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Saudi Arabia braces for impact

The kingdom may have to pay a steep price for its efforts to reassert leadership in oil politics

Saudi Arabia has been portrayed as the last man standing from its oil price war with Russia and the US, which briefly dominated the market in March before Covid-19 switched the story dramatically from supply to demand. But now the bill for attempting to bring American shale producers to their knees and discomfiting Russian president Vladimir Putin may be coming due.

Riyadh is beginning to shoulder a disproportionate burden for rebalancing global crude markets. And oil prices barely blipped on this week’s news of unilateral Saudi production cuts of 1mn bl/d, which came alongside other domestic moves including a VAT hike and austerity measures totalling $26.6bn, offering a glimpse of possible further challenges to come.

Under pressure

Part of the unexpected largesse to other producers—which will see Saudi Arabia’s June output reduced to under 7.5mn bl/d—is plain old geopolitics. The cut was announced days after the US started pulling Patriot missile batteries and other military hardware out of the Gulf kingdom. And credible media reports claimed Washington had threatened to further reduce its military assistance and commitment to Riyadh unless it acted to support crude prices.

$27bn Fall in Saudi foreign currency reserves

Given the batteries in question had been guarding oil installations against threats such as the September 2019 missile attacks, it is difficult to see such moves as anything beyond plain coercion. Adding insult to injury, enthusiasm for a formal output reduction on the part of the US is quickly evaporating even as the Saudis are left to do more heavy lifting to make real and even extend the 10mn bl/d Opec++ global production cut deal struck last month.

Last week, the Texas Railroad Commission, the closest thing the US has to a state oil and gas regulator, dismissed a proposal to codify any reductions producers made for economic or logistical reasons as storage space started to run out and May WTI futures briefly dipped into negative territory.

“There is an attempt… to stabilise prices,” says Ayham Kamel, practice head for the Mena region at Eurasia Group, a UK-based consultancy, of the Saudi production cut. “The geopolitical angle with the US is also key as Trump faces pressure in the oil-producing US states to preserve jobs. In some respects, the Trump administration has not been shy about using its levers of power to serve its interests.”

Bad optics

The unilateral production cuts by the Saudis and their allies in Kuwait and the UAE may not be the last, in the view of several oil analysts. Worse, the cuts come at a time when the size of the Saudi economy is expected to plunge by anywhere between 3pc and 5pc this year and when even its glossiest mega-projects are looking less shiny. Saudi Aramco’s acquisition of its petrochemicals counterpart Sabic may face yet more refinancing and restructuring.

The Saudi government’s austerity measures—including tripling VAT from 5pc to 15pc from July and slashing cost of living allowances for civil servants, ironically introduced in 2018 to sweeten a previous austerity drive—will have practical implications. Dampened consumption and a reduction in the country’s attractiveness to international investors will further slow efforts to wean the domestic economy off its oil dependence.

“In some respects, the Trump administration has not been shy about using its levers of power to serve its interests” Kamel, Eurasia Group

But, more than that, symbolically they feel more like the actions of a loser than a winner. Through that lens, mitigating moves such as handouts of around $260 to the poorest citizens and continued subsidies designed to prop up employment in the private sector serve to make the position of Crown Prince Mohammed bin Salman (MbS) look weaker still. Even his arrests of several high-ranking princes—to whom a description of credible opposition may have been generous—look, in retrospect, like an overly defensive move for a seemingly secure leader.

And with foreign currency reserves dropping by a staggering $27bn in March as oil prices lost over half their value, the challenges facing MbS are mounting. Attempting to balance the budget while keeping the Saudi riyal pegged at 3.75 to the dollar looks ambitious.

As for his Vision 2030 masterplan, just as 2030 quietly replaced the 2020 deadline of a previous initiative, the world’s leading brand consultancies should perhaps begin initial groundwork on a catchy slogan for a transformation by 2040. Advising them to ensure MbS pays upfront may be premature, but the March oil price war currently looks like another to file into the adventurism-gone-wrong folder. 

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