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4 reasons Saudi Arabia can't control oil
There is one key principle driving Saudi Arabia to sell shares in Aramco, the world’s largest oil producer, and that is the kingdom desperately needs money in the current context of long-term, low oil prices.
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Saudi Arabia is not in dire straits at the moment; it has sufficient reserves to sustain the country for a few years. However, if these reserves do run out, it will be in hazardously deep trouble.
In the past, OPEC—led by Saudi Arabia—would reduce production in order to maintain the oil price. Today, however, the process isn’t that easy, and there are four reasons for that …
Oil above $60 or $70 would mean that US production would continue to increase, and the US is already the world’s #1 producer. OPEC would have no choice but to keep cutting further in order to maintain that price.
OPEC members (other than Saudi Arabia) almost always cheat on their production quotas when they can. Considering that other OPEC nations are desperate for income, the incentive to cheat is all powerful.
The deal and subsequent lifting of sanctions means that an additional one million barrels per day will soon hit the market. As international oil companies vie for the privilege of drilling more oil in Iran, it will put further upward pressure on supply.
Although drilling rig usage in the US is down by nearly 75%, production has just now begun to fall off. It will take some time before enough US production comes off the market to put upward pressure on prices.
What If Oil Doesn’t Bounce Back?
So, what happens to Saudi Arabia’s budget deficit if oil stays in the $30 rather than $50 range? Bank of America Merrill Lynch gives us the following estimates:
Even with a 25% budget cut, Saudi Arabia would have just three to five years of reserves and borrowing available at $30 oil. We note that several respected investment banks are projecting that oil will fall to $20 this year.
If a crisis in Europe or China were to even slightly reduce global demand, $20 oil seems a very real possibility.
A global recession? That would add a perfect storm potential to push oil prices down to levels not seen since the 1970s. Now, we are not predicting this will happen. We’re saying that wise investors must recognize the not insubstantial tail risk of such an event and have their contingency plans already developed.
Bottom line? It is highly conceivable that Saudi Arabia could face immense budgetary pressure before 2020. That was unimaginable just three years ago.
How the Fall of Saudi Arabia Could Lead the World to the Edge of Disaster
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The article was excerpted from the report Saudi Arabia—a Failing Kingdom.
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