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Some wars cannot be won. Saudi Arabia is learning that the hard way, as the kingdom’s twin announcements on Monday demonstrate.
The first involved austerity measures that transfer most of the burden of falling oil revenues directly onto the shoulders of ordinary Saudis. The second announcement concerned cuts in oil production of the voluntary variety, not those required by the recent agreement between the Organization of the Petroleum Exporting Countries (OPEC) led by Saudi Arabia and its allies.
In case you’re a bit behind on all of the dramatic oil markets this year, here is a brief summary of the highlights:
World benchmark Brent crude prices started the year around $ 66 a barrel. At the end of February, Brent was trading around $ 50 a barrel as coronavirus blockades severely reduced global demand for oil.
Understandably, Saudi Arabia-led OPEC wanted to counter this blow with deep supply cuts. But the Saudis were unable to convince the cartel’s biggest ally, Russia, to play ball.
Riyadh retaliated in March by lowering the price it charges for crude oil and announcing that it would pump oil with abandon, moves designed to steal market share from higher-cost producers such as Russia and the United States. There is a reason why they call it a “price war.” Subsequently, Brent closed March at around $ 22 per barrel.
Oil prices may have fallen so far, so fast, regardless of Saudi shenanigans. But many analysts believe that the price war surely accelerated the defeat. And it has caused all kinds of discomfort.
The legislators of the Congress of the states of EE. USA Where oil producers cannot compete at such low prices, they accused the Saudis of participating in an “economic war”. Two US senators introduced legislation calling on the US. USA That they withdraw troops and military equipment from Saudi Arabia if the kingdom did not stop pumping so much crude.
The de facto ruler of the kingdom, the Crown Prince Mohammed bin Salman (MBS), he aligned, albeit with a push from the President of the United States, Donald Trump, who is ready for reelection this year and has promised to defend the United States’ oil and gas industry.
Last month, OPEC and its allies agreed to cut production by a record 9.7 million barrels per day. But global demand has dropped around 30 million barrels per day. Prices are likely to remain under pressure as excess persists.
This has forced some difficult decisions on the Saudis. Although the kingdom can pump oil cheaper than any other producer, it is not doing enough to finance its state budget, which the IMF considers requires oil to reach around $ 76 a barrel this year.
Although they have extensive foreign exchange reserves, in March, the Saudis spent their savings at the fastest rate in almost 20 years. The kingdom has turned to international debt markets to help close its financing gap, issuing $ 7 billion worth of bonds last month alone. But you cannot simply borrow your way out of this link. Belt tightening is also required.
From borrowing to tightening your belt
After Moody’s rating agency lowered the kingdom’s outlook from stable to negative earlier this month, Saudi Finance Minister Mohammed al-Jadaan warned of “painful” measures to come.
On Monday, a series of injuries were revealed.
The real draw on Saudi Arabia’s list of austerity measures involves VAT: value-added tax, which will rise to 15 percent in July from its current level of five percent.
Progressive economists scorn VAT because it disproportionately affects less affluent households by gobbling up a larger portion of their disposable income. The Saudis will not only see prices rise due to the tripling of VAT, but those households with a state-supported family breadwinner will also have less money in their pockets because the government also announced Monday that it will suspend its cost allocation. of life for the state workers from June.
This is somewhat complicated for any government, but especially one in which the social contract between ruler and ruled revolves around a generous welfare state in exchange for political obedience.
“During recent episodes of austerity, the government has relied on cuts to capital spending and has refrained from hitting household pockets for fear of causing social unrest,” senior economist at emerging markets at Capital Economics said Monday. Jason Tuvey in a note to customers. “Despite Mr. al-Jadaan’s comments last week suggesting that homes would be protected once again, this latest package suggests otherwise.”
The Austerity Knife is also slashing funds for some projects that fall under the umbrella of MBS ‘highly prized but hardly realized Vision 2030, a plan to diversify the kingdom’s economy away from fossil fuels and create sustainable jobs for its youth workforce. .
As long as oil prices remain depressed, Vision 2030 will push further in the future. And Saudi Arabia will continue to face difficult decisions to close its budget gap.
Oil markets rose a million barrels a day closer to rebalancing on Monday after the kingdom’s energy ministry announced it had told state oil giant Aramco to cut oil production in June. This is in addition to the restrictions that Saudi Arabia already signed last month as part of the agreement between OPEC and its allies.
The announcement probably went down well in Washington. Every barrel of oil withdrawn from world markets brings embattled U.S. oil shale producers closer to a market in which they can compete, and subsequently takes the heat off Trump to do more to protect the U.S. oil patch from Saudi competition.
Meanwhile, green outbreaks of demand revival are emerging as closure restrictions are eased and international travel is slowly waking up from hibernation. This has helped oil prices begin to regain some of the lost ground this year.
But the balance is still a long way off, and a second wave of coronavirus infections could still burn those green buds.
This played into oil prices on Monday. While Brent received a slight boost after the Saudis announced additional production cuts, fear of further disruptions of the coronavirus caused prices to drop by just over four percent, to see Brent liquidate just below $ 30 per barrel.
