Budget pressure likely to keep Saudis propping up oil price

Pressure on Saudi Arabia’s finances will make it eager to secure a deal on oil output cuts at this week’s talks among global producers, even if Riyadh has to shoulder the lion’s share of the reductions.

A rapid decline in the government’s huge budget deficit is unlikely to continue in coming months, particularly since Riyadh may have to spend more to support sluggish economic growth.

Saudi economic reformers, meanwhile, have staked much of their credibility on a successful initial public offering (IPO) next year by national oil giant Saudi Aramco, which they have predicted will achieve a valuation of at least $2 trillion.

The result, oil analysts and economists say, is that Saudi Arabia will go into the meeting of OPEC and non-OPEC producers in Vienna on May 25 determined to maximise its oil revenue through high prices, even if it must make large production cuts in return.

“The fiscal situation is going to remain challenging, especially in the context of an economy that has slowed,” said Monica Malik, chief economist at Abu Dhabi Commercial Bank.

“The government is going to have to pick up spending to support growth and diversify the economy, and for this it needs high revenues. They need to see oil prices at the very least at current levels.”

With benchmark Brent crude at $51 a barrel, Saudi energy minister Khalid al-Falih has said he wants current output cuts to be extended by nine months to next March.

Riyadh has already cut production by more than it agreed in that deal. Its cuts in April equated to 118 per cent of its quota.

Sources told Reuters that an OPEC panel was considering the idea of not only extending but also deepening the cuts beyond the 1.8 million barrels per day (bpd) specified in the original agreement.

RELUCTANT BORROWER

Thomas Streater, head of research at MB Commodities Capital in Dubai, said the possibility of the Saudis accepting deeper cuts could not be ruled out because a 1.8 million bpd reduction would only achieve a modest drawdown in global inventories.

Since last year Riyadh has averted financial crisis partly by borrowing abroad. Foreign investors are happy to lend it tens of billions of dollars, but that does not mean the government, which came close to eradicating its debt three years ago, is happy with the process.

“They will want higher oil prices to increase their revenues and not be dependent on borrowing, Streater said.”

Saudi Arabia’s budget deficit shrank 71 per cent from a year ago to a smaller than expected SAR26bn ($6.9bn) in the first quarter of this year, mainly because of oil revenue that jumped to SAR112bn from SAR52bn.

But the first quarter of 2016 saw the oil price’s trough, with Brent dropping as low as $27. By the second quarter, oil was hovering around $45. Any future improvement in the deficit, therefore, is likely to be less dramatic.

Growth in Saudi Arabia’s non-oil economy, meanwhile, has almost ground to a halt, increasing pressure on the government to stimulate activity and rein in unpopular austerity policies.

Riyadh backed down on one austerity measure last month, restoring civil servants’ financial allowances at what one official said was an annual cost of about SAR15bn. Some officials say privately that fresh energy price reforms aimed at saving SAR29bn this year could be postponed.

DEFICIT UNEASE

The result is likely to be that the budget deficit for 2017 comes close to Riyadh’s original projection of SAR198bn. Though that would be a marked improvement from last year’s SAR297bn, at about 8 per cent of gross domestic product it would still be too high for comfort.

Malik estimates that a $1 increase in average oil prices over a year reduces the Saudi budget deficit by 0.3-0.4 percentage points if spending remains steady, making a price increase of even a few dollars attractive to the Saudis.

Similarly, oil prices could have a big impact on the Aramco IPO. Consultants Sanford C. Bernstein have estimated that Aramco would make a net profit of $13.30 a barrel on its upstream production with oil at $50, but $16.90 at $60.

That suggests a $10 swing in the oil price could conceivably make a difference of hundreds of millions of dollars to Aramco’s IPO valuation, helping to determine whether the government can claim it is getting a good price.

Other factors that have contributed to Riyadh’s historical reluctance to reduce oil production also appear to be losing some validity, with some analysts arguing that improved fracking technology means that US shale oil producers are no longer likely to be deterred by low crude prices.

Furthermore, concerns that output cuts would reward Iran with higher prices may be receding, given Tehran’s failure to secure foreign investment over the past year and US President Donald Trump’s hard line towards the country.