Saudi Arabia has announced that it will cut public spending and is reaching out to Russia, as its attempt to flush U.S. oil exports out of the market backfires. Saudi Arabia is a member of OPEC (Organization of Petroleum Exporting Countries), which is effectively a cartel that seeks to control the price of crude oil by co-ordinating levels of production between the Saudis and their 11 partner countries.
Until recently, OPEC has had it all its own way. Innovations in the extraction of oil from shale and a significant expansion of Arctic and deep offshore drilling by the U.S., however, have introduced real competition into the world’s crude oil markets again, and countries like Saudi Arabia are starting to feel the pinch.
Last November, the Saudi government began an attempt to edge the U.S. out of the world oil market by creating a glut of crude. Usually, when oil production reaches certain level, Saudi Arabia and its OPEC partners will cut production in order to shore up the price-per-barrel. In an unusually confrontational move, the recently crowned Saudi king, King Salman, decided to ramp up production in the face of a glut of some 1-2 million barrels per day (b/d). This has resulted in a drop of crude prices from approximately $70 a barrel to less than $50, which, for Saudi Arabia, means selling at a loss. A loss which is eating away at Saudi cash reserves at the rate of $12 billion per month, according to Business Insider. And expensive as this strategy is, it has so far failed to work. U.S. oil companies have shown resilience and innovation in the face of the price drop, reducing production costs, and increasing yields.
Saudi Arabia is feeling the pinch in more ways than one. Oil production is a competitive and capital-intensive business, heavily reliant on high levels of debt-raised finance. It is not possible for any oil company, even one owned by a kingdom as wealthy as Saudi Arabia, to indefinitely sustain crude prices as low as this. The BBC reports that Saudi Arabia’s finance minister, Ibrahim al-Assaf, has announced a program of spending cuts to state projects.
“We have built reserves, cut public debt to near-zero levels and we are now working on cutting unnecessary expenses while focusing on main development projects and on building human resources in the kingdom.”
Despite the Saudi finance minister’s upbeat language, it is clear that low oil prices are hurting the kingdom. Saudi Arabia’s deficit is running at an horrific 20 percent of GDP and is considering borrowing money for the first time in years. This comes simultaneously with a Saudi push for regional hegemony, with significant upsurges in military spending, an increasingly costly war in the Yemen, and a “social welfare” spending program that encompasses a huge portion of the Saudi population. On top of all this, the glut has caused a snowball effect amongst virtually every other oil producer, low prices forcing them to push more crude onto the market in order to stay afloat. And all the while, the U.S. pursues its “drill, baby, drill” policies, ducking and weaving with innovations in low-cost extraction techniques like fracking, and relying on the greater diversity of its economy to pull through. Saudi Arabia, on the other hand, relies on oil prices being at roughly double the current levels in order to source about 90 percent of its income.
There doesn’t appear to be too many options left for the Saudis. They have essentially played a game of economic chicken with the U.S. oil industry and it is Saudi Arabia that has blinked first. Recently, Saudi diplomats sent “signals” to Russia, which is not an OPEC member, to cut its production in an effort to continue the price war with the U.S. But Russia, thanks to sanctions applied after their actions in the Ukraine, is in an economic tailspin itself. Additionally, unlike Saudi Arabia’s openly nationalized oil industry, Russia likes to claim that its oil companies are private and independent, despite being run by President Vladimir Putin’s friends and supporters. An order to cut production to back Saudi Arabia’s play would expose the real relationship between government, the economic oligarchs, and the industry.
Saudi Arabia, even with about $661 billion in reserves and an excellent credit rating, cannot survive crude prices this low for very long at all. Analysts predict that Saudi Arabia will need to put the genie back in the box in the next few months, or face the prospect of the kind of financial ruin that has devastated oil producers like Venezuela.
[Pictures via Getty Images]