Some wars cannot be won. Saudi Arabia is learning that the hard way, as evidenced by the kingdom’s twin announcements on Monday.
The first involved austerity measures that shift the bulk of the burden of falling oil income squarely onto the shoulders of ordinary Saudis. The second announcement concerned oil output cuts of the voluntary variety – not those mandated by the recent agreement between the Saudi-led Organization of the Petroleum Exporting Countries (OPEC) and its allies.
In case you’re a bit behind on all the drama roiling oil markets this year, here’s a brief recap of the highlights:
Prices of global benchmark Brent crude started the year around $66 a barrel. By the close of February, Brent was trading around $50 a barrel as coronavirus lockdowns severely curtailed global oil demand.
Understandably, Saudi-led OPEC wanted to counter this hit with deep supply cuts. But the Saudis could not convince the cartel’s biggest ally – Russia – to play ball.
Riyadh retaliated in March by lowering the price it charges for crude and announcing it would pump oil with abandon – moves designed to steal market share from higher-cost producers like Russia and United States shale oil firms. There’s a reason they call it a “price war”. Brent subsequently closed out March around $22 a barrel.
It is possible that oil prices would have fallen that far, that fast regardless of Saudi shenanigans. But many analysts believe the price war almost surely hastened the rout. And it has caused all kinds of upset.
Congressional lawmakers from US states where oil producers cannot compete at such low prices accused the Saudis of engaging in “economic warfare”. Two US senators introduced legislation that called for the US to remove troops and military equipment from Saudi Arabia if the kingdom did not stop pumping so much crude.
The kingdom’s de facto ruler, Crown Prince Mohammed bin Salman (MBS), did fall into line, albeit with a nudge from US President Donald Trump, who is up for re-election this year and has vowed to defend the US oil and gas industry.
Last month, OPEC and its allies agreed to cut output by a record 9.7 million barrels per day. But global demand has fallen by around 30 million barrels per day. Prices will likely remain under pressure as long as the glut persists.
This has forced some tough decisions on the Saudis. Though the kingdom can pump oil more cheaply than any other producer, it is not making enough to fund its state budget, which the IMF reckons requires oil to fetch around $76 a barrel this year.
Though they have ample foreign exchange reserves, in March, the Saudis blew through their savings at the fastest pace in nearly 20 years. The kingdom has gone to international debt markets to help close its funding gap, issuing some $7bn worth of bonds last month alone. But it cannot simply borrow its way out of this bind. Belt-tightening is also required.
From borrowing to belt-tightening
After ratings agency Moody’s cut the kingdom’s outlook from stable to negative earlier this month, Saudi finance minister Mohammed al-Jadaan warned of “painful” measures to come.
On Monday, a raft of hurt was unveiled.
The real eye-grabber on the list of Saudi austerity measures involves VAT – value-added tax, which will be hiked to 15 percent in July from its current level of five percent.
Progressive economists disdain VAT because it disproportionately hits less well-off households by gobbling up a bigger slice of their disposable incomes. Not only will Saudis see prices rise because of the tripling of VAT, but those households with a breadwinner employed by the state will also have less money in their pockets because the government also announced on Monday that it is suspending its cost of living allowance for state workers starting in June.
This is tricky stuff for any government, but especially one where the social contract between ruler and ruled pivots on a generous welfare state in exchange for political obedience.
“During past bouts of austerity, the government has relied on cuts to capital spending and refrained from hitting the pockets of households for fear of igniting social unrest,” said Capital Economics senior emerging markets economist Jason Tuvey in a note to clients on Monday. “Despite comments last week from Mr. al-Jadaan that suggested households would be shielded once more, this latest package suggests otherwise.”
The austerity knife is also carving away funding for some projects that fall under the umbrella of MBS’s highly vaunted but hardly realised Vision 2030 – a blueprint for diversifying the kingdom’s economy away from fossil fuels and creating sustainable jobs for its youthful workforce.
As long as oil prices remain depressed, Vision 2030 will be pushed further into the future. And Saudi Arabia will continue to face tough choices to close its budget gap.
Oil markets inched one million barrels per day closer to rebalancing on Monday after the kingdom’s energy ministry announced that it had told state oil giant Aramco to cut oil output by that much in June. This is on top of the curbs Saudi Arabia already signed on to last month as part of the agreement between OPEC and its allies.
The announcement likely went down well in Washington. Every barrel of oil that is removed from global markets brings beleaguered US shale oil producers closer to a market in which they can compete – and subsequently takes the heat off Trump to do more to protect the US oil patch from Saudi competition.
Meanwhile, green shoots of reviving demand are surfacing as lockdown restrictions are eased and international travel slowly awakens from hibernation. This has helped oil prices start to claw back some of the ground lost this year.
But balance is still a long way off, and a second wave of coronavirus infections could yet scorch those green shoots.
This played out in oil prices on Monday. While Brent got a slight boost after the Saudis announced the additional output cuts, fear of more coronavirus disruptions saw prices fall just over four percent, to see Brent settle just below $30 a barrel.