Saudi Oil Issues – 5/6/16

The largest producer of the OPEC oil cartel and an extremely low cost oil driller, Saudi Arabia can influence oil prices around world while bringing in staggering revenues on a single export. Few countries can boast that they would make a profit even off of sub-$20 a barrel oil and for decades the Middle Eastern nation has financed generous domestic subsidy programs, expansive regional campaigns, and expensive vanity projects thanks to its power over the crude oil vital to modern economies. Oil was a blessing for the kingdom; however, it is a fickle thing, like most commodities, and with the price of oil expected to be “lower for longer” officials look to reduce their dependence on oil revenues.

Few issues affect oil more than the tensions between Saudi Arabia and Iran. The two nations, led by opposing sects of Islam, have long been in conflict via proxy wars in regions like Syria and Yemen. Mohammed bin Salman’s decision to reject an oil output freeze at Doha unless Iran agreed to participate is only the latest example of how political conflict is seeping into economic policy. And, since Deputy Crown Prince is expected to lead Saudi Arabia after his father, the hard-line stance taken by the Saudi leader is likely here to stay. The failure at Doha dashed the hopes of Russia and many members of the Organization of the Petroleum Exporting Countries who wanted to show markets a united effort to raise oil prices.

A fierce rivalry with Iran makes it all but impossible for Saudi Arabia to stop Iran from adding more barrels to the oil market. Iran is expected to been the only producer adding significant amounts of output this year as it ramps up production in an effort to claw back market share lost during its time under sanctions. Though U.S. shale-oil output has fallen leading to a rally back to $40-$45 a barrel prices, a surge in Iranian output could send fragile prices crashing. The failure to reach a deal in Doha sent oil prices down before they rallied on unexpected news of a Kuwaiti oil-worker strike taking output offline.

Iranian officials have so far ridiculed calls for a freeze on production. Saudi Arabia produces roughly three times as much oil as Iran and is already pumping close its maximum desired output making their calls for an Iranian freeze appear self-serving. Of course, a freeze that left out Iran would likely result in Saudi Arabia losing market share since the two nations are competing for customers, something Saudi officials vehemently oppose.

Still, declining revenues are hurting Saudi Arabia as much as any other OPEC nation and Iran has said it may be ready for joint action with members of the Organization of Petroleum Exporting Countries in as little as one or two months, once it regains the market share. The group meets in June, but there are currently no proposals to revive output-quotas or put any other substantial plan into action after the Doha fiasco.

The era of separating economic and political policy that has been a facet of Saudi Arabia’s government may be over. Mr.Ali al-Naimi, a long time powerhouse as Saudi Arabia’s Oil Minister, had claimed before Doha that a deal need not depend on Iran, but following an unexpected call to reject any deals and the subsequent by Prince Mohammed.

Saudi Arabia is trying to limit the impact of subsidy cuts on its citizens as it prepares for the post-oil era. Before the price declines, citizens benefited from the cheapest gasoline prices in the world and subsidies on almost all necessities, but now the government must find a way to balance much needed overhauls with the needs of its people, who are accustomed to trading political loyalty for government-funded benefits.

“We don’t want to change the life of the average Saudi,” Prince Mohammed said in an interview. “We want to exert pressure on wealthy people, those who use resources extensively.”

Saudi Arabia has raised prices for gasoline, electricity and water as part of a broader plan to raise non-oil revenue and reduce the kingdom’s reliance on crude. In doing so, Prince Mohammed, the second-in-line to the throne, is leading the biggest shake-up of the economy in the history of the kingdom. Still, oil revenue made up 73% of government revenue in 2015 making it difficult to pivot towards other sources of economic activity and the energy-rich nations already missed the chance to diversify their economies at $100 a barrel or higher in the past decade.

Previous efforts to move beyond oil have run up against a wall of apathy from younger generations who expect the same easy jobs and money as their parents. And with oil revenues weak and unemployment at 11.6%, the chances of disillusionment with new policies are high. Unfortunately for the kingdom, it is losing reserves rapidly, oil prices are still low, and interference from religious elements dampers reform  So ultimately, the chances for success depend on the power of the prince to tame public opinion during much needed, but unpopular, overhauls of labor markets, government programs, and the inefficient quagmire that is the Saudi bureaucracy. The prince has already caused a stir by replacing both the oil minister and central bank chief, though the two were already nearing retirement and the more difficult challenge will be firing larger numbers of government workers without facing too much backlash.

The kingdom’s oil minister, Ali al-Naimi, led the country’s oil policy for decades but now the prince hopes that low oil prices will drive economic reform and weaken Iran.

“For years we’ve been told that Saudi oil policy is driven by commercial and economic considerations,” says Jason Bordoff of Columbia University’s Centre on Global Energy Policy. “Yet what happened in Doha seems to have had a big geopolitical dimension to apply pressure on Iran.”

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