Saudi Arabia’s spending addiction is bad for oil markets

Saudi Arabia cannot continue living beyond its means indefinitely.

The kingdom is projecting another hefty budget deficit this year after crude prices plummeted by about than 40% since last October. Until the Arabian petrodollar states learn to tighten their belts, oil consumers will remain vulnerable to their economic mismanagement.

Saudi Arabia is doubling down on domestic spending despite falling oil revenues. Amid a volatile start to 2019 for crude markets, Riyadh is persisting with a risky economic strategy aimed at appeasing an anxious population. Success depends on reversing the slump in oil prices.

Riyadh’s budget for 2019 gives the impression of a country in denial. Spending will increase 7% to a record 1.1 trillion riyals ($350 billion), while total government revenues are targeted to rise 9% to 975 billion riyals, according to the Ministry of Finance.

In order to have any hope of balancing its books, analysts say the kingdom would need oil prices to trade above $84/b for the entire year, at the very least. However, the odds for this happening remain long.

Few experts expect prices to hold at these levels, despite OPEC ’s deal with Russia and its allies to cut 1.2 million b/d of production starting this month. Brent crude was trading this week at around $55/b, well below Saudi ’s fiscal breakeven.

If autumn is coming for the global economy, then oil markets may still be in for a deep winter freeze to follow.

Paul Gruenwald, global chief economist at S&P Global Ratings, is forecasting global GDP growth will slow this year, led by the US , where expansion may drop to around 2% by the end of 2019. The ratings agency has lowered its Brent forecast by $10 to $55/b this year.

China —the world’s largest importer of crude —will also see its staggering rates of economic growth moderate further.

Given these warning signs, Saudi Arabia is taking a risk issuing such an expansionary budget when the short-term outlook for oil—which accounts for over 70% of its export revenues—looks so bleak.

Instead of cutting back, Riyadh is doubling down on giveaways. For example, generous cost-of-living allowances have been extended to government workers to curry favor.

Handing Trump bragging rights

However, the kingdom’s rulers have little choice other than to continue with their ruinous spending. The last couple of years have been politically tumultuous for the world’s largest exporter of crude.

Firstly, Crown Prince Mohammed bin Salman had dozens of his royal cousins and princes arrested in November 2017 in the biggest purge of the establishment since his father King Salman came to power. Officials—including family members at the top of the Al Saud dynasty—were still being held by the middle of last year as the state tried to claw back billions of dollars.

A sweeping cabinet reshuffle at the end of the year reinforced the Crown Prince’s position, but his reputation has been tarnished by events.

His campaign to isolate Qatar has backfired. Instead of capitulating to its larger neighbor, the tiny sheikhdom has fought back. Doha recently embarrassed the kingdom by resigning its membership in OPEC in December.

The killing of dissident commentator Jamal Khashoggi inside the Saudi consulate in Istanbul also provoked international criticism of the kingdom and its rulers.

Although officials deny the government ordered his death, the episode possibly handed US President Donald Trump more leverage to pressure Riyadh on oil policies in return for his unflinching support. Embarrassingly for Saudi, Trump now claims his intervention has forced prices lower and not Riyadh ’s considered policies.

Economic reforms stalling

Economic reforms aimed at weaning the kingdom off its dependence on oil exports have made slow progress.

Its flagship listing of a 5% stake in state-owned oil producer Saudi Aramco to raise $100 billion to help diversify the economy has been delayed, or permanently shelved.

With other sources of significant foreign currency income outside oil and petrochemicals limited, the kingdom has few alternatives other than to increase borrowing, or drain its foreign reserves.

Although its overseas coffers have been partially replenished, total net foreign assets held by the Saudi Arabian Monetary Authority had dipped below the $500 billion threshold last year as the government dipped into nest egg to compensate for weaker prices. Of course, the kingdom’s economic planners would prefer to keep its rainy day funds intact for the time when its oil is no longer in such demand.

Instead, economic pressures mean Riyadh will have to keep its pact with OPEC and Russia intact to boost the price of crude back to sustainable levels.

The oil producing alliance is next expected to meet in April, but with prices now in free fall, an earlier gathering cannot be ruled out.

Ahead of December's OPEC meeting when the group and its allies agreed to implement 1.2 million b/d of cuts, Ehsan Khoman, head of MENA Research and Strategy at MUFG, highlighted the Saudi position.

“Saudi Arabia’s oil strategy decision is simple—either receive higher prices and sacrifice market share through lowering oil production, or, alternatively, receive significantly lower revenues (and thus agreeing with its geopolitical US ally) by maintaining or even further raising production levels,” Khoman wrote in a research note.

The rout in oil markets at the end of last year may have steadied, but Saudi Arabia’s options remain limited. Instead of an expansionary budget, a return to austerity still looks a more prudent approach unless it can permanently reverse oil’s downward trajectory.

This article was first published as a column in The Telegraph.