What low oil prices have taught us about Saudi Arabia

Speaking at the IHS CERAWeek energy conference in Houston, Saudi Arabia’s oil minister, Ali bin Ibrahim Al-Naimi, said his country could live with producing oil priced as low as $20 a barrel. “We don’t want to”, he told the room full of US oil bigwigs and various industry notables, “but if we have to, we will.” This sentiment was borne not of a desire to see low oil prices, but rather reflects the price the Saudis are willing to pay in order to not cut their own production. The Kingdom, the minister said, was not prepared to cut production in order to keep afloat less efficient producers.

Saudi Arabia now argues the market should determine the price, with low prices forcing less efficient producers out

This marks a change in Saudi Arabia’s position among oil producers, where it has traditionally acted as the guardian of oil prices – the so-called swing producer. At the same time, however, this policy is having ramifications for the country domestically. With the Saudi economy – and by extension its entire social and political structure – largely dependent upon large oil windfalls, declining prices have caused mounting fiscal pressure for the country.

No longer the swing producer
Saudi Arabia is often portrayed as the cause of the collapse in oil prices. It is often accused of having flooded the market, leading many to conclude the collapse in global oil prices and any ramifications they may have had for the Saudi state are its own short-sighted doing. Low oil prices have benefited the Saudis by putting pressure on producers unable to turn a profit at the current low prices, but it would be a mistake to accuse Saudi Arabia of having engineered the slide.

When prices began to fall in 2014, the Saudis did not export any greater amount of oil – indeed, the year ended with them exporting less crude than at its start. Rather, much of Saudi Arabia’s production increase actually went towards increased domestic use. It was only in 2015 that the Saudis began to significantly export more crude oil than before – a year into the start of the price decline. They have been producing at near capacity for many years now, with little room for manoeuvre. What this suggests is not that the Saudis decided to flood the market in 2014, but rather that they did not respond to the decline in prices by coordinating an OPEC-wide cut.

The Saudis, however, did want to pursue a cut in production – but only in concert with other producers. In late 2014, they met with two of the largest non-OPEC producers: Russia and Mexico. The Saudis had hoped to push for a consensus on an oil production cut with both OPEC and non-OPEC producers, but no agreement was reached, largely due to Russian reluctance. As CNN Money reported at the time: “When prices plummet, OPEC and non-OPEC producers come knocking at the door of Saudi Arabia and other Gulf countries, asking for them to cut production to support prices.”

But, this time, the Saudis did not want to act unilaterally (or in concert with OPEC) without the world’s other major producers joining in. Since then, a number of other meetings with various producers, OPEC and non-OPEC alike, have failed to yield any results. The latest position, as stated by Al-Naimi in Houston, is that there will be no cut from Saudi Arabia.

All this suggests a change in Saudi policy. The country no longer wishes to act as the swing producer – either inside or outside OPEC. While the country did not precipitate the global glut in oil prices, it has allowed the glut to carry on by not playing its traditional role of reigning in production. Rather, it now argues the market should determine the price, with low prices forcing less efficient producers out. As its spokespeople have repeatedly said, they will not “carry the market”.

This is not an attempt to gain market share, but rather, defend market share. A combination of high prices and cheap credit in years past led non-conventional oil extraction methods, particularly in the US, to soar. And this is something the Saudis take into consideration when deciding not to cut production without non-OPEC countries doing the same.

Low prices have started to tug at the strings of the Saudi state’s purse

But the consideration is not an attempt to kill non-conventional extraction methods outright. With the Saudis near capacity and world demand still rising – albeit at a slower pace – extra supply must come from elsewhere. And the Saudis reluctantly recognise US non-conventional oil as playing an important role in this. Saudi refusal to scale back their own production is, rather, a refusal to keep less efficient producers afloat. Those efficient enough to swim through the world oil glut will survive.

Saudi social contract
The question, however, is how long the Kingdom itself can fare within such a glut. The Saudis are able to produce at around $10 a barrel, meaning that – unlike for many higher cost producers – such low prices still provide a return. However, it is a depleted return and a marked fall in revenue compared to what Saudi society has become accustomed. Low prices have started to tug at the strings of the Saudi state’s purse.

When oil prices started to decline, the Kingdom did not immediately feel the squeeze. As Dr Courtney Freer, a research officer at the LSE Kuwait Programme, told The New Economy: “The Saudis didn’t really feel the impact of low oil prices until [2015]”. That year,“their fiscal deficit hit a record $98bn, or 15 percent of GDP, which I think was a wake-up call”. As a consequence, she said, “we saw substantial spending cuts listed in the 2016 budget”.

The budget cut, in the words of Freer, “was huge”. The government announced it “would adjust water, electricity and fuel subsidies over the next five years – a huge and unprecedented step for the Kingdom”. While the lavish lifestyle of various members of the extensive Saudi royal family may go for the most part unaffected, the average Saudi will see generous state subsidies dry up.

The Saudi economy is almost entirely dependent on oil revenues, and in many ways the legitimacy of the House of Saud is tied up with its ability to provide its subjects with the dividends the revenues allow. Already the state has had to start scaling back on the fiscal privileges it affords its citizens – which raises questions as to how much longer it can last. As the world remains awash in cheap oil, this social contract looks increasing under strain.