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Global Oil Crash Indicates Signs of Trouble in Saudi Arabia

In addition to claiming the lives of hundreds of thousands around the world, the outbreak of COVID-19 has had a devastating impact on commodities. One industry that has been hit particularly hard is oil, and countries that rely on oil and natural gas for their economy could be facing hard times long after the coronavirus passes. A country that is particularly in danger of this is Saudi Arabia, whose oil sector makes up half of the country’s gross domestic product. Oil prices crashed to historic lows as coronavirus-forced shutdowns erased the world’s demand for it. This affects Saudi Arabia more than most, as it will have to curtail much of its supply, which in turn means hundreds of millions of dollars in lost revenue. With 70% of the country’s export earnings coming from the sale of oil, the Saudi economy will take a serious hit, something that the Kingdom’s finance minister hinted at recently. As a result, Saudi Arabia will have to reevaluate much of its spending to account for its new financial reality.

The oil industry encountered its worst crisis since the Great Depression in May, when shutdowns imposed by COVID-19 dramatically reduced demand. Futures contracts plummeted by 300%, and many went into the negative. As demand fell, oil producing nations weren’t quick enough to react, which led to a massive surplus. That is a problem on its own, but a bigger problem is the lack of storage facilities for the surplus oil. A large reason why futures contracts fell so much is because there was little appetite among traders to take delivery of oil due to the lack of storage. In reaction to the crash, OPEC+ reached an agreement to slash production by 9.7 million barrels per day through May and June. The cut amounts to about 10% of the world’s normal oil supply, although experts have warned it is not enough to solve the demand crisis. Additionally, the OPEC+ agreement came shortly after Russia and Saudi Arabia discarded years of incremental production cuts and engaged in a price war by flooding the market, despite warnings about the potential impact of the coronavirus on the world’s energy market. By doing this, Saudi Arabia facilitated its own economic crash, and fundamentally harmed its domestic economy.

To account for falling oil prices, Saudi Arabia announced it would draw on $32 billion from its cash reserves to support its economy. In its 2020 budget, Saudi Arabia assumed a price of $60 per barrel of oil, but the actual price fell as low as $25.90 during the peak of the crash. Correspondingly, the Saudi finance ministry announced a first quarter deficit of just over $9 billion. The loss of oil revenue accounted for about a quarter of the total income lost. The International Monetary Fund projected that Saudi Arabia would need to sell oil at $76 per barrel to break even with production costs. These projections now seem highly unlikely to happen, which means Saudi Arabia could be heading directly into a steep depression.

In order to cope with the lost oil revenue, Saudi finance minister Mohammed al Jadaan said the Kingdom would be forced into implementing “painful” measures to prop up the economy. Cuts to public spending are necessary to reduce the deficit, and increased regulation on public spending would also be required. Additionally, the Saudi government would redirect funds earmarked to be spent on the public to the medical industry to combat COVID-19. Al Jadaan ruled out cutting funds to basic services but said that public spending on non-essential items would be examined closely, as reducing government expenditure is paramount. Correspondingly, it was announced that cost of living allowances for state employees will be curtailed as of June 1, and the value added tax will be increased from 5% to 15% as of July 1. The savings from these cuts amount to about 10% of the 2020 budget’s predicted expenditure. In total, the Saudi government is aiming to cut $26 billion in spending, which will reduce its lost revenue to 13% of total GDP.

In addition to imposing austerity measures at home, there are additional policy options the Saudi government can pursue to mitigate future hardship caused by the decline in oil production.

One potential avenue for this is the reduction of Saudi spending on its military presence in foreign countries. The Saudi military is actively involved in conflicts in Yemen and Syria, and it is providing logistical support in Libya. Roughly 10% of the Saudi GDP is earmarked for military and defense spending, and a large portion of that money is used to perpetuate conflicts. Additionally, Saudi Arabia uses foreign aid to combat the spread of Iranian influence in the Middle East, and has taken steps to isolate Qatar due to political differences. Some of the Saudi defense spending is necessary to defend the country from attacks by extremist groups, namely the Islamic State and Al Qaeda, both of whom have targeted Saudi Arabia in the past. However, the Saudi government has spent billions of dollars in Libya, Yemen, and Syria, but has achieved nothing. Yemen’s civil war is at a stalemate despite a major Saudi air and ground campaign, Bashar al-Assad has managed to maintain power in Syria despite the support given to the opposition by the Saudi government, and the warlord Khalifa Haftar has been pushed back by government forces in Libya, despite tacit Saudi support. The bloated military budget has achieved very little, and with austerity measures being implemented at home, it would be prudent for Saudi leadership to reevaluate its priorities. Using money from the military and defense budget for social spending would be a simple way for the Saudi government to limit the hardship faced by the public due to the oil crash.

The crash of oil prices around the world poses a serious threat to Saudi Arabia’s economy, and the Saudi way of life. However, it also gives the country an opportunity to reform its spending. Crown Prince Mohammed bin Salman has grand plans for “Vision 2030”, a complete transformation of the Saudi economy. In order to bring this plan to fruition, major investment in public spending is necessary. On the surface, the oil crash seemingly destroys this idea. However, by cutting unnecessary military spending and using that money on domestic programs instead, the Saudi government can both mitigate the hardship caused by the oil crash, and fulfill the crown prince’s self-professed dream of reforming Saudi society.

NIF USA

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