Controlling almost 20% of global oil reserves, Saudi Arabia has a unique ability to control the market’s supply, something it has shown willingness to do in the past to stabilize prices. The recent crisis, however, has brought about a previously unknown version of Saudi Arabia, one unwilling to reduce supply to balance a massively over-supplied market.
This week, oil continued its 70% tumble over the past 18 months, ending under $35 a barrel. Still, Saudi Arabia refused to cut supply at the previous OPEC meeting, believing it has the money and the patience to take market share by outlasting every other global supplier.
Many have discussed the numerous factors that would logically cause Saudi Arabia to cut supply sooner than it wishes, including a crumbling fiscal situation, both politically and budgetary. However, analysts may be surprised by how long the country will be willing to pump out supply.
Last week, we wrote that “while economics and fiscal analysis may indicate that Saudi Arabia will start to act more rationally regarding supply, don’t be surprised if they keep prices low, crippling Iran’s economic benefit from repealed sanctions.” Since then, there have been a few key news items that add to this thesis.
First, a bit of history. Following Ayatollah Khomeini’s revolution in 1979, oil-rich rulers across the Middle East spread weapons and cash throughout the region, seeking to become the dominant influencer. This event is still one of the key contributors to unrest today, as Saudi Arabia and Iran were two of the biggest entitles vying for power over the area. Today, the two oil-rich theocracies, one Shiite and one Sunni, are vying for regional dominance yet again.
With sanctions set to be lifted, Iran is ready to receive hundreds of millions in additional revenues to fund whatever they please. According to a recent note from Oppoenhiemer’s James Schumm: “Though low oil prices hurt Saudi Arabia, they negatively impact Iran in a much greater way and it crimps Iran's ability to fund sectarian uprisings in Saudi Arabia's backyard.”
To maintain power and prevent an Arab uprising at home, Saudi royalty must keep the country’s powerful extremist Sunni clerical establishment on its side. Keeping oil prices low helps limit Iran’s benefits from repealed sanctions, as increased oil exports will be considerably less valuable. This wins big points at home, while also ensuring Saudi Arabia’s dominant position as chief regional influencer.
Last week, Saudi Arabia’s foreign minister revealed that it may take further steps against Iran, stating that they “are looking at additional measures to be taken if it [Iran] continues with its current policies.” It also cut off diplomatic relations with Iran, giving their diplomats 48 hours to leave the country.
More important than a few years of oil income is maintaining domestic social order and regional power. Many analysts point to Saudi Arabia’s massive budget as proof that it can’t continue its current policy for long. At last check, the country needed at least $100 oil to balance its budget. This thesis, however, may be misguided.
In reality, there is no reason to believe that Saudi Arabia is unwilling to withstand years of budget deficits. After piling up reserves during oil last bull run, the country has amassed foreign reserves equal to its GDP. To plug the budget gap last year, it spent roughly 20% of those reserves, indicating that it has roughly four years left before trouble even begins to brew. Even then, the country still has 2.6 million barrels a day of spare oil production capacity to fire up.
Plus, we have hard historical evidence proving that Saudi Arabia is willing to run deficits for years. After building up reserves during the oil bull market of the 1970s, it posted deficits every year from 1983 to 1998 until things stabilized. Once they did, Saudi Arabia reverted to budget surpluses for the next 15 years.
When dealing with issues as important as regional and domestic stability, don’t be surprised to see history repeat itself.
