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 25th, 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 27th 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 18th, 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 12th, 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 30th, 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.