Saudi
Arabia has found itself between a rock and a hard place lately. When it
comes to the direction of the price of crude oil, that is.
The Kingdom is caught in a situation where big swings in
the price of crude oil in either direction are damaging to its economic
and political future.
That’s why Saudi Arabia campaigned for production freezes
back in January, as oil was heading towards the $20-mark, rather than
for an outright production cut, in my opinion. A production freeze would help to keep the price of oil in the range of $20-$40 a barrel, while an outright production cut would cause a price spike well above $40.
Why would a price spike above $40 be a bad thing for Saudi Arabia?
Because it would provide a life
support to American frackers who have undermined the pricing power of
the Kingdom these days, as was discussed in a previous piece here.
But there’s another, more important problem: high crude
prices can help Russia and Iran raise the funds they need to support
insurgent movements that threaten the Kingdom’s regime.
As one of the commentators in my recent piece put it:
“The Saudi’s don’t care about frackers at this point. What
they do care about is Russia and Iran being able to fund destabilizing
groups that threaten their regime. Keeping oil down helps the US and
somewhat prevents Russia and Iran from funding these groups to the point
they can win. The Saudi Royals don’t want to give up power just yet.
And the only way to do that at the moment is to keep oil low.”
“What’s happening right now is to artificially pump oil
into the market to depress the prices such that the ISIS and Putin will
run out of funds for their adventures,” adds another commentator.“It’s
not a coincidence that the oil price started tanking when Putin invaded
Ukraine.”
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To be fair, Russia has been going along
with Saudi Arabia’s freeze proposal. But what oil producing countries
say in public and what they do in private isn’t necessarily the same
thing. “A four nation price freeze at January production levels,
which were already at their highest levels in years, does absolutely
zilch to balance world supply and demand,” says Kevin Rooney, CEO, Oil Heat Institute of Long Island.
While too high crude oil prices are bad for the Kingdom,
too low prices aren’t better either. For a different reason: they make
it hard for Saudi Arabia to maintain its fiscal and social budget. As a
third commentator put it:
“Saudi Arabia needs $80+ oil to balance fiscal and social
budgets. As it is they had a $90 billion dollar deficit last year
because of the lower prices.”
But there’re other ways for Saudi leaders
to maintain their fiscal and social budget, like tapping into the
country’s reserve funds, as they have already been doing. But these
funds can burn fast. “The burn rate for KSA is significant —
despite the reserves pre-collapse, they will reach a point of
non-recovery in order to maintain some degree of social order,”
adds a fourth commentator. “The last 10-15 years of seen their social
program costs significantly multiply, which cannot be reversed to a
significant degree without social unrest.”
Then there are the capital markets, where Saudi Arabia is
already issuing billions of debt. And there’s the prospect of selling
state assets.
That’s why I would place the country’s fiscal survival somewhere in the middle of the $20-$30 per barrel, in line with official assumptions for a $29 per barrel for 2016.
Still, being between a rock and a hard place is a
difficult situation to be in. In the end, the Saudi Kingdom will have to
decide what’s worse for its economic and political future — a higher
crude oil price or a lower oil price.
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