Saudi Sows Budget Busts

Oil prices fell below $80 this week and are down ~25% since June, driven in large part by a rapid increase in supply while demand growth slows.   Reasons for slowing demand are well-understood: Europe’s economic malaise and China’s slowdown are two logical explanations. Rising vehicle fuel-efficiency and the increasing use of alternative energy sources are two additional drivers.

The supply side of the story, however, is more intriguing. While the US energy boom is certainly a factor, it’s not the only one. Consider the fact that Libya – a country acknowledged by many as effectively in the midst of a massive civil war – increased oil production from about 200,000 barrels in May to more than 1 million barrels a day in October. Or that swing producer* Saudi Arabia upon noticing excess supplies, decided to increase production in September, further exacerbating price pressures.

So What? The most commonly cited reason for this seemingly-irrational decision is that Saudi Arabia is seeking to maintain its market share versus Russia and other rivals. Less common, but perhaps more compelling, is that the Saudis (in cooperation with the United States) are actively squeezing Iranian and Russian budgets for political purposes.

Half of Russian government revenues come from oil and gas, and the Kremlin assumes $100 oil to balance its budget. $80 oil creates a gaping hole in Russian finances, one that has already prompted the Russian finance minister to suggest budget cuts. Last week, Iranian leaders noted “some so-called Islamic countries in the region are serving the interests of America and (other) arrogant powers in trying to squeeze the Islamic Republic.” The 2014 Iranian budget, according to the WSJ, assumes $140 oil. Who else loses with low oil prices? Venezuela, Algeria, Iraq, Nigeria, and Ecuador do. They all have budgets that assume oil remains above $100.

In the midst of these budget busts, are there any winners? Meaningful oil importers include China, Japan, Europe, India, Korea, and Thailand, to name a few.  The US consumer is another key beneficiary, where lower energy prices increase discretionary budgets.  In this light, Saudi Arabia’s actions may be very rational: help out current and future customers and friends and simultaneously hurt enemies. Makes sense to me.

 

* Because American energy production is decentralized and spread among hundreds of companies making individual decisions, Saudi Arabia remains the world’s “swing producer.”

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