/biz/ - Business and Finance

POLITICS & SOCIETY

Saudi Arabia is medieval style Wahhabi monarchy which has repressive laws and restricts basic laws of freedom. The courts function in accordance with Islamic law called Sharia. Social spending is the glue that holds the regime together. The Saudi monarchs have been throwing money around for decades to quieten any dissent and maintain power. Citizens pay no tax on income. Subsidized petrol costs about 10 cents a litre. Electricity is given away for 2 cents a kilowatt-hour. There are generous social welfare schemes which include everything from free healthcare to a free burial and everything in between. The biggest supporter of the so called "Arab Spring" was worried about the revolution reaching its borders. Spending on patronage exploded after the "Arab Spring" as the monarchy tried to smother any dissent within its kingdom. Bonuses to state employees, increased pensions, higher unemployment benefits or simply big handouts were given to distract the public attention from the uprisings in Arab world. All this was possible and affordable because the oil was selling at $140/barrel.

SHALE OIL INDUSTRY

With significant recent advances in technology for shale oil extraction, the production of shale oil saw steady increase from 2011 onwards. The high oil prices worked in the favour of shale oil producers as many projects which were not feasible earlier, were able to generate profit because of the booming oil prices. The shale oil industry started producing oil in record numbers. Even though these numbers were not huge if compared to OPEC oil production, they were enough to influence the global oil market. The global oil prices fell slightly due to shale oil industry.

SAUDI ARABIA'S REACTION

Saudi Arabia which has built its welfare state around the assumption that oil prices go only one way, that is up, started feeling the pinch of falling oil prices. In late 2014, Saudia Arabia "discovered" that supply has a direct effect on price. They came up with a "brilliant" plan. They decided to increase the oil production. Saudi Arabia believed that the over supply will reduce oil prices to a level where shale oil industry will go broke and wont be able to continue with production. Thus, making Saudi Arabia the undisputed king of the global oil market. Even though a large number of shale oil producers were US based, Saudi Arabia had the blessing of USA because the strategy would supposedly hurt Russia also. The plan was put into action and Saudi Arabia was saying, what could possibly go wrong.

EFFECTS ON GLOBAL OIL MARKET

Saudi Arabia was indeed right. The increased oil production by Saudi Arabia started effecting crude oil prices. Saudi Arabia was hoping a manageable decrease in price will put high cost shale oil industry out of business. In the past whenever the crude oil prices dropped they bumped back to previous prices quite quickly, so it seemed as if Saudi Arabia will kill off the competitors and the oil prices will rise again. In worst case scenario, Saudi oil wells are cheapest to run so there is no way anyone could be beat them at their game. Saudi Arabia had played its card right. Many shale oil wells had to shut down, Russian economy was hurt by falling oil prices, countries like Algeria, Venezuela were crying in pain while the Saudi were laughing. The prices dropped to $80 a barrel which prompted a meeting of OPEC countries which are responsible for 40% of world production. Countries like Iran and Venezuela wanted Saudi Arabia to cut back production to stabilize oil prices which were in free fall. But Saudi Arabia was not in a relenting mood.

SAUDI ARABIA'S DREAM TURNS INTO NIGHTMARE

Though Saudi strategy seemed perfect on paper, it was deeply flawed. Saudi Arabia ended up hurting no one but itself. Shale oil extraction costs more than oil rig but with advances in extraction technology, its not high cost drilling anymore. To give you an idea, a shale oil well in Texas costs less than drilling in Gulf of Mexico or Arctic. So even though some shale oil wells had to shut down, the high yield wells were still profitable and shale oil production hit a record high. Russia is among the largest exporters of oil and gas but its not entirely dependent on these exports. Gold, diamonds, precious metals, iron, wheat are among other Russian exports. Russia has a sophisticated defence industry worth billions of dollars. It also has a well developed fishing and timber industry along with expertise in manufacturing, aerospace & aviation, construction etc. Saudi Arabia lacks any such expertise or capacity and is largely dependent on foreign technicians for even running their petrochemical industry. There has also been a general decline in demand for oil, so there are several other factors affecting the oil industry. Saudi assumptions that China will continue to increase its demand for energy and Iran will continue to suffer under sanctions also proved to be false. Saudi Arabia not only failed miserably but it also ended up hurting its own economy more than anyone else.

CURRENT OIL MARKET

Saudi Arabia might have started this price war but its like a helpless beached whale now, it has lost control over the market price. There is no easy way out for the Saudis who have gambled without much thought. One option for Saudi Arabia will be to cut down its oil production and hope that the price will rise. The prices will eventually rise to their previous levels but the shale oil producers will also return in record numbers. This will also result in other countries grabbing their market share. Sanctions on Iran have also been eased and Iran will add another million barrels to the oil market. The Iranians would love to hurt the Saudis even further by supplying more oil. The other option will be to be patient and see what happens. The patience game is a very expensive affair. Saudi Arabia might run out of money well before it runs of out patience. So things are not looking good for Saudi Arabia.

WILL SAUDI ARABIA GO BANKRUPT ?

I dont think Saudi Arabia will go bankrupt. Atleast not just yet. Remember the $740 billion foreign reserves? They are very handy but they have been shrinking at an unprecedented pace. A whopping $70 billion are already gone in less than a year. The costly Saudi welfare state is built around petro dollars. The Saudis need oil prices to be at $110/barrel to balance their budget. At the moment the Saudis need $5-10 billion a month to fill in the gap. If Saudi Arabia keeps taking out the money from foreign reserves, by 2020 they will be empty. The other option will be to borrow money. Borrowing money saves them from dipping into foreign reserves but it doesnt change the fact the government has no means to make up for the huge budget deficit. Saudi Arabia's foreign reserves might be large but so is its population. If you calculate per capita foreign reserves, they are more comparable to Jordan or Thailand. Saudi Arabia's economic growth over the past decades has been fueled by petrodollars. If the petrodollars are gone, its quite likely the economy will also stagnate. Saudi Arabia is also involved in a very expensive war against Houthis in Yemen and heavily involved in funding and supplying weapons to Islamists in Syria. Saudi Arabia's entire military build up is dependent on foreign imports and defence accounts for 11% of the annual budget. If the oil prices rebound before Saudi Arabia runs out of cash, the house of Saud will breath a sigh of relief. If Saudi Arabia runs out of money, then monarchy has other things to worry about than bankruptcy like saving the regime because the "Arab Spring" may finally arrive in the kingdom.

Good read.