Mandel Ngan/AFP/Getty Images
Donald Trump with Crown Prince Mohammed bin Salman during a White House meeting in March
Saudi Arabia has instigated two oil price wars in the last decade and
has lost both. Given its apparent inability to learn from its mistakes
it may well instigate another one but it will lose that as well. In the
process, it has created a political and economic strait-jacket for
itself in which the only outcome is its eventual effective bankruptcy. OilPrice.com outlines why this is so below.
The
principal target for Saudi Arabia in both of its recent oil price wars
has been the U.S. shale industry. In the first oil price war from 2014
to 2016, the Saudi’s objective was to halt the development of the U.S.
shale sector by pushing oil prices so low through overproduction that so
many of its companies went bankrupt that the sector no longer posed a
threat to the then-Saudi dominance of the global oil markets. In the
second oil price war which only just ended, the main Saudi objective was
exactly the same, with the added target of stopping U.S. shale
producers from scooping up the oil supply contracts that were being
unfilled by Saudi Arabia as the Kingdom complied with the oil production
cuts mandated by various OPEC and OPEC+ output cut agreements.
In
the run-up to the first oil price war, the Saudis can be forgiven for
thinking that they stood a chance of destroying the then-relatively
nascent U.S. shale sector. It was widely assumed that the breakeven
price across the U.S. shale sector was US$70 per barrel and that this
figure was largely inflexible. Saudi Arabia also held record high
foreign assets reserves of US$737 billion at the time of launching the
first oil war. This allowed it room for manoeuvre in sustaining its
economically crucial SAR-US$-currency peg and in covering any budget
deficits that would be caused by the oil price fall. At a private
meeting in October 2014 in New York between Saudi officials and other
senior figures in the global oil industry, the Saudis were ‘extremely
confident’ of securing a victory ‘within a matter of months’, a New
York-based banker with close knowledge of the meeting told OilPrice.com.
This, the Saudis thought, would not only permanently disable the U.S,
shale industry but would also impose some supply discipline on other
OPEC members.
As
it transpired, of course, the Saudis had disastrously misjudged the
ability of the U.S. shale sector to reshape itself into a much meaner,
leaner, and lower-cost flexible industry. Many of the better operations
in the core areas of the Permian and Bakken, in particular, were able to
breakeven at price points above US$30 per barrel and to make decent
profits at points above US$37 per barrel area, driven in large part
through advances in technology and operational agility. After two years
of attrition, the Saudis caved in, having moved from a budget surplus to
a then-record high deficit in late 2015 of US$98 billion. It had also
spent at least US$250 billion of its precious foreign exchange reserves
over that period that were lost forever. In an unprecedented move for a
serving senior Saudi politician, the country’s deputy economic minister,
Mohamed Al Tuwaijri, stated unequivocally in 2016 that: “If we [Saudi
Arabia] don’t take any reform measures, …then we’re doomed to bankruptcy
in three to four years.”
The even more enduring legacy of this first oil price war, though –
and part of the reason why the Saudis could never hope to win the last
one, or any future oil price war either – is that it created the
resilience of the U.S. shale sector as it now stands. This means that
the U.S. shale sector as a whole can cope with extremely low oil prices
for a lot longer than it takes Saudi Arabia to be bankrupted by them.
Saudi Arabia has much greater fixed costs attached to its oil sector,
regardless of how low market prices go. Before the onset of the latest
oil price war, the Kingdom had an official budget breakeven price of
US$84 per barrel of Brent but, given the economic damage done by this
latest price war folly, it is much higher now. By stark contrast, the
U.S. shale sector that Saudi crucially helped to shape in the first oil
price war is now so nimble that US$25-30 per barrel of WTI is enough to
bring some of the production back on line, as long as operators believe
that prices will not fall and hold below the US$20 per barrel level.
But, even if prices are below that key US$25-30 per barrel level, it
does not matter to the long-term survivability of the U.S. shale sector
as the key players are able to shut down wells instantly as and when
needed and to start up them up again within a week as demand requires.
In sum: in any oil price war, the Saudis simply cannot wait out the U.S.
shale sector.
On the other hand, though – in a rising oil price
environment - the Saudis are also doomed. This is because the U.S. –
even before the latest oil price war – had intimated that it would not
tolerate oil prices above around US$70 per barrel of Brent. When the oil
price rose last year during the March-October period consistently above
US$70 per barrel level, U.S, President Donald Trump Tweeted about Saudi
Arabia’s King Salman that: “He would not last in power for two weeks
without the backing of the U.S. military.” The US$70 per barrel level is
considered one that brings into view oil price levels that might pose
problems for the U.S. economy. Specifically, it is estimated that every
US$10 per barrel change in the price of crude oil results in a 25-30
cent change in the price of a gallon of gasoline, and for every 1 cent
that the average price per gallon of gasoline rises, more than US$1
billion per year in consumer spending is lost.
Before
this latest Saudi-instigated oil price war, the U.S. had little
interest in the fact that this US$70 per barrel level was way below
Saudi Arabia’s then-budget breakeven oil price. After this latest attack
on its strategically vital shale sector, the U.S. has absolutely no
interest whatsoever in this budget breakeven fact or indeed in whether
Saudi Arabia continues to slowly haemorrhage into bankruptcy in the
coming years, according to a number of Washington-based sources close to
the U.S. Presidential Administration spoken to by OilPrice.com in the
last few weeks. Partly this indifference is due to the perceived
‘betrayal’ of the foundation stone deal that had determined the two
countries relationship since 1945. This was that the U.S. would receive
all of the oil supplies it needed for as long as Saudi Arabia had oil in
place, in return for which the U.S. would guarantee the security of the
ruling House of Saud. This altered slightly with the advent of the U.S.
shale sector to ensure that Saudi Arabia also allows the U.S. shale
industry to continue to function and grow.
Partly as well, this
indifference is due to the series of other blunders that senior U.S.
politicians believe have been made by Saudi Crown Prince Mohammed bin
Salman (MbS), which now make him a liability. This includes – but is not
limited to – the Saudi-led war in Yemen, the cosying up of Saudi to
Russia in the OPEC+ grouping, Lebanese President Michel Aoun’s
allegation in 2017 that then-Prime Minister Saad al Hariri had been kidnapped by the Saudis and forced to resign, and the murder of dissident Saudi journalist, Jamal Khashoggi, which even the CIA concluded was personally ordered by MbS.
These factors culminated in President Trump making his earlier
Tweeted implied threat about the fragile hold that the al-Sauds have on
power in Saudi Arabia without U.S. assistance into a guaranteed promise
during a telephone conversation on 2 April with MbS.
During this call, Trump reportedly told MbS that unless OPEC started
cutting oil production (with the implication being to push up prices to
levels where the U.S. shale producers could start making decent profits)
then he would be powerless to stop lawmakers from passing legislation
to withdraw U.S. troops from Saudi Arabia. Shortly thereafter, MbS did
what he was told. The change in this rhetoric from implied threat to
guaranteed action means that this is now in the fabric of all future
U.S. dealings with Saudi Arabia and it brings the Saudis crashing back
to the basic problem. That is: economically it cannot afford to continue
to crush oil prices for long enough to cause sustained damage to the
U.S. shale sector, politically it is not permitted to allow prices to
rise high enough to avoid eventual effective bankruptcy, and any pricing
in between just allows the U.S. shale sector to make greater profits
and grow even more. In this regard, the OPEC+ production cuts are
perhaps the cruellest cut of all for the Saudis: the Saudis have to
implement them and abide by them because they are needed to keep oil
prices high enough to ensure the profitability and growth of the U.S.
shale sector but the cuts cannot continue for long enough to allow the
Saudis back into an ongoing budget surplus.
Already in this
context, March saw Saudi Arabia’s central bank depleted its net foreign
assets at the fastest rate since at least 2000, falling by just over
SAR100 billion (US$27 billion). This is a full 5 per cent decrease from
just the previous month, and the total reserves figure now stands at
just US$464 billion, the lowest level since 2011. It leaves only US$164
billion of ‘fighting reserves’ that can be used on everything else that
Saudi needs when the US$300 billion that is estimated to be needed to
keep the economic cornerstone SAR/US$-peg is subtracted. At the same
time, the Kingdom slipped into a US$9 billion+ budget deficit in the
first quarter and a number of independent analysts are predicting that
its overall gross domestic product could shrink by more than 3 per cent
this year (the first outright contraction since 2017 and the biggest
since 1999), whilst the budget deficit could widen to 15 per cent of
economic output.
By Simon Watkins for Oilprice.com
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