What goes up fast must come down fast. That's the law in the world of commodities. So is oil doomed? Oil has climbed by two-thirds in the past year, suggesting a big, ugly downturn is coming.
Don't count on it.
Your first clue that prices are unlikely to plummet comes from Saudi Arabia, whose experiment in free-market economics is officially dead and buried in the sand. In late 2016, the Saudis decided that the gaping holes in their budget – the combined 2016 and 2015 deficits reached $175-billion (U.S.) – were unsustainable. So it persuaded OPEC, where it calls the shots, to trim production – if only slightly.
While the cuts have yet to be fully implemented, or even measured with any accuracy, the OPEC agreement was enough to lift prices by a quarter since the end of November alone. On Friday, Brent crude traded at $57 (U.S.) a barrel; the low, almost exactly a year ago, was $37.
Your second clue comes from the Saudi budget. It's expanding in 2017 after last year's severe contraction, which met with public anger, as all austerity programs do. It seems unlikely the Saudi government would return to big-ticket fiscal policies if it feared an imminent price collapse.
RBC and other banks report that Saudi spending is to rise by 8 per cent this year, to $237-billion, ensuring that a hefty deficit, while smaller than last year's, will remain intact. The shopping list includes 38 new hospitals, two medical cities, several "sports" cities, plus ramped-up outlays on roads, railways, ports and airports.
The biggie is defence spending, which is the costliest item in the Saudi budget and has every chance of rising relentlessly as the government develops a fondness for foreign wars. Saudi Arabia, as RBC noted, overtook Russia in 2015 to become the world's third-largest spender on defence, after the United States and China. Before the Arab Spring, it was the eighth-largest.
The question is whether the oil-price rise – oil revenue is expected to rise by almost 50 per cent this year – is a blessing or a curse for the Saudis and their exceedingly ambitious new plan, known as Vision 2030, to overhaul the economy and end its overwhelming dependence on oil. Saudi Arabia is a one-product wonder. When oil goes into the toilet, so does the economy – the price of a shocking lack of diversity.
We all know that free or cheap money can wreck economic-reform plans. It happened in Alberta, which also turned itself into a one-product, low-value-added wonder during the era of strong oil prices, which ended in 2014. It's happening now in the euro zone, where the European Central Bank's money-printing juggernaut, in the form of €80-billion a month in quantitative easing, has propped up the finances of national governments, removing almost all incentive to make their economies more competitive – or competitive at all. Why bother when the ECB will finance your sinning ways? Thanks to the ECB's generosity, the euro zone has let a good crisis go to waste.
Vision 2030 is under the stewardship of deputy crown prince Mohammed bin Salman Al Saud, who is also Defence Minister and chairman of the Council of Economic Development Affairs. After King Salman bin Abdulaziz Al Saud, he is the most powerful man in the land.
The young prince – he is 31 – faces a formidable task over the next 13 years. The essential goal is to greatly expand the non-oil sector of the economy, which today is negligible. About 90 per cent of the economy is linked in some way to oil and chemical production and exports, and the easy money has financed a welfare state of mind-boggling proportions. About two-thirds of Saudis work in the public sector.
The plan, through reform and education, would create an entrepreneurial class, financed partly by a $2-trillion sovereign wealth fund. Some state companies would be privatized or partly privatized, including Saudi Aramco, the world's biggest oil company, whose potential market value would be three or four times that of Apple (the Aramco initial public offering, perhaps 5 per cent of the company, should happen in 2018 and will be the market event of the year).
The diversification and reform mission is crucial. In 2015, when oil prices were plunging, the International Monetary Fund said that burgeoning Saudi deficits, should they persist, could trigger outright economic collapse by 2020.
Prince Salman's job is all the more difficult because he has to keep Saudi civil society from falling apart while he turns the economy on its ear. In the wake of the Arab Spring, the government, afraid that the revolution would roll into Saudi Arabia, unleashed some $130-billion in social spending. The drug seemed to work.
The point being, the economic reform agenda, if taken seriously, is going to upset millions of Saudis. If the government resorts to its usual formula to buy peace – massive spending – it will require high oil prices. But high oil prices will reduce the incentive for reform. Prince Salman may have the world's toughest economic assignment, one that might extend well beyond 2030. But oil investors probably can bet that his effort will prevent another oil collapse any time soon.
Eric Reguly