Saudi Arabia’s Crown Prince Mohammed bin Salman is learning the hard way that barrels of oil with nowhere to go are worth approximately zero. Saudi barrels aren’t worth nothing – yet – but they’re getting close.
On Tuesday, the day after U.S. oil prices actually went negative, Brent crude, the international benchmark, fell 25 per cent to US$19 a barrel. A year ago, it was trading at US$70.
In early March, MBS, as the crown prince is known, apparently thought he had figured it all out. He wanted OPEC, which is led by Saudi Arabia, and Russia, an OPEC ally, to cut production to support prices, which were sagging as the novel coronavirus was bursting out of China. Russia said nyet.
MBS didn’t take Russia’s refusal to play well. He broke Saudi Arabia’s alliance with Russia and vowed to open Saudi Aramco’s spigots, flooding the world with oil. For him, it would be a nice little twofer: Punish Russia and punish the shale-oil industry, whose burgeoning output had transformed the United States into the world’s biggest oil producer and one of its biggest oil exporters.
What could go wrong?
A week later, on March 11, Saudi Arabia signalled that it would dump another 2.3 million barrels a day onto the global market, taking the country’s total output to 12.3 million barrels. Energy analysts were astonished. Olivier Jakob, a former oil trader who is now the managing director of Swiss oil consultancy Petromatrix, called the move highly aggressive, “forcing as much crude as possible in a market that does not want it.”
Indeed. By mid-March, oil was falling fast, and MBS apparently realized that his timing was rather off. So he did a U-turn and convinced OPEC and its allies to cut production by almost 10 million barrels a day. But the cuts would take months to implement, and by then, it would be too late anyway. The COVID-19 crisis had shut down economies around the world. Unsold oil was filling storage tanks and parked supertankers to the brim.
This week, the dire situation reached the point where the cost of storing American oil was higher than the price of oil itself. That’s when prices turned deeply negative. (On Tuesday, West Texas Intermediate rebounded to US$6 a barrel – a price that would still destroy the shale industry within months.)
MBS seems to have lost more than he has gained. Yes, the U.S. shale industry – the business that had the audacity to challenge Saudi Arabia’s dominance of the market – is in deep trouble. U.S. oil-company bankruptcies have started and will continue.
But the Saudi economy is also taking punishing blows. The prospect of oil going back to US$70, even US$50, this year appears slim, as big economies make only tentative steps to dismantle their quarantines. Demand could stay unusually low until a COVID-19 vaccine is developed, which may not happen until sometime next year. Italy gives you a sense of the demand destruction. Figures released Tuesday reveal that March oil sales were 34-per-cent lower than a year ago. Gasoline sales were down 52 per cent, and diesel was down 41 per cent. April’s consumption figures will be even lower, because the Italian quarantine did not start until March 9.
Saudi Arabia is not facing financial and economic catastrophe, as Italy is. The kingdom has ample foreign currency reserves and a low public debt – its debt-to-GDP ratio is 24 per cent (Italy’s is 135 per cent and rising). Saudi Aramco, the world’s biggest company, has the lowest pumping costs of any oil producer and can endure US$20 oil for some time, though the price could keep falling.
That’s pretty much where the good news ends, because Saudi Arabia itself is a high-cost operation. The extended royal family has some 15,000 members, and a lot of them like their yachts and Ferraris. The country is an undiversified welfare state with a small entrepreneurial class. The upshot is that the government needs oil at about US$80 to balance its budget.
Already, there are signs of stress in the kingdom. Fitch Ratings has placed the top 10 Saudi banks on “rating watch negative.” It did so after oil prices plunged in mid-March (the high rating of the country itself was left stable). The budget deficit is widening fast. The Finance Minister in late March said he expects the deficit to reach 7 per cent to 9 per cent of GDP. But that was when Brent crude was still hovering around US$30. The price has fallen by a third since then, suggesting the deficit could be much higher.
MBS knows that he has to wean Saudi Arabia off its oil dependence. In 2016, he unveiled his Vision 2030 plan to modernize and diversify the economy. The plan would recruit women into the work force, create tech and logistical centres, build new cities along the Red Sea, open the country up to tourism and develop a manufacturing base. But turning the vision into reality would require fortunes; those fortunes would, by definition, have to come from oil production.
Vision 2030 is looking ambitious within the next decade as oil falls out of favour and Saudi Arabia’s financial health deteriorates. The pandemic, of course, propelled prices down at an alarming rate. But MBS’s decision to go to war against Russian and American oil producers last month was badly timed, spectacularly so. Vision 2040 anyone?
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Eric Reguly