Oil war: Is Saudi Arabia walking into its own trap?

While Saudi Arabia is busy pursuing a covert alliance with Israel, the “oil war” it’s started with other producers, including the US, is already impacting the kingdom and the rest of the world. What Riyadh’s doing on the oil front will create more repercussions as the “war” drags on into next year — most of them economically bad for Saudi Arabia.

The Saudis are certainly not happy with the US due to the Iran-nuke deal. This is adding to their eagerness to ensure that US shale oil companies go bankrupt. However, Saudi policy seems to be falling short of  its “grand” objectives.

The scenario that appears to be developing goes something like this: Production of shale oil is on the rise in the US, and with the US maintaining current levels of production, the Americans would be in a position to further cut its dependence on Saudi oil imports and other OPEC countries. Hence, the US will definitely be able to follow a more relaxed financial policy, and much more relaxed foreign policy, especially with regards to the Middle East.

As a matter of fact, according to the data provided by the US Energy Information Department (EIA), US oil imports from OPEC have already fallen to a 28 year low. The US is pumping more oil and relying less on OPEC imports than at any time since 1987.

While the US imported 45.62 million barrels of oil every month from Saudi Arabia in 2005, the figure dropped to as low as 25.42 million in January 2015. In June 2015, the import figure went slightly high again, reaching 32.32 million barrels of oil per month. The overall trend for oil imports is certainly showing a heavy decline, thanks to the extra pumping of crude oil as well as increased production of shale oil.

The US’ overall production jumped by 1.2 million barrels per day in 2014, to 8.7 million barrels per day. This has been called the biggest expansion in the US oil production since record-keeping began in 1900. Even after oil prices fell by more than 50% last year, the U.S. boom continued. Production will increase 8.1% this year and 1.5% next year, according to the EIA.

bear-trapWith OPEC not ready to cut production and with low oil prices not affecting the US economy as much Saudi Arabia’s, it seems that the Saudis are walking straight into the very trap they set for the non-OPEC oil countries, including US shale oil companies.

There’s no way the Saudis could have directly manipulated production of oil in the US. The only way they could make an impact was to increase production and knock oil prices further down. With the Saudis depending on 90% of their budget collections on revenue collected from oil production sector, low prices were eventually going to hurt them.

Notwithstanding that the cost of Saudi Arabia’s oil production is the lowest and that oil shipments are much more convenient because of close proximity of seaports to oil wells, the low prices have already started to blowback on them.

With oil prices continuously falling, Saudi Arabia’s national budget is certainly going to suffer because of a high reduction in the annual revenue earned. For instance, the kingdom earned almost 1.05 trillion riyals in 2014. The 2014 budget was prepared based on an estimated oil price of $103 per barrel. However, the 2015 budget was based on an oil price estimated at $80 per barrel. Hence, the total revenue earned in 2014-2015 stood at 715 billion riyals. With this fall in revenue earned, Saudi Arabia’s budget deficit may rise this year to 20% of GDP, or $140 billion. Highly reduced oil revenues have already forced the Saudi authorities to issue two series of government bonds in a row this summer.

The Saudis were forced to tighten down to make up for the reserves they had used to the tune of $65 billion. These two series of bonds would help the Saudis earn $27 billion by year’s. But this is far from adequately recovering their monetary loses.

With global oil production set to increase following the lifting of sanctions against Iran, oil prices are expected to fall by another 21% from their current level next year, according to World Bank. With Saudi Arabia set on pursuing its key strategy and unwilling to reduce its spending, especially on defense, it seems that its foreign exchange reserves will soon run out. This would cause Riyadh to fall a victim to the trap it was trying to for its two main rivals: Iran and US shale-oil producers.

According to Saudi Minister of Petroleum and Mineral Resources Ali al-Naimi, lower oil prices in the short term will lead to higher prices in the long term because of reduced investments in the sector. He was speaking about the US. The kingdom’s officials also have been expressing confidence that the country’s substantial foreign exchange reserves would help counter the effects of falling oil prices. Keeping prices low for an extended period  seemed to be a good idea at one point, on the expectation that producers of more costly oil would be squeezed from the market. Production was expected to shrink and prices to recover.

However, instead of driving producers of expensive oil from the market and feasting on a recovery in oil prices, the expected addition of Iranian oil to the market will knock prices down further. This is will create a “between the devil and deep sea” situation for the Saudis. Their economic situation will deteriorate further as a result.

Due to Saudi Arabia’s direct and indirect involvement in various wars across the Middle East and beyond (funding right wing religious parties in Pakistan, for instance), it’s defense spending is also reaching an all-time high. Saudi Arabia is now the world’s largest importer of defense equipment. Its spending is expected to reach$9.8 billion in 2015.

The Saudis are also keen on maintaining their expenditures in other sectors outside of defense areas. Despite the catastrophic decrease in oil revenues, they will not cut government spending on domestic sectors and will continue to subsidize health care and education. If the trend continues (which all indications suggest) the Saudis will soon see their $672 billion in foreign reserves begin to evaporate.

To recapitulate, this is due to Saudi Arabia’s miscall about how non-OPEC oil producers would react to low oil prices. With the contract price of the US crude oil for delivery in 2020 still set at almost $62 per barrel, OEPC countries face hard times ahead. If nothing else, it certainly implies a drastic change in the economic landscape of the Mideast petro-states.

According to a recent claim in a Bank of America report, OPEC is now “effectively dissolved.” The fear of the  “oil war”  backfiring was also clearly stated by a recent Saudi central bank stability report. It said: “It is becoming apparent that non-OPEC producers are not as responsive to low oil prices as had been thought, at least in the short-run.” It added: “The main impact has been to cut back on developmental drilling of new oil wells, rather than slowing the flow of oil from existing wells. This requires more patience.”  It’s not clear what the Saudis can do to make “patience” a worthwhile policy option.

The one thing the Saudis also can’t do at the moment is reduce their own oil production. If they cut production, shale oil producers from the US will replace them, dealing them a huge loss. A further loss to the Saudi economy will also have serious repercussions for Saudi adventurism in the Mideast and beyond.

With time running out, the Saudis, are running out of options. The question is how long can they continue to play the “oil game?”

Salman Rafi Sheikh is a freelance journalist and research analyst of international relations and Pakistan affairs. His area of interest is South and West Asian politics, the foreign policies of major powers, and Pakistani politics. He can be reached at salmansheikh.ss11.sr@gmail.com

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