PetroFinance: Saudis on brink of financial crisis

The economy of Saudi Arabia is on the brink of a crisis, because of growing domestic and external deficits caused by the collapse of oil prices.

This is the view of Petroleum Finance Co., Washington, D.C., which estimates that the kingdom's budget deficit was more than 9% of gross domestic product (GDP) in 1998, with no relief expected in 1999.

Inaction not an option

"Faced with the prospect of increasing economic difficulties in the medium term," said PetroFinance, "and continued erosion in both its market share and oil prices, doing nothing is not an option for Saudi Arabia."

Short of a significant boost to oil prices this year, combined spending cuts and new revenue-generating measures are not expected to bring debt below 9% of GDP this year.

PetroFinance reckons Saudi Arabia has two options to address its economic difficulties: a short-term program to defend oil prices, and a long-term pursuit of market share.

Defending prices

"A price-defense option," said Petro-Finance, "would call for Saudi Arabia to take the lead in restraining production and break the sanctity of the 8 million b/d production floor, cutting output proportionately more than other OPEC (Organization of Petroleum Exporting Countries) countries-50% of a 1.5 million b/d overall reduction."

The analyst said this would reduce Saudi production to 7.25 million b/d of oil and help purge high oil inventories, pushing oil prices to an estimated average of $17/bbl in 1999. This would bring an immediate boost to Saudi finances, but the gains would be short-lived because higher oil prices would encourage further OPEC and non-OPEC production growth, leading to weaker prices relatively quickly.

Defending market share

"Defense of market share is a longer-term strategy that entails a fundamental shift in Saudi oil and national economic policy," said PetroFinance.

"Under this option, the kingdom would seize the opportunity presented by the low oil price environment to recapture significant market share and marginalize high-cost producers. "By allowing prices to remain at $11-12/bbl (WTI) for 2-3 years, Saudi production would grow from 8.3 million b/d in 1999 to 11 million b/d in 2003.

"This policy would increase the economic pain in the short term, but would secure a more viable production and revenue profile in the medium term."

PetroFinance said Saudi Arabia's pursuit of market share would trigger a total restructuring of the energy business. Oil prices would become structurally lower and technological development and cost-cutting would be undermined by removal of all production with costs exceeding $8/bbl.

"The implications of the second option for the global oil industry would be colossal," said PetroFinance. "The map of oil and gas exploration would be redrawn in favor of low-cost producers in the Persian Gulf."