We survived fairly well at 90 per barrel hence why not do this. We would have to drill baby drill and also take advantage of new technologies that provide heavy sweet from oil sands in the US without tailings ponds.

  4. Ed Marinelli
    November 10th, 2015 at 01:13 | #4

    From the article : “Crude below $50 a barrel is a short-term consideration.” How short term?

  5. November 11th, 2015 at 12:46 | #5

    I find it incredible that some people think we need higher oil prices.
    Almost everything we buy has to be transported us. All the food we buy has to be tranported usually from far away unless it was grown locally. Cheaper energy means better prices for everyone including business. Don’t forget all the things made from oil, chemicals, plastics etc..
    How can you feel sorry for OPEC who have gouged us for decades. OPEC caused most of the inflation we experienced in the past 40 years.
    Oh sorry the oil producers may be feeling some pain!
    IMHO

  6. November 18th, 2015 at 00:24 | #6

    Thanks for ones marvelous posting! I truly enjoyed reading it, you
    may be a great author.I will make certain to bookmark your blog and
    may come back from now on. I want to encourage yourself to continue your great work,
    have a nice holiday weekend!

  7. ohmer weeks
    January 21st, 2016 at 10:53 | #7

    I really enjoy you reports gives a person a better understanding of what going on in the world other than the petty crime and human interest kind of stories you get from the regular nightly news the analysis of the cause and effect relationships given the take into account of the politics, demographic, and finances of all these different regions gives a person a clearer picture of what is actually happening and the possible direction of things to come. Send me more please. Keep up the great work

  8. Jesse
    January 21st, 2016 at 18:14 | #8

    Can you update this article with your insight on the current situation? including the much lower current oil price?
    thanks,

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