Saudi Arabia Cuts Subsidies As Budget Deficit Soars

The price of crude oil has dropped so low that Saudi Arabia is facing a growing budget deficit, prompting the rich oil kingdom to make sharp cuts in its budget, levy new taxes and reduce government subsidies for water, electrical power and even gasoline.

This is an abrupt change in the country, OPEC's largest oil producer, which has used its vast oil revenues to prop up the national economy to serve a population of about 30 million people. But even Saudi Arabia can't sustain such practices when it runs a $98 billion deficit this year - about 15 percent of its gross domestic product.

As a result, Riyadh announced Monday it will cut government spending by 14 percent in the coming fiscal year as it sees no quick end to the depression in oil prices, especially now that Iran, expected to be free of Western sanctions in the near future, will return to the global oil market. Related: Oil Crash Shrinks Russian GDP; Energy Minister Blames Saudis

And without even waiting for 2016 to arrive, the government immediately raised the price of retail gasoline by 50 percent, from 0.60 of a riyal to 0.90 of a riyal per liter of premium gasoline - or from 16 cents to 24 cents. That may not seem a huge cost compared with even today's lower gasoline prices in the West, but it's crucial in a country that relies on cars because there is no public transportation.

Certainly the low price of oil isn't the only reason Saudi Arabia is running a deficit. It's also spending generously on military action in the Middle East. It is giving financial support to rebels opposed to Syrian President Bashar al-Assad, whom Riyadh wants out. And since last spring it has waged an air war in Yemen against Houthi rebels, who are supported by Iran, a religious rival of Saudi Arabia.

But the biggest reason for the deficit is the price of oil. In June 2014, the average global price for a barrel of crude was above $110. Increased production in non-OPEC countries began to create a supply imbalance, putting downward pressure on oil prices. Now a barrel of oil costs less than $40. Related: Warren Buffett Beats Elon Musk In Nevada

How did Saudi Arabia get to the point where it lacks the wealth to basically subsidize its entire society? Call the wound "self-inflicted." More than a year ago, OPEC's less affluent members were hoping that the cartel would take some kind of action - presumably lower its production ceiling - to help halt the fall in oil prices.

At the time, Venezuela, for example, relied on oil sales for 96 percent of its income, and Iran, whose revenues already were being limited by Western sanctions over its nuclear program, needed to get the best price for what little oil it still was capable of selling. And back in December 2014, 10 of OPEC's 12 member states reportedly could no longer rely on oil exports to balance their budgets.

But at OPEC's ministerial meeting in November 2014, the cartel, led by Saudi Arabia, decided to maintain production levels to keep oil's price falling and eventually make production unprofitable for drillers, primarily in North America, who had been relying on the relatively expensive technology of hydraulic fracturing. Related: The New Cartel Running The Oil Sector

The architect of this strategy was Saudi Oil Minister Ali al-Naimi. He explained that it eventually would allow OPEC to reclaim the market share it had lost to competitors. So far it's worked, at least by reducing U.S. production significantly.

But the conventional wisdom at the time was that, despite the plight of such countries as Venezuela and Iran, OPEC's richest countries in the Gulf region could afford to wait out the Americans. It appears that conventional wisdom missed the mark, and now even Saudi Arabia has begun to succumb to oil prices that it deliberately kept low.

By Andy Tully of Oilprice.com

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