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Saudi Arabia far from economic crisis, says crown prince

Muhammed bin Salman gave an interview with The Economist this month - here's what Petroleum Economist picked out

Muhammed bin Salman, Saudi Arabia’s youthful deputy crown prince, defence minister and, according to most kingdom-watchers, the power behind the throne, gave a lengthy interview to The Economist on 4 January. Several answers were significant for the oil market and investors.

On Saudi oil-market policy

The kingdom has pursued a laissez-faire strategy in oil markets since November 2014, when it directed Opec not to stop a price slump. Since then, Saudi output has been high and its sales tactics aggressive, including discounts to customers in Asia and Europe. Oil prices have plummeted in part thanks to this policy, which is designed to recover market share lost in recent years to higher-cost producers.

Muhammed is thought to have much control over oil policy – and while the interview didn’t touch on the Saudi market strategy since 2014 its clearest implication is that a reversal is not on the cards despite fresh price plunges in recent weeks.

Saudi Arabia is “far from” an economic crisis at $35 a barrel Brent, Muhammed said. Non-oil Saudi revenues are up by 29% and should reach $100bn over the next five years. The national debt is just 5% of GDP; and the kingdom has the world’s third-largest reserves to draw on. Muhammed mentioned “clear programmes” over the next five years, a reference to energy-price liberalisation, which is already underway. The interview suggests the kingdom is bedding down for a long fight. The comments were bearish: Saudi Arabia isn’t about to cut production to rescue prices.

On Aramco

The big scoop from the interview was Muhammed’s suggestion that state firm Saudi Aramco could be privatised – “something that is being reviewed”, with a decision to come “over the next few months”. The prince said he was “enthusiastic” about the idea, believing it to be in the company’s interests, and would add transparency and counter any corruption “that may be circling around Aramco”.

A few points. First, the idea has been floating around for about a year, gaining currency since King Abdullah’s death in January 2015. It’s another sign of the profound change in the leadership’s thinking since then. It’s also a sign that, in the face of the bruising oil-price slump, everything is on the table.

Second, an Aramco IPO at $30/b Brent would be odd timing, to say the least. Yes, hypothetically, floating the whole company at prevailing prices would value Aramco at around $9 trillion, based on its reserves alone. But that would be a much better deal for share-buyers than for Saudi Arabia if, as most analysts expect, prices eventually start rising again.

Third, it’s hypothetical anyway. That doesn’t mean it isn’t being discussed – it is. Following The Economist scoop, the Wall Street Journal interviewed Khalid al-Falih, Aramco’s chairman, a very influential policymaker in Saudi Arabia and a possible contender to replace Ali al-Naimi as oil minister. “There are studies ongoing,” he told the Journal. “Serious consideration.” He was vague about the timeline, but said any flotation could include the “main company, and obviously the main company will include upstream”.

But grounds for scepticism are many. “It’s just balloon-floating,” says one consultant close to Saudi oil-ministry thinking. Imagine, for a minute, the prospect of Saudi Arabia giving away long-held and closely guarded state secrets about Aramco’s reserves base in a prospectus. (And who would audit it?) None of it sounds probable. If anything happens, it seems likelier to involve some Aramco downstream assets – Falih specifically mentioned three downstream joint ventures: Sadara (with Dow Chemical), Satorp (with Total) and Yasref (with Sinopec). Any listing may only be for a small stake in Aramco or these units, and most likely on the Saudi exchange, though Falih didn’t rule out an international flotation.

Above all, don’t expect this to mean Aramco turns into a normal – but very very large – oil company, fretting over crude prices and not helping to set them. Aramco would remain under the control of its Saudi masters, serving the aims of the kingdom. That might mean cutting production again one day. Investors would certainly have to get used to a new kind of political risk, not least the new notion that Saudi oil and economic policy has become less predictable than in the past.

On a “Thatcherite” revolution

The Aramco IPO idea at least shows the way the leadership is thinking. Muhammed liked The Economist’s description of his plans as a “Thatcherite revolution” in Saudi Arabia, including other privatisations and “free energy markets”. Some of that has begun, with price hikes announced in December. But full-on liberalisation would be a shock to the system. Even after the recent price rises, a litre of gasoline still costs just $0.24 and diesel half that, according to a January report from Saudi bank Apicorp. Natural gas sells for just $1.25 per million British thermal units. The family would need to make sure that steeper rises in the next five years don’t exacerbate social tensions. Apicorp says it will need to communicate the policy better and probably offer some other kind of “mitigating measures” to offset the impact on households. If the reforms work, though, don’t underestimate the effect elsewhere in the Gulf, where governments will probably step up their own price-reform programmes.

On Iran

Muhammed was unrepentant about the execution of the Shia cleric Nimr al-Nimr in early January, an act which prompted protests among Shia Saudis in the restive Eastern Province, angered Iran, and has sharply worsened sectarian tensions in the Gulf. “What has this to do with Iran?” the prince asked, pointedly referring to Nimr as a Saudi who committed crimes in Saudi Arabia, where he was sentenced to death by a Saudi court.

“We fear” that tensions will be further escalated, he said. “Iranian escalation has already reached very high levels and we try as hard as we can to not escalate anything further, we only deal with the procedures and steps taken above us.” Nor does Muhammed “foresee at all” a war between the two countries, which would be a “major catastrophe in the region”. “For sure we will not allow any such thing.”

It’s all true but it doesn’t tell the whole story. Iranian and Saudi proxies are already in conflict in Syria. Saudi Arabia claims Iran is also supporting the Shia Houthis against which Riyadh, helped by other Gulf Araba states, is waging war in Yemen.

Senior Saudis are convinced that Iran has duped the West into a soft nuclear agreement (this is a common view in the Arab Gulf). Relations between the two are crucial to the Syria conflict, in which Iran backs Bashar al-Assad’s regime and Hezbollah, which is defending it. Gulf Arab funding has supported Assad’s Sunni opponents, including some jihadi groups. It’s hard to see an end to the conflict without cooperation between Riyadh and Tehran (among others). Some analysts believe the Nimr execution was a deliberate ploy to provoke Iran, hoping that when it showed its teeth the nuclear deal might be endangered.

What is plain is that a new era of more muscular Saudi policy in underway in the region. Saudi Arabia will not sit passively and watch events unfold; it is actively engaging with them – from Yemen to Syria. Its GCC neighbours are falling into line too.

This sends two signals to oil markets. First, geopolitics is back: the risk of a wider accidental sectarian war in Gulf is rising, with unknown consequences for the world’s most important oil-exporting region. Second, oil policy is part of this more proactive regional posture. Iran’s return to oil markets in the coming months is a key pin Saudi Arabia’s plan to keep pumping – ensuring it doesn’t lose market share to Iranian barrels or reward Tehran with a higher price and more income.

Saudi Arabia’s leadership is projecting a new boldness. The very fact of an open interview with the crown prince was significant. Muhammed has a plan and oil policy will be a key plank of it. On its strategy to let the market drift, the kingdom looks more likely to double down than to quit.

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