Saudi finances sparked oil production cut decision

Kingdom hoping a small cut will boost prices and revenues

29th September, 2016
Saudi Arabia has highest budget deficit of 20 biggest economies. Pic: Getty

It took Saudi Arabia’s new oil minister, Khalid Al-Falih, just six months to blink, ending the country’s two-year policy of pump-at-will.

The decision taken last night after a meeting of the Organization of Petroleum Exporting Countries in Algiers to cut production was necessitated by Saudi Arabia’s tattered finances. The kingdom has the highest budget deficit among the world’s 20 biggest economies, it’s enduring a delay in its first international bond issue and now faces fresh legal uncertainty as the US Congress voted on Wednesday to allow Americans to sue the country for its involvement in 9/11.

The consequences could be vast. Giants such as Exxon Mobil may soon be flush enough to revive abandoned projects. Finances of cash-strapped OPEC countries like Venezuela will get a boost. Russia and other independent oil-rich countries will have to decide whether to follow Saudi Arabia’s lead.

US shale producers, which OPEC hoped it could push into bankruptcy, will use higher prices to drill new wells, and American consumers, who have enjoyed the lowest petrol prices in more than a decade, will pay more at the pump.

Just months ago, Al-Falih’s predecessor, Ali Al-Naimi, proclaimed that it didn’t matter whether oil prices went “down to $20, $40, $50, $60 a barrel – it is irrelevant.” Al-Falih now says prices, hovering under $50 a barrel, need to rise to encourage long-term investment.

In 2014, when Saudi Arabia led OPEC’s pump-at-will policy, Riyadh calculated that if it reduced output, prices would not rise enough to compensate. This time is different.

“Saudi Arabia is betting that a small cut will pay for itself through higher oil prices and hence higher revenues,” said Jamie Webster, a fellow at the Center on Global Energy Policy at Columbia University in New York.

It’s not as if the previous policy has not had its moments. Saudi Arabia has achieved some of its objectives. Low prices tossed water on the US oil boom, and energy companies have cut as much as $1 trillion in new projects, creating a possible supply hole in the next decade. The kingdom has also scared investors who are now more likely to think twice before plunging money into risky oil ventures. And from the US to China, sales of petrol-guzzling cars have soared, bolstering demand.

For all the justifications, the last two years have not panned out as Riyadh thought they would. At home, the kingdom has burned through more than $150 billion of foreign exchange reserves, government contractors have gone unpaid, and this week the king announced unprecedented pay cuts for civil servants.

Saudi Arabia will suffer a fiscal deficit equal to 13.5 per cent of gross domestic product this year, the International Monetary Fund estimates. When it comes to economic growth, Saudi Arabia is slowing sharply to about 1 percent this year while Iran, its nearby rival, is accelerating toward 4 per cent.

The pump-at-will policy brought chaos to the oil industry as prices plunged from $100 a barrel to a 12-year low of less than $30 a barrel. Companies tightened their belts, cancelled

projects and sold assets. But they kept pumping.

That may continue even as the Saudis advocate a reversal. Producers who fell in love with drilling projects approved during the boom years of plus-$100 a barrel have kept production humming from the Gulf of Mexico to Brazil.

Iran will be exempt from capping production, a major concession by Saudi Arabia. Many of the details remain to be worked out and the group will not decide on targets for each

country until its next meeting at the end of November.

Goldman Sachs said the deal to cut output could add as much as $10 a barrel to oil prices, though it remains sceptical along with other banks on how the accord will be implemented.

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