Daniel Lacalle

Saudi Arabia prepares itself for lower oil prices

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Yesterday the government published the final deficit figures for Saudi Arabia , which exceeded $98 billion. With an economy where oil accounts for nearly 90% of the tax revenues and more than 40% of GDP , revenues have fallen while expenditure increased above estimates. This led to a deficit of almost 17% of GDP. However, in this figure there are positive and negative elements.

On the positive side, Saudi Arabia is one of the countries with a lower debt in the world, 19% of GDP . Government policy avoids getting in debt as a tool and therefore during the decade of high oil prices the country reduced its debt burden to a bare minimum. Additionally, it has dollar reserves exceeding $645 billion.

On the downside, actual dependency on oil prices seems higher than estimated in an economy where subsidies, political and military spending are virtually impossible to reduce.

But what matters is the future. The government estimates that in 2016 the deficit will be about 87 billion dollars, as revenues drop despite spending cuts (subsidies, which amounted to $25 billion annually, will go down with the oil price, as should be expected, while gasoline prices have increased and wages have been slightly reduced). The Saudi government expects another drop in revenues and this shows that the Kingdom does not consider any improvement in oil prices in the near term.

In 2016, Saudi Arabia can produce up to 11 million barrels a day in its strategy to improve market share. That, added to the more than likely increase Iranian production following the lifting of sanctions, can lead to OPEC at levels of 32 million barrels a day, if estimates from other countries are met. Remember that OPEC countries tend to produce above their quotas.

The war we mentioned in my book ‘The Energy World Is Flat’ (Wiley) is fought on several fronts. Efficiency , which makes  demand grow slower despite economic growth, technological transition, which leads to the fall of the monopoly of oil in transport, and diversification , with new sources of production in non OPEC countries.

The strategy of maintaining market share in Saudi Arabia, therefore, is logical. Cutting production makes no sense. Why would the lowest cost and most efficient producer have to be the one who balances the market? Additionally, it would show their customers that they are not the reliable supplier of cheap and flexible product. And thus it would accelerate the transition to renewable technologies. Cutting production is suicidal, moreover, when the US has already approved to export its production surplus.

The US has become in six years the second global oil producer. This is a threat not only to the oil price but also for market share

Until a few months ago, the US was just a problem for oil prices globally but not market share one, as it was forbidden to export. Lifting this ban makes the US , which has become in six years the second largest global oil producer, a threat not only for price but for market share. This can be up to half a million barrels a day more competing for Russia and OPEC’s traditional customers. Russia is also producing at record levels (more than 10 million barrels a day).

Many fracking companies are suffering in a low oil price environment. If Saudi Arabia was to cut output it would help the inefficient and do very little to balance the market.  More than 89% of the production of fracking in the US is in large companies with little debt (95% of production is in 127 companies with less than 1.8x net debt to EBITDA). Lower cost strategies will prevail and the most efficient operators will absorb the inefficient. It is the story of 150 years of oil industry. It has always been like this.

And producing countries? The ones who have saved and become stronger in the decade of high oil prices will continue to battle and compete in better conditions. The ones that thought that high oil prices would last forever are suffering. Because the mother of all battles has only just begun. Now comes the second phase, accelerated replacement . In a world of low growth, technology further reduces costs. The efficient operators will be winners.

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