Will pump-and-dump strategy come back to bite Saudi Arabia?
In the battle between shale and sheiks, it’s not about who’s winning, but who has the staying power to withstand heavy losses.
Last November, when Brent crude was trading at close to US$100, Saudi Arabia and other influential OPEC members decided against cutting production, which helped collapsed prices to where they are today, at about US$43 per barrel.
The Saudis had hoped their pump-and-dump strategy would flush out high-cost North American oil producers and also hurt rivals Iran and Russia in the bargain. Certainly, OPEC’s move has spread pain liberally across the global energy landscape. In the process, however, the Saudi government has been unable to shield its own economy from the headwinds, despite an ample fiscal cushion.
Compared with other oil exporters, the kingdom has the wherewithal to survive a period of lower prices, says Paul Gamble, senior director at Fitch Ratings, who spent six years in Saudi Arabia as an economist. “But I am sure they are not comfortable with this price level,” Gamble said. Last week, Fitch cut Saudi Arabia’s credit outlook to negative.
The kingdom is certainly running through its reserves quickly, burning as much as US$68 billion, or nine per cent, of its war chest of foreign assets within six months.
“If they want to have some of these reserves as a longer-term savings fund then they would naturally cut down spending, because at the moment they are spending far more than they are receiving in oil revenues,” Gamble said.
Still, the world’s largest oil exporter has US$668 billion in foreign assets, and recently issued bonds worth US$9 billion to plug a looming US$97-billion budget deficit, said to be the largest in its history.
To protect its reserves, the kingdom is also reportedly seeking advice on cutting its budget for next year — a sign that it expects a lower-for-longer oil price environment.
King Salman, who took over after the death of King Abdullah in January, has pursued an assertive — and certainly expensive — foreign policy, launching a war in Yemen, cranking up production even as prices fell and offering a two-month bonus for public sector workers, which dented the budget.
But the bonus-fuelled boost has faded as lower oil prices and China’s recent devaluation rocked Saudi Arabia’s stock market.
Saudi retail investors, who account for 90 per cent of the US$2 billion traded daily on the exchange, have racked up losses of US$50 billion so far in August alone with the market erasing 32 per cent of its value over the past 12 months.
Foreign investors, who have been allowed to invest only since July, cut stakes in roughly a third of the firms on the exchange in recent weeks, according to Argaam, a local data intelligence firm.
The Saudi capital market is seen as a key wealth-distributing instrument for its citizens, and the government has partially floated strong public sector companies at nominal face value for the benefit of retail Saudi investors. These stocks are often heavily backed by public sector entities to ensure they have a strong institutional investor base.
But the market is now hovering in bear territory, leaving many retail investors upset. The decline prompted the authorities to issue a statement that the market plunge was not due to government entities selling shares to raise money following the drop in oil prices. The unprovoked clarification suggests the Saudi government is concerned about citizens connecting its oil policy to their shrinking investment portfolios.
Business confidence is also souring with the purchasing manager’s index declining in four of the first six months of the year. The oil slowdown has already seen public sector construction contracts — a key driver of non-oil activity — decline this year.
“They have taken a more cautious approach to implementing new projects, and our understanding is they haven’t started any large new projects this year,” Gamble said.
The International Monetary Fund expects the country’s real GDP growth to slow to 2.8 per cent this year, and then to 2.4 per cent in 2016 as government spending begins to adjust to the lower oil price environment, compared with the four to five per cent average growth rates of the past decade.
Even the Saudi currency is under pressure. The riyal has been pegged to the U.S. dollar for 30 years, but markets are beginning to question the sustainability of its peg.
Last week one-year dollar/Saudi riyal forwards jumped as high as 305 points, the most since 2003, as traders positioned themselves for a possible riyal depreciation.
While Deutsche Bank believes the riyal can withstand the pressure, “Saudi Arabia is unlikely to be able tolerate the pain from low oil prices indefinitely,” Robert Burgess, chief economist at the German bank, said in a report. “The government’s stock of assets buys time but does not avoid the need for adjustment.”
Some analysts, meanwhile, wonder whether Saudi Arabia’s motivation in seeing oil prices stay down is more politics than economics.
“Why is Saudi doing this?” wrote Neil Beveridge, analyst at Sanford Bernstein Ltd. in a note titled Shale Versus Sheikhs, after speaking to Saudi Aramco officials. “Some believe that Saudi is using low oil prices as a weapon against Iran, which is now a more important geopolitical competitor in the Middle East following the nuclear deal with the U.S. Others believe that Saudi is running out of time.”
Others are unconvinced the Saudis will cede ground first.
“The economy is not doing great, private sector confidence has been affected and stock market has been hit,” Bassam Fattouh, director of the Oxford Institute for Energy Studies. “But would that basically result in a change in its oil policy? I don’t think so. We have not reached that tipping point, at least not yet.”