Can Saudi Arabia really afford to wage an oil price war?

MBS’s Vision 2030 aims to diversify the kingdom’s economy, but analysts say oil price war could jeopardise those plans.

MBS Prince
Saudi Arabia's Crown Prince Mohammed Bin Salman's Vision 2030 plan was already struggling before the kingdom declared an oil price war [File: Reuters]

It was the last thing a slowing global economy needed. 

With the coronavirus pandemic hammering international travel, supply chains and production, Saudi Arabia delivered another shock to the system by declaring an oil price war. 

On March 6, having failed to convince Russia to agree to deep production cuts aimed at shoring up crude prices against the demand destruction unleashed by coronavirus, Saudi Arabia-led OPEC retaliated by announcing it would start pumping crude with abandon.

The next day, the kingdom lowered the price it charges for oil. Come March 9, the markets delivered their verdict. Oil prices crashed 30 percent at one point – the biggest one-day drop since the 1991 Gulf War.

Though some of those losses were pared, announcements of pending production boosts next month by the kingdom and other Gulf producers ensured oil prices had their worst week since the 2008 financial crisis.

The price war is a gamble for the kingdom, one that could either pay off or land it in a deep hole.

Dramatically lower oil prices set up Saudi Arabia, which can produce oil more cheaply than any other country, to steal market share: both from the world’s second-biggest oil producer-Russia-as well as higher-cost United States shale oil producers.

But analysts say it could come at a cost to Saudi Arabia and the ambitious plan of its de facto leader Crown Prince Mohammed bin Salman (MBS), to break the kingdom’s oil-dependence and set it up for a more prosperous future.

A transformation in trouble

Crude accounts for roughly 80 percent of Saudi Arabia’s revenues, and that level of fossil fuel dependence comes with huge drawbacks.

As oil prices rise and fall, so too do the kingdom’s fortunes, which can stall plans and force tough spending choices.

The future is also moving against oil, with the Paris Climate Agreement spurring more governments to reduce emissions and petroleum products like plastic raising environmental alarms.

The kingdom needs to diversify its economy, and soonest. But that is easier said than done. Overdependence on any commodity for export effectively salts the earth where other productive sectors could take root.

Vision 2030 seeks to spring the kingdom from this trap by reinvesting fossil fuel wealth into sustainable industries of the future, shrinking a bloated state sector, and creating a thriving, diversified private sector to employ the kingdom’s youthful workforce.

And the government does not see itself doing all of this alone. A successful transformation also hinges on convincing investors, both foreign and domestic, to buy into MBS’s vision.

On many counts though, the blueprint for transformation was struggling even before Riyadh fell out with Moscow.

“Vision 2030 was already lagging on most of its interim targets for 2020,” Laura James, senior Middle East analyst at Oxford Analytica, told Al Jazeera.

A cornerstone of raising cash to reinvest into other sectors was the much-hyped initial public offering (IPO) of Saudi state oil giant Aramco.

As it neared its delayed debut late last year on Riyadh’s Tadawul stock exchange, an attack on Aramco’s facilities in September reminded investors of the geopolitical risk festooning the company and its operations.

After failing to attract sufficient international interest, MBS pressured wealthy Saudis to step up and buy a piece of the company. The IPO raised a record $29.4bn, effectively valuing the firm at $1.7 trillion- well shy of the $2 trillion MBS had originally sought.

Now, the oil price war is hammering shares of Saudi Arabian Oil Co -as Aramco is officially known.

The stock fell 12 percent last week and continued to slide on Sunday, after Aramco announced it is cutting capital spending this year in response to coronavirus, and reported a 21 percent decline in 2019 net profits due to lower oil prices.

On Monday, Aramco is due to hold a webcast to discuss its full-year results.  Company executives could be grilled over whether pumping crude full-throttle is in the best interests shareholders. 

Another Vision 2030 metric – foreign direct investment (FDI) in the kingdom- has also been lacklustre. Though it recovered to $3.2bn in 2018 having not even cracked $2bn the previous year, FDI was still way down from the $8.1bn achieved in 2015 and a mere fraction of the $29.2bn the kingdom attracted in 2010, according to the United Nations Conference on Trade and Development.

Growth in the kingdom’s non-oil private sector is another benchmark.  It was looking promising, until it started slowing in December and continued to decelerate in January. February saw the slowest growth in two years, as output and new orders fell, thanks to disruptions spawned by the coronavirus.

Now, the fiscal stress of an oil price war could make non-oil sector growth even harder to achieve.

Austerity on tap

The kingdom has healthy foreign exchange reserves, roughly $500bn, to ride out a price war, and it does enjoy the lowest production costs among all oil producers.

The Saudis “can still turn-out a profit at these low oil prices, at least for a time,” Tarik Yousef, director at Brookings Doha Center, a nonprofit public policy organization, told Al Jazeera.

Balancing its budget, however, is another story. 

The International Monetary Fund reckons the kingdom needs oil to fetch around $83 a barrel to balance its state budget.

Global benchmark Brent crude last traded at $33.84 a barrel on Friday.

Goldman Sachs reckons that should oil prices average $30 a barrel over the next two quarters and the kingdom boosts output by 10 percent, its budget deficit could swell to 12 percent of gross domestic product (GDP) this year -nearly double its fiscal deficit target.

That would increase the government’s financing requirement by $36bn.

There could be a silver lining. Goldman estimates that if oil prices recover to $60 a barrel by the end of 2021, the kingdom’s budget deficit could narrow to less than 2 percent of GDP by 2022.

But if oil prices only recover to $50 a barrel by the end of next year, Goldman sees the budget deficit remaining “wider for longer, implying an additional $63bn in funding requirements” over the next two years.

More drama

Austerity measures may have been in the cards before the kingdom declared a price war, as Riyadh prepared for slowing oil demand in the face of coronavirus.

State agencies were asked to submit proposals for slashing 20 to 30 percent from their 2020 budgets before the kingdom fell out with Russia, Reuters News Agency reported, citing sources. One source said salaries would not be touched, but projects and the awarding of new contracts could be delayed.

“With salaries largely protected, the impact could be on capital expenditure, which will have a knock-on impact on the private sector and likely hinder diversification efforts,” said James.

Shielding salaries helps maintain loyalty, which is important for any ruler, especially one surrounded by intrigue.

The price war was not the only Saudi drama unfolding while the alliance between OPEC and Russia was collapsing.

Two of the royal family’s most influential members, Prince Ahmed bin Abdul Aziz, the youngest brother of King Salman, and Mohammed bin Nayef, the former crown prince and interior minister, were reportedly being detained in Riyadh. Both men are seen as legitimate contenders for the throne, sparking speculation that at the very least, MBS was making a move to consolidate his power.

The price war “threatens stability at a time where MBS is already facing political pressure and possibly threats from within the royal family as evidenced by the recent arrests,” said Yousef.

Which makes pulling off an economic transformation like Vision 2030 that much harder, say analysts. 

“It’s tougher for oil-dependent countries that need higher prices to fund their budgets,” Jim Krane, Wallace S Wilson Fellow in Energy Studies at Rice University’s Baker Institute for Public Policy, told Al Jazeera.

“If they cut spending too much, they could have a rebellion on their hands. Saudi Arabia is vulnerable in this respect.”

Source: Al Jazeera