The Saudis are on track to sacrifice some $100 billion in crude export revenues in 2015, or roughly 45% of last year's $219 billion in crude export revenues, in pursuit of market share, the measure of success Saudi Oil Minister Ali bin Ibrahim al-Naimi announced at the November 27, 2014, OPEC meeting.
What do the Saudis plan as their encore in 2016? Will they continue pursuing market share over other goals (e.g., total revenue, economic diversification, OPEC conciliation), or will they alter course, and if so, is there a superior alternative? Dalan McEndree wrote for OilPrice.
Publicly, Saudi officials appear unwavering in support of market share. The crude oil futures markets and many pundits reflect this official line. Saudi economic fundamentals, IEA projections through 2020 for the oil market and the currency markets, pressuring the riyal-dollar peg, suggest the pursuit of market share is at best a chimera, at worst necrotizing fasciitis for Saudi Arabia.
The Saudi economy can lose revenue equal to 13 to 14% of GDP (around $100 billion of $752 billion 2014 GDP) and continue to grow. The April 2015 IMF GDP projections in current national currency show a 14.8-percentage point drop in 2015 GDP—roughly equal to 13-14% revenue loss—with the downturn in GDP continuing until 2017.
The April and October 2014 forecasts, which preceded the Saudi decision to pursue market share and reflect $100+ crude prices, show growth.
The EIA estimates Brent prices will average $54.40 and $59.42 in 2015 and 2016 respectively, and the agency is likely to reduce its estimate as Brent as of September 9 was $50.63 and CME Brent crude futures currently show prices staying below $56 in 2016.
Eating Away Reserves
In addition, the Saudi government’s capability to compensate for the crude oil export revenue loss will diminish.
It is on track to use $100 billion of its currency reserves to maintain 2015 government spending, $229 billion, at 2014 levels (the quarterly run rate is around $25 billion).
Since Saudi currency reserves, unlike the UAE’s and Kuwait’s sovereign wealth funds, do not generate a meaningful return, they will steadily deplete without inflows from budget surpluses and current account surpluses (both turning negative this year).
The currency markets sense the squeeze. Against the backdrop of low crude prices, pressure on the Saudi economy and currency depreciation in many emerging markets, the Chinese August 11 decision to devalue the yuan led to a sharp spike in bets against the riyal-dollar peg in futures markets.
Toxic Global Crude Market
Absent a change in course by major oil exporting countries, individually or collectively, the pressure on crude oil prices will be intense and unremitting.
The Saudis and their fellow OPEC members will be forced to compete ferociously against each other and against non-OPEC crude exporters, including Russia, Canada, Brazil and Mexico.
As the IEA’s Medium-Term Market Report 2015 for oil states:
“With oil down more than 50% from its June peak, OPEC’s battle for market share may only just be starting. OPEC, along with rival producers outside the group, has been targeting energy-hungry Asia … Through its monthly formula prices, Saudi Arabia has sought to price its oil ever more competitively, leading other Middle East producers to follow suit.”
The current market turmoil has created a once in a generation opportunity for savvy energy investors.
Saudi Alternatives
In response to the perceived growing threat to their market share, the Saudis could have pursued (at least) four strategies.
First, they could have reprised their traditional role as swing producer and reduced output to accommodate the major sources of growing output (the US, Canada, Iraq and Iran).
Second, they could have maintained their 2014 crude export volumes (6.56 mmbbl/day) and let their share of global exports decrease over time.
Third, they could have maintained their export market share against various benchmarks (e.g. global output or global net export estimates).
Fourth, they could have sought aggressively to expand their share of the export market.
The uncertainty of demand, supply and prices, given uncertainty over potential policy changes, threats to production, global economic growth rates, the impact of changes in output and demand on prices, mean the scenarios should be considered with several grains of salt.
Diversifying the Saudi economy away from dependence on crude output and exports, as reflected in Saudi economic plans, has been and continues to be a priority of Saudi economic policy.
The current Saudi approach seems to undercut this priority in at least two ways: It reduces the volume of funds available to finance diversification, without substantial borrowing, and thereby, in the long run, increases Saudi dependence on crude oil exports.
Presumably, the Saudis are evaluating the impact of their change in policy (and its actual implementation) on this and other economic priorities and will decide how to proceed.
The evaluation will not necessarily be straightforward. Each potential strategy has advantages and disadvantages, risks and rewards.
the Saudis rightly fear that sacrificing output in the medium-term, for higher revenues now, might lead to long term reduction in output and therefore ultimately to lower total revenues.
On the other hand, suffering substantial revenue losses through 2020 might be worth the severe damage to the Saudi economy if, and it is a big if, currency reserves and borrowing could replace the lost revenue and fund major economic priorities.
Of course, the negative impact of any strategy could be mitigated through a binding agreement on production cuts with OPEC members and other major national oil producers.
