The price of oil is hovering around $50 per barrel of West Texas Intermediate crude, and $60 per barrel of Brent crude, the lowest levels since the global economic downturn of 2008-2009. Until the end of February, when they rebounded slightly, oil prices had been dropping since the middle of last summer.
In the past, Saudi Arabia has cut its oil output to halt this sort of freefall. As the “swing producer,” the country with the largest and most easily extracted reserves, the desert kingdom can afford to reduce supply in the short run to steady price levels in the long run. This time, however, the Saudis ordered their rigs to keep pumping as usual, doing nothing to stop the downward spiral. Why?
Saudi Arabia’s government has been pushing development plans to diversify the economy away from dependence on hydrocarbon exports for the last two decades. While oil exports were still 90 percent of total export revenues as of 2014, and still accounted for 80 percent of government revenues, “diversification” has resulted in reducing hydrocarbon production to 45 percent of the domestic economy, and the “non-oil” sector of the economy has generally grown faster than the oil sector since the 2008-2009 crisis.
There are two caveats to this rosy picture of “non-oil” growth. First, much of the diversification and employment, even in the private sector, is financed out of export-dependent government revenues funneled through development programs for infrastructure such as transportation, including light rail networks for the main cities and expansion of King ‘Abd al-‘Aziz International Airport, power plants (including a solar project), housing, financial services and consumer products. Second, much of the “non-oil” sector is actually dependent on hydrocarbon production for domestic energy and feedstock, for example for petrochemicals, fertilizer, plastics, construction materials and aluminum.
The Saudi regime’s ability to finance this ambitious and complex development program could be undermined in the long run by a steep and lasting fall in oil prices and export revenues, a reality driven home by the crisis of 2008-2009, with its plunge in oil revenues and financial returns, that made the drive to diversify the domestic economy more urgent than ever. But the regime is calculating that it can hold out longer in the short and medium terms than can other exporters to the global hydrocarbon market, and that it would have more to lose from cutting production now than it would have from staying fully in the competition for the long haul.
The long-haul calculation has two aspects, the immediate oil market dynamics and the larger global economic realm. At present, the Saudis are determined to hold on to their share of the global oil market, even if prices fall further, while their competitors falter and drop out. Saudi Arabia and other well-endowed Gulf producers Kuwait, Qatar and the UAE can hold out longer because they are the lowest-cost producers per barrel in the world. Falling prices have already led to the decommissioning of more than 500 oil rigs in the United States since the beginning of December 2014, down to a total of about 1,000 by the end of February, announcements by Shell and Chevron that they are cutting $50 billion from their exploration budgets, and an unplanned stockpiling of the glut of crude oil in the United States.
For the long run, the Saudi regime projects (along with the international financial institutions) that a spell of relatively low oil and gas prices will eventually stimulate increasing demand for their exports along with higher growth overall in both developed and emerging economies. Saudi Arabia sells about two thirds of its exports to East and South Asia, where the fastest growth is taking place, anyway. In addition, the Saudi riyal, like other GCC currencies, is linked to the value of the US dollar. At least for the next year or so, as Europe and Japanese central banks engage in quantitative easing to stimulate their economies while the US Federal Reserve tightens up on its money supply to avert inflation, the US dollar will continue to strengthen relative to the euro and yen. (Quantitative easing is a policy used by central banks to help bring an economy out of recession and reduce unemployment. The central bank increases the money supply and reduces interest rates in order to encourage more bank lending and induce new business investment and consumer borrowing. The increased lending and borrowing for productive activity increases aggregate demand for expanding output and stimulates overall economic growth and job creation.) The riyal will strengthen, too, giving Saudi Arabia a break on relative prices of imported food and productive inputs and slowing the downward pressure on its current account, even as hydrocarbon revenues fall, plateau and then recover with the global economic recovery.