Saudi Arabia's oil policy, unveiled just under two years ago at the November 2014 OPEC meeting where it effectively splintered the OPEC cartel by announcing it would produce excess quantities of oil in hope of putting shale and other high-cost producers out of business, has backfired spectacularly. OPEC has failed to crush the U.S. shale industry, which as a result of increasing efficiencies and debt-for-equity exchanges has seen its all in production costs tumble. This has made far cheaper oil prices profitable (especially with the addition of hedges), not to mention Wall Street's ravenous desire to buy any debt paper that offers even a modest yield, allowing U.S. oil producers to delay or outright avoid bankruptcy.
But while shale has avoided annihilation, it is Saudi Arabia that has been suffering. In "Kingdom Comedown: Falling Oil Prices Shock Saudi Middle Class", the WSJ reports that "a sharp drop in the price of oil, Saudi Arabia’s main revenue source, has forced the government to withdraw some benefits this year—raising the cost of living in the kingdom and hurting its middle class, a part of society long insulated from such problems."
The kingdom is grappling with major job losses among its construction workers—many from poorer countries—as some previously state-backed construction companies suffer from drying up government funding. Those spending cuts are now hitting the Saudi working middle class.
Saudi consumers in major cities, the majority of them employed by the government, have become more conscious about their spending in recent months, said Areej al-Aqel from Sown Advisory, which provides financial-planning services for middle-class individuals and families. That means cutting back on a popular activity for most middle-class Saudis: dining out.
“Most people are ordering less food or they change their orders to more affordable options,” she said.
We have previously documented the soaring interbank funding costs and plunging bank stock prices, but that's just part of it: Saudi's entire economy is suddenly collapsing. To boost state finances, Saudi Arabia cut fuel, electricity and water subsidies in December, after posting a record budget deficit last year. It also plans to cut the amount of money it spends on public wages and raise more non-oil revenue by introducing taxes. But in response to these moves, inflation more than doubled from last year to about 4 percent now, crimping consumers even more.
Making matters worse, Saudis are beginning to speak out about a sense of anxiety about the economy. “I think we are going through a difficult period,” said Emad al-Majed, a Riyadh-based pharmacy technician. “There will be suffering.”
Which is probably why as OPEC prepares for an "informal" meeting in Algiers this week, Saudi Arabia is now officially panicking and, according to Algeria's oil minister, is prepared to slash its production by as much as half a million barrels.
As Bloomberg reported, Saudi Arabia offered to cut its oil output to January levels, according to Algeria’s energy minister, as the group’s members seek ways to stabilize crude prices at talks this week in Algiers. “Saudi Arabia is ready to freeze production at the January level,” Boutarfa said, calling the offer “an interesting step.” Saudi Arabia pumped a record 10.69 million barrels a day in August compared with 10.2 million in January, data compiled by Bloomberg shows.
Fellow OPEC member Algeria wants the group to cut its collective output by 1 million barrels a day, Boutarfa said.
However, for that to happen, Iran would have to agree to curb its output at current levels, which is precisely the intent of Saudi Arabia, which went into a production spree in the past few months, just so it can appear to be "generous" with its production cut offer which will keep the Kingdom's output just shy of all time high supply, while impairing Iran's ability to capture further market share, mostly in India, Japan and various other Asian importers.
The oil market is in a “much more critical” state than when the Organization of Petroleum Exporting Countries last met three months ago, and its members must seek ways to shore up crude, possibly by freezing or trimming production, Noureddine Boutarfa, said Sunday in an interview. Aside from the Saudis, producers have made additional proposals, he said later at a news conference, without giving details. OPEC ministers plan talks in the Algerian capital on Sept. 28.
While a few months ago analysts were giving assurances that the global market would return to balance as soon as a few months ago, today markets remain oversupplied by as much as 1 million barrels if not more. According to Bloomberg, more than 800,000 barrels a day of additional crude is flooding into the global market this month compared with August as Russia pumps at an all-time high and Libya and Nigeria restore disrupted supplies, according to statements from their ministry officials in those nations. The surplus will last for longer than previously thought, persisting into late 2017 as demand growth slumps courtesy of a suddenly plunge in Chinese teapot refinery demand, as well as a slowdown in Chinese imports to fill the country's almost full strategic petroleum reserve, while supply - mostly out of the U.S. - proves resilient, the International Energy Agency said. Tumbling crude has put financial pressure on OPEC members from Saudi Arabia to Gabon.
In fact, some calculate that even an 800,000 barrel cut would not be sufficient to bring the market back into balance.
Meanwhile, it is not just Saudi Arabia who is panicking: “The situation since the last meeting in June has worsened, the situation is much more critical,” said Boutarfa, who’s been involved in talks with Saudi Arabia and other members in the run-up to the meeting. “So it’s important to see what measures can be adopted in the short term and very short term to find a solution to this situation that isn’t helping any OPEC country.”
That said, it's all up to Iran, which is currently resolutely refusing to cut production, knowing it can easily capture market share even if the price of oil remains under pressure and capping maximum potential revenues.
Saudi Arabia and Iran, whose rivalry blocked a deal with other major producers in April, did not reach an agreement after two days of preparatory talks in Vienna, including a Saudi offer to pump less crude if Iran caps output at current levels, according to two people familiar with the negotiations. Saudi Arabia doesn’t anticipate any formal decision on supply in Algiers, a delegate familiar with its policy said.
The main difference between the Algiers talks and producers’ failed attempt to agree on a freeze in April in Doha is that Iran will be present for this week’s discussions. Iran is more concerned with its market share than with actual output levels, Boutarfa said.
OPEC’s talks in Algiers will be informal but can be converted into an extraordinary meeting, which could result in a decision by the group, Boutarfa said.
While odds of a deal in Algiers are virtually nil, keep an eye on oil volume: with a barrage of "headlines" (mostly from anonymous Reuters "sources") imminent, the only guaranteed move is that oil will move dramatically higher and lower in the next three days.
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