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ANALYSIS

Fiscal muscle gives Saudis oil market options

Riyadh, February 9, 2013

By Angus McDowall

A combination of massive currency reserves and a 2013 spending plan based on a conservative oil price projection means Saudi Arabia has considerable flexibility in deciding its oil output policy this year.

The world's top oil exporter has boosted state spending sharply in the past couple of years, adding hundreds of thousands of public sector jobs, introducing new social entitlements and starting big infrastructure projects.

Many economists agree this largesse will pose fiscal challenges for Riyadh in future. But for now, the government's strong budget position means it can opt either to cut oil output in support of prices, or withstand a fall in prices to maintain market share versus rival producers.

"It gives them a little bit of comfort in their policies," said Alexander Poegl, business development manager at JBC Energy in Vienna, which does consulting work for the Saudi oil sector.

He said Saudi Arabia's priority was to pursue a middle way in the energy market, trying to maintain stability of prices and supply.

Analysts' estimates for Saudi Arabia's break-even oil price this year - the price it needs to balance the state budget - vary from around $65 a barrel to $85, depending on projections for its spending. Those levels are well below the current market price of Arab Light, the country's main type of crude oil for export, which is now at about $115.

The flexibility which that gap provides may prove important for Saudi Arabia, the main swing producer in the Organization of the Petroleum Exporting Countries, as a dispute with Iran threatens to destabilise oil markets and with Iraq likely to rebuff Saudi calls to moderate its crude output.

Saudi officials have always insisted the kingdom's energy policy is based solely on its reading of market forces, a lesson it learned after damaging boom-and-bust cycles in the 1970s and 1980s that followed the 1974 oil embargo.

However, local political analysts say Saudi leaders are always very aware of the impact of oil on foreign policy.

"In general they have not used oil as an instrument of political pressure. But in the real world, I don't think a country that has such a strategic commodity can divorce its foreign policy from that fact," said political science professor Asaad al-Shamlan.

At the height of Arab Spring unrest around the Middle East in February 2011, Riyadh announced a package of spending that amounted to about $110 billion, on top of an already expansionary budget.

Government spending growth has averaged about 14 per cent a year over the past decade. Even so, historically high oil prices have allowed Saudi to effectively wipe out government debt and build a cushion of foreign reserves worth $648 billion by the end of last year.

What concerns some economists is that although a lot of the extra expenditure has been on infrastructure projects aimed at making the Saudi economy more productive, there have also been major additions to current spending.

The kingdom is on an unsustainable long-term fiscal trajectory, Steffen Hertog, author of "Princes, Brokers and Bureaucrats", a book about Saudi Arabia's economy and politics, wrote in a paper that he delivered at a seminar in Riyadh.

"The welfare and employment decrees indicate a return to the distributional policies of the 1970s oil boom period - but on a much larger and less sustainable scale," he added.

The government has financed hundreds of thousands of new public sector jobs since 2011, introduced an unemployment benefit and pledged more low-interest loans for home purchases. The International Monetary Fund warned last year that Saudi Arabia could slip into fiscal deficit by 2016.

But Finance Minister Ibrahim Alassaf has described the warning as a "doomsday scenario" which the country will avoid, and he said last month that Riyadh could sustain current spending levels in the medium term and beyond.

So far, the figures bear him out. Saudi Arabia reaped record state revenue of more than $331 billion last year, leading to a huge budget surplus of $103 billion.

Its budget plan for this year aims for revenue of $221 billion and spending of $219 billion. Spending will almost certainly be much higher than targeted; the government has overshot its spending plans by an average of more than 20 percent a year over the past decade.

But because of high oil prices, this year's revenue also looks set to be much higher than the target; Jadwa Investment estimated this year's budget plan was based on a conservative oil price projection of only about $65 a barrel.

So another big budget surplus is in prospect. And even if Saudi Arabia does slip into a moderate deficit - perhaps to the tune of several tens of billions of dollars - its reserves could easily cover a deficit of that size, for years to come.

Saudi Arabia appears most comfortable with a global oil price of around $100 or moderately above; Oil Minister Ali Naimi has said $100 suits both producers and consumers by facilitating oil exploration without hurting global growth.

From that perspective, Riyadh's budget and market positions look favourable, with the oil price well above $100 after the kingdom cut its output by around 700,000 barrels per day to 9.02 million bpd in the last two months of 2012.

Opec predicted in a report last month that demand for the organisation's crude would be lower than originally expected in 2013 because of higher supply from other producers. But the International Energy Agency, formed by major consuming countries, said it saw markets tightening in coming months.

Saudi Arabia showed 18 months ago that it was ready to boost its supply to compensate when Libyan crude output was slashed by the North African country's revolution.

Now exports by Shi'ite Iran, which has tussled for influence with Riyadh across the Middle East, are faltering. Iranian exports fell by a quarter last year, to about 1.09 million bpd, and might dip further in 2013 as new US sanctions over Iran's nuclear programme come into force.

That means a high oil price is increasingly important to Tehran to compensate for its falling export volumes. A price closer to $100 a barrel would help clip the wings of a country which Riyadh sees as threatening.

Meanwhile, Saudi Arabia may want fellow Opec member Iraq to contribute to output cuts by the cartel should they be required, after decades in which Baghdad enjoyed an exemption. That is a prospect which Iraq strenuously resists, raising the possibility of a contest for market share between the two countries.

"It would be very significant if (Riyadh) can do with less than $80 a barrel. It would be in a stronger arguing position" within Opec, said Manouchehr Takin, senior petroleum upstream analyst at the Centre for Global Energy Studies in London.-Reuters




Tags: Saudi Arabia | Oil | fiscal |

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