Saudi Arabia’s 2016 Budget Suggests Little Relief In Price Pain

In unveiling its 2016 budget in Riyadh today, the government of Saudi Arabia is sending a broad signal to oil markets and fellow producers alike that it has no immediate plans to change its current oil policy of sustained heightened production, but that it also recognizes the need to rein in spending as the Kingdom anticipates no substantive recovery in oil prices in the coming year. While the 2015 Saudi budget appeared to be based on an overly-optimistic oil price of $80 a barrel, the 2016 budget may be grounded in more realistic terms, apparently predicated on an average oil price of $45 a barrel.

The new budget is the first to be issued under the regime of King Salman Bin Abdul-Aziz, as the Saudi monarch assumed the throne on January 23rd upon the death of King Abdullah Bin Abdul-Aziz. The 2016 Saudi budget forecasts a deficit of $87 billion, with expenditures set at $224 billion and revenue slated at $137 billion. This suggests that the Kingdom is bracing for continued economic upheaval and is trying to stem the fiscal hemorrhaging as it seeks to defend market share and force independent producers to participate fully in balancing oil markets.

The Saudi Finance Ministry announced today that the Gulf producer had recorded a $98 billion budget deficit for 2015, based on spending of $260 billion and revenues of $162 billion. While this is the highest deficit the Kingdom has officially announced, it is lower than what was forecast by analysts and financial institutions, including the International Monetary Fund (IMF), which had suggested that Saudi Arabia’s 2015 budget deficit would likely exceed $106 billion.

Thanks in part to the Saudi-led strategy adopted by the Organization of Petroleum Exporting Countries (OPEC) just over a year ago that was meant to punish independent producers through price pain and help the Kingdom and its Gulf allies recover market share, global oil prices have fallen by as much as 60 percent since mid-2014 to lows not seen in over a decade, and few producers have been spared deep economic pain.

In its 2015 budget announced on December 25, 2014, the Saudi government anticipated a budget deficit of $38.6 billion, predicated on spending of $229.3 billion and earnings of 190.7 billion. However, when that budget was released, the Kingdom had yet to initiate a proxy war with Iran in neighboring Yemen, nor had it been expected that oil prices would fall to the depths they have as demand in key regions has been tepid and oil markets greatly oversupplied. All of these factors have contributed to an economic crisis in the Kingdom, which has compelled the Saudi government to tap into its sizeable financial reserves as well as sell bonds to meet budgetary needs.

The Kingdom has been aggressively dipping into its foreign exchange reserves, which were estimated at $739 billion late in 2014, and have since fallen to $654.5 billion, with the IMF in October cautioning that Saudi Arabia may only have five years left of financial assets if the oil price slump continues and Riyadh maintains its spending habits.

The OPEC heavyweight began issuing public bonds this summer to local banks and institutions as a means to meet budgetary needs. Saudi Arabia is expected to raise some $32 billion in 2016 from selling bonds monthly, adding to the nearly $20 billion it has garnered from debt issuance in 2015.

Not surprisingly, there are indications that the Saudi government has already initiated some economic belt-tightening, including freezing new construction contracts while also delaying payments to some contractors on infrastructure projects for as much as six months and attempting to negotiate lower contract prices.

One area where the Saudi regime is not holding back on spending is in military expenditures, with funds reportedly having been directed from other government sector budgets in 2015 to the Defense Ministry, headed by Deputy Crown Prince Mohammed Bin Salman. While the Kingdom’s defense budget had been growing at a rate of about 14 percent a year over the last decade, it has jumped to a rate of 19 percent a year since 2011, following the Arab Spring. Since then, not only has the Saudi government been contending with domestic Shi’ite dissent but more recently growing attacks being carried out by Islamic State supporters, as well as waging a war in Yemen and participating in air strikes against Islamic State in Syria.

Saudi Arabian defense-related spending is anticipated to rise to about $60 billion a year by 2020 from $49 billion, which will make it the fifth-largest global defense spender. In fact, it appears that the Kingdom is already allocating $56.8 billion to military and security expenditures in 2016.

The Saudi government has indicated that it is ready to take some possibly unpopular steps at home to generate revenues through a new national agenda of reform measures expected to be announced next month, including oil, water and electricity subsidy cuts that will be phased in over five years and a privatization program that will offer up stakes in both state-owned and partly-privatized companies. Deputy Crown Prince Mohammed Bin Salman, who has been granted responsibility over the Kingdom’s economic policies, is believed to be a strong advocate of these reform measures.

Despite intense pressure earlier this month from producers within OPEC with less of the financial cushion that Saudi Arabia, Kuwait, the United Arab Emirates and Qatar have had to withstand the oil price collapse, Riyadh was able to fend off efforts to slash collective OPEC production at the minsterial conference on December 4^th in Vienna. Instead, the group opted to continue to produce at full tilt, pumping at roughly 31.5 to 3.2 million b/d, with the looming threat of Iran bumping up its output in 2016 and adding extra barrels into a saturated oil market as U.N. sanctions on the Gulf producer are gradually eased.

Although Iranian officials have claimed that the OPEC country could boost exports by 500,000 b/d within a week of sanctions being lifted and increase exports by another 500,000 b/d in the following six months, this declaration is thought to be overly ambitious given the inherent challenges of restarting aging oilfields. That’s not to say that Iran won’t push out large volumes initially, but if so it’s likely originating from storage. Saudi Arabia will be watching how much oil actually gets exported from Iran in the coming months before it even considers shifting its current production strategy and welcomes a collective reduction within OPEC as well as demanding cuts from non-OPEC producers.

King Salman Moves Up Second-Generation Princes In Succession Line

Three months after ascending to the Saudi throne, King Salman Bin Abdul-Aziz is making bold moves that will have a profound impact on the direction that the Kingdom takes in the coming years, setting the stage for the next two rulers of the Gulf country to be grandsons of founder Ibn Saud. Ironically, the two princes that are now in line to succeed King Salman share the same name, meaning that one day a King Mohammed could potentially succeed a King Mohammed.

In addition to significantly altering the leadership landscape for the coming decades, the new Saudi monarch also shook up his cabinet, including ending the 40-year career of the Gulf nation’s Foreign Minister and naming a new Health Minister, who curiously also becomes the new chairman of the board of state oil giant Saudi Aramco.

For the traditionally conservative Saudi Arabia, the move to the next-generation of leaders within the Al-Saud family has been a source of much debate within the Kingdom as well as among Gulf watchers for the last decade or more, as those aging sons of Ibn Saud in the succession line began to die. King Salman appears to be continuing to consolidate his power and formally moving to ensure that one of his sons is now directly in line for assuming the throne one day.

In January, upon King Abdullah Bin Abdul-Aziz’s passing, King Salman immediately dealt with the question of when the next generation of Al-Saud princes would appear in the line of succession. In following with the established succession put in place by his predecessor, on January 23^rd King Salman named his half-brother, 69-year-old Prince Muqrin, the youngest surviving son of Ibn Saud, as his Crown Prince and Deputy Prime Minister. But he also appointed his nephew, 55-year-old Interior Minister Prince Mohammed Bin Nayef, as Deputy Crown Prince and Second Deputy Prime Minister, not only setting the stage for a return of the Sudairi clan to the throne but also making Prince Mohammed Bin Nayef the first grandson of the Kingdom’s founder to be officially placed in the line of succession. At the same time, King Salman elevated his 34-year-old son, Prince Mohammed Bin Salman, as the Kingdom’s new Defense Minister, the job the new King himself had held since 2012.

In several surprise decrees issued early today, April 29^th, King Salman abruptly removed Crown Prince Muqrin, appointing Prince Mohammed Bin Nayef as his new Crown Prince and the Deputy Prime Minister, and naming his son, Prince Mohammed Bin Salman as Deputy Crown Prince and Second Deputy Prime Minister.

When King Salman had immediately named Prince Muqrin as Crown Prince upon taking the throne in January, it was seen as the monarch maintaining the status quo for those conservatives within the Kingdom fearing change and assuring the domestic population and the world of a smooth succession, by honoring the wishes of his late half-brother as well as the ruling echelon within the Al-Saud clan.

Crown Prince Muqrin was clearly King Abdullah’s man. Crown Prince Muqrin did not have a support network of full brothers to establish a power base and he hadn’t reportedly particularly distinguished himself when he served as Saudi Intelligence Minister from 2005 to 2012.

What is clear is that the new Crown Prince and Deputy Crown Prince have enhanced their statures quickly and strengthened their individual power bases, appearing for now to be in agreement on dividing leadership in key areas. In addition to his new titles and responsibilities, Crown Prince Mohammed Bin Nayef will continue as Interior Minister and chairman of the Political and Security Affairs Council, while Deputy Crown Prince Mohammed Bin Salman will continue to oversee the Defense portfolio while also chairing the Economic and Development Affairs Council.

As Interior Minister since 2012, Crown Prince Mohammed Bin Nayef has taken a hard line on combatting internal threats from Islamist radicals, notably al-Qaeda and more recently attacks believed to be instigated or supported by the Islamic State of Iraq and Syria (ISIS).

The new Crown Prince became Assistant Interior Minister in 1999 and forcefully moved against Islamic militants within the Kingdom after September 11, 2001 while surviving an assassination attempt by an Al-Qaeda suicide bomber in 2009. He has become the public face in the Kingdom and abroad of overseeing domestic counterterrorism policy, responding swiftly to internal attacks and thwarting potential threats.

Just yesterday, on April 28^th, the Saudi Interior Ministry announced that in arresting 93 people in the last several months that were linked to ISIS, it had prevented several terrorist attacks from occurring within the Kingdom, including a planned suicide car bombing plot to strike the U.S. Embassy in Riyadh, as well as threats to residential compounds, prisons and security forces. Perhaps most worrying to the Saudi leadership should be that of the 93 individuals that were arrested, 65 of them were Saudi nationals.

In November 2014, following an attack on a Shi’ite shrine in the town of Dalwah in the al-Ahsa region of the Eastern Province that killed seven Saudis, raids across the Kingdom resulted in the arrests of 77 people in a terrorist cell believed to be responsible for the attack. The Interior Ministry subsequently announced that ISIS had ordered the attack in Dalwah and that the cell’s leader as well as three others in the group had direct links to ISIS.

As for the young Defense Minister, the relatively untested Prince Mohammed Bin Salman has seen his profile prominently raised since March 26th, when a Saudi- led coalition began its airstrikes and shipping blockade against the Houthi rebels in neighboring Yemen, in what is in effect a proxy war between Riyadh and Tehran over Saudi Arabia’s perception of Iran’s power moves and rising Shi’ite influence in the region.

The Saudi Defense Ministry announced on April 21^st that the coalition had ended Operation Decisive Storm because its goals had been reached and was moving into a second phase, Operation Restore Hope, the goal of which is to find a political solution to the crisis in Yemen. However, on April 28^th, coalition jets bombed the runway at Sana’a airport as a means to prevent an Iranian aircraft from landing and effectively making the runway unusable for scheduled aid flights, a coalition spokesman stated, claiming that the plane had not coordinated with the coalition and refused to turn back when it ignored a warning.

In the most significant of the several cabinet changes and other appointments he made through his royal decrees early on April 29^th, King Salman let go the world’s longest-serving foreign minister, Prince Saud Al-Faisal, replacing him with Saudi Ambassador to the United States Adel Al-Jubair. The decree announcing the departure of Prince Saud, who was appointed Saudi Foreign Minister by King Khaled in March 1975, cited that the 75-year-old prince “had asked to be relieved from his duties due to his health condition.” King Salman has retained Prince Saud on the Saudi cabinet by naming him a Minister of State and adviser on foreign affairs. Al-Jubair has served as Saudi ambassador to Washington for the past eight years and from 2000 to 2005 had been foreign affairs advisor to then Crown Prince Abdullah before serving as advisor to King Abdullah from 2005 to 2007. He will be the first non-royal to oversee the Saudi foreign ministry.

In what is causing a lot of head scratching and reading of tea leaves today, Saudi trackers are attempting to make sense of King Salman’s appointment of Saudi Aramco CEO and President Khalid Al-Falih as the new Health Minister as well as the chairman of the state oil firm. This means that Al-Falih takes over the chairmanship of Saudi Aramco from long-serving Saudi Oil Minister Ali Naimi. Both the positioning of Al-Falih on the cabinet and overseeing the board of the state oil firm suggests that he is next in line to replace Naimi. Traditionally the Oil Minister also serves as chairman of Saudi Aramco, so this is a bit of unchartered territory.

Al-Falih, who has worked at Saudi Aramco for his entire career that spans more than 30 years, has served as President and CEO since January 2009 and was appointed as a member of the Saudi Aramco board in 2004. Nothing in his professional background shows involvement or experience in medical or health-related issues.

It well could be that the reasoning behind appointing him to the Health portfolio was to give him ministerial ranking and more public exposure domestically and allow him to give input at ministerial meetings on energy issues, paving the way for him to succeed Naimi. However, there are believed to be other potential candidates for the job of Oil Minister, including King Salman’s son, Prince Abdulaziz Bin Salman, who is currently Saudi Deputy Oil Minister.

Increasingly in recent years, there was expectation that King Abdullah was going to relieve his long-serving oil minister from his job, but Naimi has proven resilient, in large part due to his technical knowledge and great understanding of the oil markets. Certainly, when King Salman came to the throne in January of this year, most anticipated that he would be replaced, given that Naimi was perceived as specifically King Abdullah’s man. But, as the country was in the midst of sponsoring an oil price war with help from its Gulf OPEC allies against U.S. shale producers and fellow OPEC and non-OPEC producers, it appeared that the new monarch did not want to rock the boat by firing Naimi at that time.

There is speculation that Naimi may be replaced following the upcoming scheduled OPEC conference on June 5^th in Vienna, or more likely, that he will remain in place until he has seen the price war run its course, however long that is to take.

Three Months In, No Sign of Saudi Wavering on OPEC Strategy

As February has drawn to a close—marking three months since OPEC agreed to hold to production levels of 30 million b/d—there is a widening fissure within the group over the impact that low oil prices are having on member countries’ economies. With Nigeria joining the ranks of its fellow disgruntled member countries Iran and Venezuela in trying to publicly and privately pressure the group to convene an emergency meeting to discuss production cuts for a price recovery, the divide between OPEC’s “haves” and “have nots” is glaringly obvious. Nigeria’s oil minister even alluded to the differences among members in an interview with the Financial Times on February 23^rd, essentially pointing the finger at the GCC contingent within the organization as feeling less of a financial pinch than everyone else.

However, it’s clear that without the go-ahead of Saudi Arabia, an emergency OPEC meeting will not occur before the next scheduled gathering of the oil ministers in Vienna on June 5^th. As far as Riyadh is concerned, things are exactly where OPEC’s largest producer wants them to be. With oil prices in the $50-$60 range, some 60% lower than June 2014, Saudi Arabia’s wish to see high production from both independent producers and errant OPEC members start to wane as they cede valuable market share is happening.

Saudi Oil Minister Ali Naimi even reinforced the notion that the Kingdom has no plans to change its current strategy of focusing on market share rather than worrying about high production and oil prices in comments he made on February 25^th. Speaking to reporters on the sidelines of a conference in southwestern Saudi Arabia, the veteran Saudi oil official noted that the markets have calmed down, with the price of Brent stabilizing at around $60 a barrel and that demand is growing, with lower oil prices beginning to foster demand particularly in China and the United States.

The Saudis are losing little sleep over that fact that among the hardest hit financially are independent producer Russia and fellow OPEC member and regional antagonist Iran. Indeed, should Riyadh’s fear that the United States and its five negotiating partners will broker an historic agreement with Iran on its nuclear program in the coming weeks be realized, Saudi Arabia is unlikely to want to give Tehran another reward in the guise of higher oil prices anytime soon.

In an interview with The Financial Times on June 23^rd, Nigerian Oil Minister and current OPEC President Diezani Alison-Madueke stated that she had been in consultations with other members within the group and that if the price of oil fell any further, “it is highly likely that I will have to call an extraordinary meeting of OPEC in the next six weeks or so.” According to the Nigerian oil official, most of the OPEC member nations, with the exception perhaps of the Arab Bloc (meaning Saudi Arabia and its fellow GCC members within OPEC—Kuwait, the U.A.E. and Qatar), “are uncomfortable.”

Not surprisingly, Alison-Madueke’s public insistence that an emergency OPEC meeting was in the offing was quickly shot down by Gulf delegates, according to reports. According to one OPEC source in the Gulf, no extraordinary meeting was slated and there is “no price target to trigger” such a meeting. To underscore the point, the source said that any change in the organization’s current policy of quota-free high production would require some independent producers to agree to cut back on their output and that doesn’t appear likely.

Oil prices experienced quite a bit of volatility in the latter part of the last week of February thanks to conflicting reports about supply and demand. Based in part on inventory data released on February 25^th by the U.S. Energy Information Administration (EIA) that indicated that U.S. oil stockpiles had reached heightened levels not seen in nearly 80 years and that U.S. oil output had hit a new weekly high of 9.3 million b/d amid an oversupplied market, crude prices took a dive on February 26^th, with U.S. April crude plunging $2.82 to settle at $48.17 and the price for Brent falling $1.58 to settle at $60.05. However, on February 27^th, oil prices rebounded, bolstered by surging demand for refined gasoline and diesel, with the U.S. benchmark oil contract adding $1.59 to settle at $49.76 a barrel and the contract price for Brent jumping $2.53 to settle at $62.58 a barrel.

The markets shrugged off news on February 27^th from Baker Hughes that its count for U.S. oil rigs drilling for oil had fallen by 33 the last week of February to 986, the first time the rig count had slid below 1,000 since June 2011. In addition, JBC Energy suggested that the rig count decline should translate into U.S. crude levels shedding 200,000 to 250,000 b/d in the second half of 2015.

Some reports have suggested that U.S. shale producers are scaling back so dramatically on drilling and capital spending as a result of the sustained low oil prices that U.S. crude output could start to take a hit sooner rather than later. In fact, a number of U.S. shale producers have reported 25-70% reductions in drilling and collectively at least $25 billion in spending cuts.

Iraqi Oil Set For Record Output Despite Slight Dip

Part of the credit for OPEC’s swelling output numbers during the last half of 2014 certainly goes to Iraq—which despite ongoing domestic turmoil as Baghdad and Erbil join the U.S. in battling Islamic State insurgents—has seen its crude production and export levels continue to rise. That is, until this past month, when it appears that there were declines in both exports from Iraq’s southern oil fields and oil pumped from northern Iraq, resulting in the Gulf producer’s output in January reportedly falling as much as 300,00 b/d from December levels.

However, this does not appear to be a lengthy setback for Iraq, with suggestions that record exports from southern fields are anticipated for this month, which will bring its numbers back up. The warmer political climate between the federal government and the Kurds has prompted a consensus between the two sides on the principle that lower oil prices need to be offset by volumetric increases.

While Iraqi Oil Minister Adel Abdul Mahdi stated first on December 21^st that Iraq’s oil production would hit a record 4 million b/d following the strategic oil revenue sharing agreement reached between Baghdad and Erbil on December 2^nd and then a month later insisted that his country had produced nearly 4 million b/d in December, he may have been overreaching a tad.

There are conflicting reports of Iraqi oil output in December, with some reports suggest that Iraq’s total production for December reached just shy of 3.8 million b/d, while others were more conservative at around 3.4 million b/d, though there was consistency with the fact that the country’s output fell by around 300,000 b/d in January. Mahdi’s assertion that Iraq had reached a record 4 million b/d in December combined with reports of Chinese economic worries caused oil prices to decline more than a $1 a barrel on January 19^th.

Baghdad has been stridently opposed to the Saudi-led push within OPEC that prompted the cartel to decide against cutting collective output of 30 million b/d at the group’s November gathering in Vienna. Last month, Iraqi Vice President Ayad Allawi, in an interview at the World Economic Forum in Davos, suggested the need for a summit meeting between OPEC members and independent producers to tackle the issues of low oil prices and the impact of shale oil. Also at Davos, Iraqi Deputy Prime Minister Rowsch Nuri Shaways argued that his country was forced to boost its production and exports to counter the plunge in oil prices.

That historic December 2^nd deal between the Iraqi federal government and the Kurdistan Regional Government (KRG) resolved a long-simmering dispute over sharing oil wealth and budget allocations, at least for now, and has seemingly slowed Kurdistan’s push for autonomy, again at least for now. The deal specifies that the KRG will export 250,000 b/d of oil from its fields through the pipeline it built to Turkey, from which the Iraqi federal government’s State Oil Marketing Organization will assume responsibility for its sale. The KRG will export another 300,000 b/d of oil produced from Kirkuk fields.

In return, Erbil will receive its 17% share of the national budget as well as $1 billion doled out in installments to pay the salaries of the KRG’s Peshmerga forces and provide necessary equipment as they contribute to U.S.-led efforts to rout advances made by the Islamic State. The question is whether Erbil will commit to supplying all of the 550,000 b/d of combined output as stipulated by the agreement and whether Baghdad will hold up its end of the bargain in terms of budget allocations and Peshmerga financial support.

The agreement de facto hands to the Kurds the oil-rich area of Kirkuk, which Peshmerga forces had seized when Iraqi troops retreated from an advancing Islamic State threat in June. Earlier this month, Kurdish forces were able to wrest back control from Islamic State militants of a small crude station at the Khabbaz oil field 20 km southwest of Kirkuk, but not before extensive damage was done to the station, which in turn caused production at the Khabbaz oil field to be halted. The field was only producing around 10,000 b/d, but it signals the first major effort to capture Kirkuk fields since Islamic State forces took over four small oil fields in northern Iraq last summer.

Just this past weekend, coalition airstrikes included a dozen or so strikes on Mosul, which had been seized by the Islamic State in June. As part of the campaign to oust the Sunni terrorist group from Iraq’s second largest city, Kurdish forces recently have been attempting to surround the city in an effort to put a stranglehold on supply lines from Syria in advance of a looming battle to retake Mosul.

The huge inroads made by the Islamic State helped force the Iraqi federal government and the KRG to reach that December agreement on sharing oil revenue and budget allocations. With both governments in dire need of American military aid to stem the threat from the Sunni terrorist organization, Washington obviously had a bargaining chip in trying to ensure that Erbil didn’t move forward on its drive for independence.

The new federal government of Prime Minister Haider al-Abadi needed the Kurds to pull together a coalition government that would be effective and the KRG could not afford to continue without the financial support that came from the federal government budget allocations. Both sides were suffering as a result of oil prices that have plunged as much as 60% from last summer. There is interesting speculation that the KRG’s near-term independence movement recently became derailed when the Turkish government reportedly withdrew its support of Erbil’s efforts to seek full autonomy, after having implicitly championed the cause by signing historic oil and gas supply agreements in 2013 with the KRG.

Succession In Saudi Arabia: King Salman Assumes Throne Upon King Abdullah’s Passing

This post has been revised on January 23rd to reflect key changes in the Saudi government following several decrees announced by new King Salman, namely the move to appoint his nephew, Interior Minister Prince Mohammed Bin Nayef, as Deputy Crown Prince and second deputy prime minister, formally establishing a grandson of Ibn Saud in the line of succession.

Three weeks after he was hospitalized for pneumonia, Saudi King Abdullah Bin Abdul-Aziz, age 90, died in the early morning hours of January 23^rd Riyadh time, according to a statement issued by the Saudi royal court.  As expected, his successor to the Saudi throne is his half-brother, 79-year-old Crown Prince Salman Bin Abdul-Aziz. As mentioned in my previous post about Saudi succession following the late king’s hospitalization, the throne returns to the powerful Sudairi line with the ascension of King Salman Bin Abdul-Aziz. Upon assuming the throne, King Salman immediately named his half-brother Prince Muqrin Bin Abdul-Aziz as his Crown Prince and heir.

And, in a surprise move for the traditionally cautious Saudi regime, King Salman appointed his nephew, Interior Minister Prince Mohammed Bin Nayef, as Deputy Crown Prince and second deputy prime minister in one of six decrees the new monarch issued on January 23rd. This bold step ensures that the 55-year-old Prince Mohammed, a grandson of founder Ibn Saud and another member of the Sudairi branch, is in place to one day become King and eliminates speculation about the future of governing in the OPEC country presumably for decades to come. Prince Mohammed, who had been named Interior Minister in November 2012, had been perceived as one of the leading contenders in the line of succession among the next generation of Saudi princes.

The smooth succession of Crown Prince Salman to the throne upon King Abdullah’s death is not surprising as it had been well-choreographed and intended to signal continuity in leadership and to reassure global oil markets about stability in the world’s largest crude exporting nation. Defense Minister Prince Salman had been named Crown Prince and deputy prime minister in June 2012, following the death of his brother, Crown Prince Nayef Bin Abdul-Aziz. And, in March 2014, King Abdullah appointed his half-brother, 69-year-old Prince Muqrin Bin Abdul-Aziz—the youngest surviving son of founder Ibn Saud—as Second Crown Prince (a new position) and second deputy prime minister.

Because of the intense jockeying for power among the sons and grandsons of Ibn Saud, the position of second deputy prime minister—traditionally the indicator of who is next in line behind the Crown Prince—had remained vacant for more than two years between the time that Prince Nayef had been named Crown Prince in October 2011 and King Abdullah appointed Prince Muqrin as second deputy prime minister and Second Crown Prince early last year. That King Salman moved so quickly to appoint Prince Mohammed to that post as well as designate him Second Crown Prince suggests that this had been in the works and that Prince Mohammed had the blessing of the inner circle of leadership. It also means that the Sudairis have extended their powerful reach into the next generation of Saudi governing.

In another important decree he issued, King Salman appointed his son, 34-year-old Prince Mohammed Bin Salman, as the country’s new defense minister, the job the new King had previously held since 2012. King Salman also named Prince Mohammed as chief of the royal court, replacing Khaled Al-Tuwaijri, who had been a key advisor to King Abdullah. King Salman also decreed that all other cabinet positions would remain unchanged. The cabinet had just experienced  a major overhaul by King Abdullah in early December, which left long-serving Oil Minister Ali Naimi in place.

Though oil prices have jumped on the news of King Abdullah’s passing, this is likely only a temporary boost. Indeed, oil markets should not expect to see a sudden and dramatic shift in current Saudi strategy regarding its oil policy or OPEC’s agenda as the Kingdom is in the throes of a calculated production push and price war to gain back market share that is just starting to see results that Riyadh wants.

Maduro’s Tour Comes Amid Proof That Saudi Strategy Is Beginning To Sting

The glaring divide between OPEC’s “haves”—those member countries who are pumping at near full production capacity and have a buffer of substantial financial reserves to withstand a sustained price decline—and OPEC’s “have nots”—those within the group with declining capacity from lack of investment and little if no financial buffer to weather the current price collapse— has become more readily apparent in the past several weeks. No greater sign of this divide was Venezuelan President Nicolas Maduro’s feverish tour of several OPEC nations as well as China and Russia to seek support in shoring up oil prices and to secure financial aid for his struggling economy.

While Maduro reported  he was successful in gaining $20 billion in new Chinese investment for a number of projects in the Latin American country and that the Qatari government had pledged to lend him “various billions”, his pleas to Riyadh and Doha to moderate OPEC’s current strategy and agree to cut the group’s production to begin an oil price recovery most certainly fell on deaf ears.

And why not, giving that the strategy pushed by Riyadh and supported by the other member countries of the Gulf Cooperation Council (GCC) in OPEC apparently is beginning to see results, particularly in terms of hitting non-OPEC producers where it hurts and reclaiming market share. Reports show that in the past six weeks, the U.S. oil rig count has fallen by 209, marking the sharpest six-week drop since tracking began in 1987, with the oil rig count falling by 55 in the week ending January 16^th and the count for horizontal rigs that are used in shale production dropping 48 in the same week, reflecting its biggest single-week decline.

OPEC also got encouraging news from the latest monthly oil market report from the International Energy Agency (IEA)—at least in the short term. In its report released on January 16^th, the IEA pointed to declining oil prices cutting into non-OPEC production growth in 2015, with the organization reducing its estimates for non-OPEC supply growth by 350,000 b/d. The IEA now forecasts non-OPEC supply growth at 950,000 b/d for this year.

However, in its report, the IEA did suggest that “A price recovery—barring any major disruption—may not be imminent, but signs are mounting that the tide will turn.” And, interestingly enough, the IEA indicated that U.S. oil output for 2015 will remain pretty strong, with supply growth falling by a mere 80,000 b/d. The market watchdog sees larger losses in production growth during the year from Colombia (175,000 b/d) and Canada (95,000 b/d).

The IEA now puts its call for OPEC crude at 29.2 million b/d for 2015, a tad higher than OPEC’s own adjusted call of 28.8 million b/d announced a day earlier, which was reduced by about 100,000 b/d from OPEC’s December monthly report. And, OPEC itself boosted its previous estimate for U.S. oil production for 2015 by 90,000 b/d to 13.81 million b/d in its latest report, but it also lowered its forecast for U.S. supply growth for the year from 1.05 million b/d to 950,000 b/d, which is now in line with the IEA’s new forecast.

There are no indications that OPEC’s GCC contingent is wavering on its stance on maintaining the group’s high production levels, currently over 30 million b/d for the seventh consecutive month. In the midst of Maduro’s touring of OPEC nations and China and Russia, U.A.E. Oil Minister Suhail Mohamed al-Mazrouei, speaking at an energy event in Abu Dhabi, argued that OPEC “cannot continue protecting a certain price … We are concerned about the balance of the market but we cannot be the only party that is responsible to balance the market.”

Venezuela has been a strong opponent of Riyadh’s plan to stem non-OPEC production through a painful price war and market share battle, given that the Latin American producer’s economy is in shambles. Maduro is facing increasing heat at home, where inflation has risen to 64 percent, the country appears close to defaulting on its foreign bonds, food shortages are on the rise and the latest polls suggest he only has support from 22% of the population. The Venezuelan leader, admitting last month that his country is in recession, has insisted that the financial crisis  is the result of an “economic war” waged by political foes.

Maduro received the full royal treatment during his visit to Saudi Arabia on January 11^th, meeting with Saudi Crown Prince Salman Bin Abdul-Aziz, Deputy Crown Prince Muqrin Bin Abdul-Aziz, Intelligence Chief Prince Khaled Bin Bandar and several sons of the ailing King Abdullah Bin Abdul-Aziz, who has been hospitalized since December 31^st, as well as Saudi Oil Minister Ali Naimi. While the official Saudi Press Agency gave no details about Maduro’s visit with the Saudi leadership, the Venezuelan government released a statement saying that, “We agreed to work to recover the market and oil prices with state policies between the two energy powerhouses.”

In Doha on January 12^th, Maduro spoke to Venezuelan state television, declaring that, “We’re finalizing a financial alliance with important banks from Qatar that will give us sufficient oxygen to help cover the fall in oil prices and give us the resources we need for the national foreign currency budget.” He indicated that the financing would involve billions of dollars covering 2015 and 2016.

Maduro met more kindred spirits for supporting a return to higher oil prices through production cuts while visiting Iran. In Tehran on January 10^th, Maduro first met with Iranian President Hassan Rouhani and later with Iranian Supreme Leader Ayatollah Ali Khamanei. Both Iranian leaders took the opportunity of Maduro’s stop in Tehran to again accuse Saudi Arabia (and ostensibly the United States) through veiled references of instigating the price rout for political reasons. Rouhani called on OPEC members to “neutralize schemes by some powers against OPEC and help stabilize an acceptable oil price in 2015.” The Ayatollah, on his part, insisted that, “Our common enemies are using oil as a political weapon and they definitely have a role in the sharp fall in oil price.”

The fact that Maduro turned to Beijing and Moscow for financial help is no great surprise, although Russia—also hard hit by oil prices that have collapsed 60% since last summer—may not be in the strongest lending position currently to help bail out Caracas and it is questionable how much aid Maduro was pledged when he met with Russian President Vladimir Putin on January 15^th. Following that meeting, the Venezuelan leader declared that, “I have got the funds needed so that the country can maintain its rhythm of investment, of imports and economic stability.” 

While Maduro announced during his visit to Beijing earlier this month that he had signed bilateral deals with the Chinese government for $20 billion in new Chinese investments in projects in the Venezuelan energy, industrial and housing sectors, he gave few details and it is unclear if these deals will entail a loan-for-oil arrangement that has come to typify Chinese-Venezuelan agreements.

The Chinese government had cultivated a strong relationship with Maduro’s predecessor, Hugo Chavez, beginning in 1999, and it was Beijing that Chavez increasingly turned to when his Bolivian Revolution started hitting tough financial times and the Venezuelan president had to boost borrowing to cover government spending and debts. Since 2007, China has offered Caracas as much as $50 billion in credit in exchange for dedicated oil supplies.

Indeed, in April 2010, the Chinese government stated that it had signed seven cooperation deals with Venezuela, including a framework agreement for financing that entailed the China Development Bank offering Venezuela a $10 billion loan and an additional credit worth approximately $10.4 billion. As required by the Venezuelan law that was passed to endorse the financing, Caracas was to repay China with no less than 200,000 b/d of crude in 2010, no less than 250,000 b/d in 2011, and no less than 300,000 b/d in 2012. The question today is how much of Venezuela’s crude output is already committed to repaying existing Chinese loans and how much more will be heading to Asia’s largest market from the latest deals?

Saudi King’s Health Crisis Puts Succession, Oil Strategy Under Microscope

Oil markets have all but shrugged off news of Saudi King Abdullah bin Abdul-Aziz’s week-long hospitalization for complications from pneumonia and the question it again raises of Saudi royal succession. But Saudi oil policy was still fresh on everyone’s agenda amid renewed signs that Saudi Arabia is committed to holding firm to current levels of its own production as it engages in a battle for market share.

Prices early this week fell below $50 a barrel—roughly halved since the summer of 2014—in part on the Kingdom’s decision to further trim its official selling price for Arab Light for February delivery to the United States by 60 cents a barrel, a deliberate move to secure market share in its once top priority market against rising pipeline shipments to the U.S. Gulf coast from Canada. The markets also took note of a televised speech to the Saudi Shura Council on January 6^th delivered by Crown Prince Salman bin Abdul-Aziz in King Abdullah’s name in which the Crown Prince emphasized that the Kingdom will deal with the steep drop in oil prices with a “solid will” while attributing the price collapse to “slow growth in the global economy” without referring to oversupply issues.

In addition to the pressing health issues of the Saudi monarch, news of a suicide and gun attack on a Saudi border patrol on January 5^th by four armed men from Iraq that resulted in seven dead raises more security concerns for the Kingdom as it faces increasing threats from the Islamic State and al-Qaeda as well as ongoing disturbances from within its own Shi’ite community. It was just two months ago that militants linked to Islamic State carried out an attack at a Shi’ite mosque in the al-Ahsa region of the Eastern Province, killing seven people. It is still unclear who carried out Monday’s border attack, with some reports suggesting that Islamic State is taking credit for the move while the Saudi Interior Ministry says it cannot tell who committed the attack until it has identified the remains and that could take some time.

It was 19 years ago in December that then Crown Prince Abdullah became regent of Saudi Arabia, effectively taking over the day-to-day running of the Kingdom following the stroke of his half-brother King Fahd bin Abdul-Aziz, and it will be ten years ago this coming August when Crown Prince Abdullah assumed the throne upon King Fahd’s death.

News of the 91-year-old King Abdullah’s  hospitalization on December 31^st caused Saudi stocks to slightly dip while the oil markets seemed almost indifferent to the news. The royal court revealed on January 2^nd that the Saudi monarch was suffering from pneumonia, requiring temporary aid from a breathing tube, having been moved from the King Abdulaziz Medical City Hospital in Riyadh to a military hospital. Since then, there have been almost regular updates from the royal court about the King’s health in what appears calculated to reassure both the domestic population as well the international community.

It is clear that King Abdullah is in frail health, but there is also very little doubt that the succession will play out as planned, with 79-year-old Crown Prince Salman slated to assume the throne upon the King’s death. The Crown Prince has been ably filling in for the ailing monarch, despite his own health concerns, notably attending the early December heads of state GCC gathering in Doha, chairing cabinet meetings and as mentioned above, giving a televised speech in King Abdullah’s name to the Shura Council on January 6^th.

In March of last year, King Abdullah named his half-brother Prince Muqrin bin Abdul-Aziz as second deputy prime minister and second crown prince. In an indication of just how difficult it is to establish the order of succession in the Saudi royal family, the position of second deputy prime minister—long the signal of the next in line behind the crown prince—had remained empty since October 2011, when Prince Nayef bin Abdul-Aziz was named Crown Prince, a period of more than two years.

At 69, Prince Muqrin is the youngest surviving son of founder Ibn Saud, and is said to be a close advisor to King Abdullah. A former officer in the Saudi air force, he was educated in the United States and United Kingdom. His appointments as second deputy prime minister and second crown prince came within hours of a visit to the Kingdom by President Barak Obama, making some surmise that the move was calibrated to reassure Washington about the Saudi line of succession before Obama’s trip.

While the appointments of Prince Muqrin to those two posts might not have gone down well with some within the royal family, it would suggest that the conservative old guard had won out and that the status quo of the sons of Ibn Saud sitting on the Saudi throne had been maintained, putting off the question of when a grandson of Ibn Saud will one day come to power. It appears that Crown Prince Salman was on board with Prince Muqrin’s promotions and the two are believed to enjoy a good working relationship.

Named head of the National Guard in 1962 and named Crown Prince in 1982, Abdullah came politically from outside the powerful “Sudairi seven” circle inside of the Saudi leadership (the seven sons of ibn Saud from Hussa Bint Ahmad Al-Sudairi, which included King Fahd and Princes Nayef and Sultan–who both served as Crown Prince and died within eight months of each other–and current Crown Prince Salman). With Crown Prince Salman eventually becoming King, a Sudairi son would again be on the throne and this could signal a shift back to policies more aligned to the United States, as was seen under the reign of the last Sudairi circle monarch, King Fahd. King Fahd was serving as King during previous periods when Saudi Arabia implemented oil market share oriented policies in 1985 and 1998.

When the current King was named Crown Prince in 1982, some Western commentators and Royal watchers raised concerns about Abdullah’s perceived reputation as a xenophobe who had a particular dislike of Americans and was open to more balanced ties with Russia. However, this proved to be an inaccurate assessment; rather the King proved to be willing to embrace a more regional focus and to remedy what he perceived as an unbalanced relationship between Riyadh and Washington. Indeed, since assuming more authority in the Saudi leadership in 1995 and then becoming King in his own right, King Abdullah demonstrated his willingness to undertake independent foreign policy stances and not always remain in lockstep with the United States on foreign policy and oil policy.

Beginning in 2003, it was with King Abdullah’s guidance that Saudi Aramco began shifting its market focus to Asia away from the United States, deciding it was more beneficial economically to concede its position as top oil supplier to the United States and instead be in the “top few” suppliers. At the same time, Riyadh also sent the political message that the Saudis were not going to acquiesce when Washington wanted support on foreign policy initiatives which deviated from the Kingdom’s national interests.

Relations between the United States and Saudi Arabia in recent years have seen the two allies take widely different stances on Iraq, Syria and Egypt. But the two countries have come together when it has been politically expedient for both of them, such as the Kingdom playing an active role in the airstrikes led by the United States on the Islamic State in northern Syria.

Over the past two decades, first as Crown Prince and then as King, Abdullah has been fully engaged in oil policy changes and has strongly backed Saudi Oil Minister Ali Naimi, who has served in his position since August 1995, and is now one of the senior members of the Saudi cabinet. As I referred to in my December 28^th blog post on the 2015 Saudi budget, the Saudis were willing to sacrifice much financially in the late 1990s to engage in a price war to protect market share.

It is important to note that during the height of the current price war being marshalled by the Kingdom, on December 8th the Saudi monarch maintained Minister Naimi in his post at the oil ministry while making dramatic shifts in his cabinet that saw changes to eight ministries, sending a clear message that King Abdullah supports the current Saudi oil policy and its ramifications at home and in the markets. Crown Prince Salman’s recent reading publicly a message on oil from the King would seem to imply that he too supports the current policy.

As succession issues have loomed large on the minds of those tracking the Kingdom in the past week, it’s hard not to give thought to the next generation of princes—the grandsons of Ibn Saud—who are being positioned in the line of succession. Within recent years, King Abdullah has made several strategic choices in appointing younger generation princes to ministerial positions. Notably, in November 2012, the Saudi monarch named Prince Mohammed Bin Nayef, the son of the late Crown Prince Nayef, as his Interior Minister, and in May 2013, King Abdullah created a cabinet position for the National Guard and appointed his own son, Prince Miteb Bin Abdullah, as its minister.

It bears mention that both of these younger generation princes have made official trips to Washington in the past several months, with Prince Miteb meeting with President Obama and Defense Secretary Chuck Hagel and visiting the U.S. National Guard Command in mid-November, and Prince Mohammed making a week-long visit in mid-December, meeting with President Obama, Vice President Joe Biden, Secretary of State John Kerry, and other senior officials in the Obama Administration.

Saudi Budget: Optimistic or Calculating?

It is fitting that the first post of this blog addresses the 2015 Saudi budget. As a fledgling oil journalist more than 20 years ago, I was assigned the OPEC beat, and because I had lived and worked in the region, my particular focus was on the Gulf producers within the organization. I began reporting on and writing about Saudi budgets back then and over the past two decades have continued to closely monitor them. Without understanding what the Kingdom is doing, you can’t get a true gauge of where OPEC is heading.

In announcing its new budget on December 25^th, Saudi Arabia may have signaled that it is willing to hunker down for a year of relative austerity based on ongoing low crude prices. Or the Kingdom is bluffing as it presumes errant fellow members of the Organization of Petroleum Exporting Countries (OPEC) and independent producers like Russia and U.S. shale producers will be forced to reduce or shut in output, allowing Riyadh and its Gulf allies to begin curbing production themselves to strengthen oil prices.

In fact, it likely is a combined strategy that the Kingdom is taking with its new budget, given that the budget appears to be based on higher average oil prices than analysts had predicted Riyadh would use. Although the expectation among some market watchers was that the Kingdom would base its new budget on a conservative average oil price of $60 a barrel, it appears the Saudi leadership wants to reassure the markets that oil prices will rebound, with a presumed average price of $80 a barrel needed to balance the Kingdom’s 2015 budget.

In the aftermath of the November 27^th OPEC meeting in which the Saudi-led move to maintain the group’s current production ceiling of 30 million b/d won out over a push by others to reduce output, Saudi Oil Minister Ali Naimi has stressed that OPEC (and one can easily read Saudi Arabia itself) should not cut its production at the expense of others who have already benefitted from increased market share.

In an interview with the Saudi Press Agency (SPA) on December 18^th, Naimi, noted that OPEC’s output, including that of the Kingdom’s, has remained relatively static for several years, while production from outside the organization continues to increase. Said the Saudi Oil Minister; “In a situation like this, it is difficult, if not impossible, for the kingdom or for OPEC to take any action that would reduce its market share and increase the shares of others, at a time when it is difficult to control prices.” A few days later, in an interview with the Middle East Economic Survey (MEES), Naimi suggested that the Kingdom was willing to play hard ball even if it meant a return to oil prices of the late 1990s. As quoted by MEES, the long-serving Saudi official said “…it is not in the interest of OPEC producers to cut their production, whatever the price is. Whether it goes down to $20, $40, $50, $60, it is irrelevant.”

Naimi continues to stress that he believes the slump in oil prices is temporary and that as the global economy begins to improve and high-cost producers are forced to trim output, prices will recover. However, the short-term prospects for crude prices certainly don’t bode well as the International Energy Agency (IEA) cut its forecast for the call on OPEC crude for the first half of 2015 on December 12^th, warning that if the oil cartel maintained its present production levels, oversupply in the market would hit 2 million b/d in the coming six months, when seasonal demand is traditionally weak.

The Kingdom’s 2015 budget, which was signed off on by the recently reshuffled Saudi cabinet, projects a whopping $38.6 billion deficit, which the government has suggested will be tackled by the regime tapping into its well-padded reserves. The budget for next year calculates spending at $229.3 billion and revenues at $190.7 billion. Projected income will be down some $88 billion or one third from 2014, largely attributed to the collapse in oil prices.

Riyadh can handily meet such a deficit, thanks to sustained oil prices averaging more than $100 a barrel from 2011 into the summer of 2014 that allowed Saudi Arabia to boost its foreign exchange reserves to $739 billion. Though the Saudi Finance Ministry claimed that the government would attempt in the coming year to reduce government salaries, wages and allowances, which contribute to about 50 percent of total budgeted expenditures, one has to wonder whether the leadership will indeed risk incurring more discontent within portions of the population already chafing over economic disparity, the government’s failure to move forward with political and social reforms and high unemployment.

The Saudi government will have posted its first budget deficit in 2014 since 2009, as total expenditures ran 29% higher to help generate a budget shortfall of $14.4 billion, according to the Finance Ministry.

The projected spending for 2015 of $229.3 billion is up nearly one percent from the planned 2014 budget. Finance Minister Ibrahim Al-Assaf had suggested the week before the new budget’s release that government expenditures would fund massive development plans in 2015, with spending on health care, education, social services and security as priorities.

One assumes that spending on security has been beefed up over the last year, both from the regime’s ongoing tensions with its minority Shi’a population and increasing threats from the Islamic State, as evidenced by the November attack on a Shi’ite mosque in the al-Ahsa region of the Eastern Province for which the Saudi government has claimed militants associated with the Islamic State are responsible. Saudi Arabia’s overall defense expenditures are not publicly disclosed and it’s not uncommon for some defense purchases to become off-budget items. But regional threats have prompted Saudi Arabia to boost its arms spending in recent years, with the Kingdom becoming the fifth largest arms importer in the world between 2009 and 2013, just behind fourth-place United Arab Emirates, according to the Stockholm International Peace Research Institute (SIPRI).

While basing their 2015 budget on $80 oil may have temporarily given the oil market confidence and provided a slight bounce in prices, the Saudis must recognize that reaching that price point is unrealistic given the demand picture for the coming year unless a lot of oil is taken off the market. But those chronic over producers within and outside of OPEC need only look at past history if they think Saudi Arabia will blink first and move to rein in its own barrels.

Back in the late 1990s, the Saudis were willing to endure several  years of budget deficits (without the safety net of the hefty financial reserves they have today) to get OPEC and non-OPEC members to come together on a joint agreement to reduce production rather than bear the brunt of the work themselves. On December 30^th, 1998, Riyadh released its projected budget for 1999 amid a price collapse that saw Saudi revenues from oil sales plunge 30 percent from $43 billion in 1997 to $30 billion in 1998 and the price of Saudi benchmark Arabian Light decline from $17 in 1997 to $11 in 1998. In its 1999 budget, the Saudi government had forecast a deficit of $11.7 billion, based on expected revenues of $32.26 billion and projected spending of $44 billion. The Saudis were believed to have based their 1998 budget on an expected price of $15-$16 a barrel for their crude exports, and for their 1999 budget appeared to use $9 a barrel for their budget base, with the price of West Texas Intermediate (WTI) having averaged $14.42 a barrel for 1998.

The Saudi heir apparent, Crown Prince Abdullah Bin Abdul-Aziz, had famously warned his fellow GCC leaders at a summit in early December of 1998 that “The period of boom has gone and will not come back. We must all get used to a different way of life, which does not stand on total dependence on the state.”

History is telling. In the spring of 1998, it took the diplomatic initiative of non-OPEC producer Mexico to cobble together an accord that eventually brought OPEC and several non-OPEC producers together to reduce overall production and allowed crude prices to slowly recover over several years. The question is whether the Saudis will be able to get that type of cooperation this time around.