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The oil price war backfires on Saudi

The oil kingdom is set to borrow heavily from the bond market as low oil prices force the government to raid its reserves… Will Saudi go broke?

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Here’s a headline we didn’t see coming: “Saudi Arabia is not as rich as you thought.”

But after draining $65bn from fiscal reserves (the consequence of the now infamous November meeting in Vienna) the country is being forced to return to the bond market and hopes to raise $27bn by the end of this year. Even though out of all the OPEC countries Saudi Arabia has a vast amount of foreign exchange and is able to produce the cheapest oil in the world, the fall in oil prices by more than half since last year is finally having an impact.

With contract prices of US crude oil for delivery in December 2020 estimated at $62.05 the long-term future for the Middle East is not what they would have pictured sitting around the table as Ali al-Naimi spoke of combatting US shale drillers. Then the depressed price strategy was a sharp short hit. Now, nine months later are the OPEC members wondering if they got it right?

It’s estimated Saudi Arabia’s foreign bank accounts once held $737bn but it has been forced to spend huge amounts on its social programmes which were promised following the tumult of the Arab Spring four years ago. It’s intervened in the conflict in Yemen and been involved in airstrikes against ISIS in Syria. Public sector workers were given huge bonuses by King Salman when he took the throne – a popular gesture but one that stretched the kingdom’s finances even further.

Saudi needs around $105 per barrel to balance budgets. It’s around $60 short right now.

Bank of America says OPEC is now “effectively dissolved” and The Guardian says (tongue firmly in cheek) that “the cartel might as well shut down its offices in Vienna to save money.”

Despite that, the government shows no signs of changing course. Last month for the first time since 2007 Riyadh issued its first $4bn in local bonds, according to the governor of the Monetary Agency. Analysts estimate that the deficit will reach SR 400bn by the end of 2015.

The Financial Times highlights a commonality with what happened in the 1990s, when Riyadh issued local banking debt via government development bonds. “At one point Saudi debt reached 100% of GDP. It was only when oil prices began their sharp ascent in the early 200s that debt levels began to come down.”

Ali al-Naimi predicted this. In December he admitted that the kingdom would lose money. He told MEES that “A deficit will occur. But..we have no debt. We can go to the banks. They are full. We can go and borrow money and keep our reserves. Or we can use some of our reserves.”

But how long can they keep it up? And how much will they sacrifice? According to consultants Wood Mackenzie the cancellation of 46 large projects by oil and gas companies has resulted in $200bn deferred investments. The oil price crash has many casualties – high-cost projects in the Russian Artic, the Mexican Gulf, Canada’s tar sands and the Atlantic’s deep waters.

OPEC gambled, intent on pushing US shale drillers out. But that industry has proved more resilient than predicted. Advancements in technology are leading to reduced costs. Experts at IHS think shale companies will cut 45% of costs by this year. Now there’s a thought to bring a chill to Saudi, even in the middle of the summer.