Oil prices are high again. However, there's not much to cheer about for Saudi Arabia.

STEVE AUSTIN | 2018/11/01

For a nation, what's a year? Well, in the timing of the bigger picture, not much. Still, a year can cast its shadows long and fast. Essentially, as I was analyzing the ebb and flow of oil prices the past year, I couldn't but reflect on the changes a year can make.

A year ago, Saudi Arabia was making the news for its intense, and seemingly earnest, efforts to drag the Kingdom into the present era by allowing women to drive, creating jobs and making giant strides to diversify its economy by luring investors and planning to file state owned Saudi Aramco's IPO, the largest ever in the world. Oil prices were low, and this impediment helped portray Saudi Arabia as vulnerable, struggling yet willing to change, almost likeable.

Today that oil prices are high again, the pell-mell is back as we meet the unyielding Saudi Arabia of old- again. Let's go into the details:

Saudi Arabia and its war on fracking

Saudi Arabia enjoyed an envious position in the oil market for decades. It could, in no time, add more than ten million barrels per day of oil to global supplies. Though part of OPEC, the Saudis have always dictated oil prices at will. In fact, Saudi Arabia was one nation that had the capability to set the oil price on fire and escape the consequences of incendiarism. So far, so good. Along came renewed fracking in the US, thanks to the development of new technologies. With fracking, there emerged a serious contender for top producer crown on the horizon. That said, the cost of oil production in Saudi Arabia is relatively low unlike the expensive fracking process employed in the US. Notwithstanding, Saudi Arabia looked at the emerging oil scene with alarming distrust. Soon, the Saudis came up with a brilliant plan.

To undermine the US shale oil industry, the Saudis oversupplied the market with oil. That simple? Unfortunately, yes. Supply and demand far outweigh other factors in determining the oil prices. It's not imperative that there's war, strife, hurricanes, earthquakes or infrastructure woes in actuality. Even unjustified speculation on some of these can send shivers of panic among investors who then fear for the imaginary supply crunch. In reality, Saudi Arabia knew that the USA posed a greater threat as new technologies was making oil exploration viable in places historically known for inaccessibility. Effectively, more supply meant low demand and thus lesser price for Saudi Crude.

Now, the kingdom, far from a being passive spectator, saturated the market with oil. More than anticipated, the feat was easily achieved with 10.6 million barrels a day of oil in November 2015. OPEC at the behest of Saudi Arabia decided to leave output unchanged at 30 million barrels per day.

Of course, oil prices corrected and Saudi Arabia chose not to cut production even when the oil prices fell to $37 a barrel in December 2015. As we know, the oversupply was to torpedo the US shale producers who were shooting at 9.42 million barrels per day. For a minute don't think that they were dancing with happiness at the low oil prices. Saudi Arabia consciously chose public spending cuts and the misery brought on by low oil prices. Never an easy thing to do as the Kingdom was relying on oil prices for over seventy percent of its revenue. Anything to choke the US oil producers, you see. After all, fracking is an expensive process that feeds on high oil prices- oil prices have to be at $40-60 for viable shale oil production. Significantly, Saudi Arabia decided to endure a short term loss with clear sight on the long term goals. By 2016, the results were in as many projects were shelved, investments deferred, workers laid-off and many oil producers in the US going bankrupt.

Fall-out of the battle against US oil producers

The Saudis, however, severely underestimated the downfall of their master plan. In a tale of twisted results, the fall in oil price was steeper and longer than what Saudi Arabia envisioned. If you are interested, Saudi Arabia received a mighty telling off as its cash reserves depleted rapidly resulting in an expansion of budget deficit because of low oil prices (and the proxy war in Yemen). As the dry spell continued, Saudi Arabia, the IMF warned that Saudi Arabia could become bankrupt by 2020 due to persistent glut in the oil market. As the Saudi Public Investment fund (PIF) was hemorrhaging cash with low oil prices, the Kingdom briskly moved money offshore in more "productive" economies. As the woes continued, a new sovereign wealth fund was also proposed. Some of the ministries were merged, while few like electricity and water shelved in a wide drive to reform the government.

Aramco IPO

In a root canal procedure on a nation, along with plans of austerity, modernization, subsidy cuts, jobs for youngsters and more taxes, Saudi Arabia also announced initial public offering of state-owned Saudi Aramco to fund the PIF and diversify the kingdom's economy as part of Vision 2030. Pegged as the largest ever, energy giant Aramco was expected to attract handsome money in valuation when listed on stock exchanges. Banks, investors and exchanges were vying with one another for a pie of Aramco whenever it arrived at the market. Not for nothing as Aramco produces ten percent of the world's oil making it the most profitable company in the world. Last year, recession gripped the nation with a budget deficit of $79 billion. With a profit of 433.8 billion, the company effectively is the nation's "trust-fund".

A year later, let's see where we are.

First, Saudi Arabia has halted the IPO of Aramco scheduled for next year. As part of vision 2030, selling 5% of the stake was expected to raise a whopping $100 billion. Of course, this IPO has been the plot of speculation for some time with the timeline changing every year since 2016. The latest, according to the crown Prince, is that the IPO is scheduled for 2021. Because public offerings require account transparency and the 15,000 Saudi Princes have been hitting Aramco like a proverbial piggy bank with no records. So much so that so far, the Saudis haven't found an exchange shaddy enough to underwrite their IPO. It goes to show how cooked the books must be. I mean, even if publicly listed, there's no guarantee that the royal family won't park the high taxes into their own pockets. Initially, it was said that the shares of Aramco will be transferred to a sovereign wealth fund after the IPO. However, as per recent reports, the Saudi government will keep the shares.

Anyway, why is the nation vacillating on the IPO? In a so called 'corruption purge', 381 of its "progressive" wealthy citizens accused of corruption were kidnapped and then held for ransom. The government is said to have seized as much as seventy per cent of some of the suspect's wealth. Amidst accusations of torture, the Kingdom, nevertheless, seized 400 billion this way and cleansed the political sphere of any "progressists". The official line has been the assertion that the crackdown will boost investment climate. In fact, what would have really boosted investor confidence is the IPO of Aramco. But instead, what occupies the headlines is the recent and widely publicized murder of Saudi journalist Jamal Khashoggi at the hands of the Saudi regime in Turkey. What's more, the Saudi Royals ineptitude at handling this disastrous PR fallout has prompted key foreign investors to hastily rapatriate billions in Saudi investments - who would blame them, one cannot buy a reputation. That's got to put a damper on the IPO and I hear crickets. Anyone listening?

Diversification, in reality

Another project that's been dismissed is a $200 billion, 200-gigawatt solar project. Scheduled for completion in 2030, the network of plants was to be developed by Japanese SoftBank and Saudi Investment Fund as the world's largest solar power plant. Much of the electricity produced in Saudi Arabia comes via courtesy of natural oil and gas. This solar project would have allowed the Kingdom to diversify away from petroleum and provided jobs for the population. As we all know, the nation has enough land and plenty of sunshine to tap into. And solar is a good source of renewable energy, to boot.

In spite of the much hyped diversification efforts, on ground, we see clear patterns emerging to dismantle the branching. Instead of putting the eggs in different baskets as announced a year ago, right now the eggs are all going into a single basket. Saudi Arabia is all set to invest in a new oil refinery in India. State owned Saudi Aramco has signed a deal with some Indian refiners to construct a $44 billion refinery and petrochemical project in the Indian state of Maharashtra. Diversification? What diversification?

Oil prices at $100

Oil prices are headed to $100 and Saudi Arabia which dictated global oil prices for long will be incapable of preventing a supply choke even if it tries. Talk about irony.

As we previsoulsy covered, the US reimposed sanctions on Iran after withdrawing from the Iran nuclear agreement in May. As Iranian oil stops flowing into the market, $100 a barrel by year-end will be no surprise. No buyers for Iranian oil? It was tacitly understood that China will continue buying Iranian oil, come what may. However, China is slowly towing the US line. Iran is OPEC's third largest producer and China's biggest crude oil refiner has already slashed Iranian crude in September by half. The only major economy left is India, which is heavily dependent on Iranian oil. Still, we are losing about 1.5 million bpd of Iranian oil and shouldn't Saudi Arabia able to fill the gap with ease? After all Saudi Arabia can add 12 million bpd from its spare capacity. In the recent OPEC+ meeting, Russia and Saudi Arabia assured the world that there was enough oil to offset any supply crunch.

Remember, Saudi Arabia adding to the supply glut not so long ago. So, do the math. The US wants Saudi Arabia to add 2 million bpd but Saudi Arabia will add only about 550,000 more bpd to offset the lost Iranian supply, to answer the question. Well, the decision, when it hit the news, hardly influenced the oil prices. See, times have changed.

Till last year, Saudi Arabia was considered the swing producer that could control the supply of oil. One or two billion bpd would have been a non-issue for the Saudis. Not anymore. In some ways, this is not good news for oil prices this year. In the long run, though, this development is a welcome step.

Per se, the loss of Iranian oil isn't pushing oil prices. What's doing the shenanigans is panic among investors. Everyone knows the undulating decisions of the present Saudi regime. The 'now on' 'now off' decisions make Saudi Arabia a shadow of its previous mighty self. Right now, Saudi Arabia is contributing to the panic in the market. Also, the Saudi wants the oil at $80 a barrel and are wary of another supply glut. The threat of Shale oil regaining market share isn't a priority for the Kingdom anymore. That is a lesson learnt as far as they are concerned.

Looking at the oil forecast, JP Morgan has increased the 2018 Brent crude forecast by $5 per barrel than the previous announcement. Trafigura puts the oil per barrel at $100 by the end of the year. On the back of Iranian sanction, Bank of America Merrill Lynch raised the price range from $90 a barrel by the end of the second quarter of 2019 to $120 a barrel by this November itself. But first and foremost, oil-price.net estimates $100 a barrel by 2019 is in the cards.

If there's any production hiccups from other oil producers, the oil prices will escalate. For now, the only thing that can claw back the running oil prices is a demand slump. Do you see that happening?

Upheavals in the Saudi royal family

The Saudi crown prince, second in line to the throne, is the architect behind Saudi efforts to diversify the economy in areas other than oil. Considered to be a modern reformer with a liberal stance, Prince Salman's 'Vision 2030' has run into a thickset of troubles. As seen earlier, his ambition of selling five percent stake of Arambco is almost cancelled, many of the diversification projects shelved and the Kingdom is evermore dependent on oil.

Indeed, the conservative and religious elements in the nation are out publicly blaming Prince Salman for the present state of affairs. Internationally, the prince is facing criticism for his war on Yemen and the blockade of Qatar. Not stopping there, Prince Salman seems to have lost favor with his father, who is the present Saudi King. On the Israel-Palestine issue, the prince supports Israel while the King is on the Palestinian side.

Well, it was never going to be easy. Reform in a deeply conservative country filled with Wahhabi clergy and a deep-set patriarchal mindset is a sure way to attract censure and opposition. Sooner than later, those rigid extremist elements were going to push back. Prince Salman wanted dramatic changes even in the social order at home. In a nation where citizens pay no income taxes and are handed fat subsidies at the drop of a hat, why would anyone welcome the tilt in power balance? Not even the King, who could well remove the prince for his vision to free Saudi Arabia from dependence on oil and bringing in a 21st century outlook. In the event of the King passing away, there are many extremist elements, religious and social, waiting to lock back the nation into the conservative bag. The opposition Prince Salman is facing is massive, both internally and externally. Any criticism of the royal family can lead to jail sentences, fines and punishments in Saudi Arabia. In spite, the opposition to Prince Salman has been increasingly vocal. With his life in danger, Prince Salman spends most of his time inside his half a billion dollar yacht in Jeddah as if signaling the end of reforms.

So, will the social reforms work? To put it bluntly, diversification and reforms would require Saudi citizens to create wealth with their own merit and competence, even women to work, a notion that does not resonate with conservative Muslims, who consider hard line rhetoric to be the identity of Saudi Arabia, the alleged birthplace of Islam.

Conclusion

Unlike even the near past, Saudi Arabia, OPEC or Russia can no longer sway the global oil market to their tune. In fact, minor ripples are all they can manage, should they try. We have to thank US shale oil for dishing out this new equation. Unlike the OPEC, strictly weighed down by quotas, US oil producers can dictate their production.

This new order is a significant step for oil prices as no one wants high oil prices except the oil producers. We know that oil prices play an important role in elections. Usually high oil prices correlate to electorate un-happiness, higher volatility and vote swings. That is for western democratic society. Although sharing few societal and political values with the democratic societies, Saudi Arabia's politics is significantly affected by gyrations in oil prices, as proved in this article. Periods of low oil prices cause a sentiment of malaise, helplessness and weakness. Low oil prices prompt Saudis to look for creative ways to come through outside of 7th century religious stifling outlook. The systemic efforts announced would have triggered a new social order in Saudi Arabia for the first time in centuries. By contrast, high oil prices bolster conservative hardliners and strengthen the conviction that their unyielding ways are working.