Saturday, February 06, 2016

Saudi's brinkmanship is wilfully causing severe hardships in some countries

I have been trying for some time to get my head around just why Saudi Arabia is pursuing its apparently calamitous path in pushing down the price of oil, and a timely article in the ever-dependable Globe and Mail has helped me along with that.
The aim of the Saudi regime, as I already knew, is to choke off more expensive oil production elsewhere (USA, Canada, Brazil, Nigeria, etc), and preferably to put those industries out of business permanently, although that seems like something of a forlorn and implausible hope. Saudi's cost of producing oil is as little as $10/barrel, significantly less than most other sources, and in particular much less than the relatively expensive Canadian oil sands and US shale oil. So, by increasing their supply and forcing down the price, they hope to compel the world markets to buy from them and not from their competitors.
With few considerations other than price holding much sway among oil consumers, that actually seems like a valid strategy, and indeed seems to be working, at least to some extent. The days of price-fixing by the OPEC cartel seem to be well and truly over, as Saudi Arabia ploughs its own lonely furrow. Hell, it has turned the whole basis of supply-and-demand economic theory on its head, based as it is on the assumption of rational actors.
Yes, the Saudi oil industry itself is seeing a huge diminution in its profitability, offset to some extent by the higher turnover, but after decades of building up reserves (particularly during the salad days of triple-digit oil prices), they are able to ride out the consequences for some time. Before this play began, they had reserves of as much as $800 billion by some estimates, and more recent counts still put this at a relatively comfortable $600 billion.
But this is not something they can keep up indefinitely. It is estimated that, in 2015, Saudi Arabia required an oil price of about $100/barrel in order to balance their budget, whereas the average price in that year was maybe half that. In 2016, due to "austerity measures" (whatever that might mean in Saudi terms), a price of $77/barrel would be needed to balance the books, whereas the actual price is looking like less than half of that. Saudi Arabia will continue to burn through their reserves, then, and who knows how long they will be willing to continue to do that
In the meantime, though, there are other less prosperous countries who are on the brink of collapse, all as collateral damage in a power-play by one rapacious country's trade policies. Probably top of that list is Venezuela, which has huge oil production capacity and is sitting on massive reserves (at least equal to those of Saudi Arabia). Venezuela, though, is a failed state with few friends, eternally teetering on the edge of chaos and the abyss. It has built up no financial cushion, and is recently seeing shrinkage in its economy of around 10% a year. Inflation is running in the triple digits, its currently is essentially worthless, and its budget deficit is around 20% of its GDP. Venezuela will not last long in this climate. And, as usual, it is the poor and the already needy who will suffer the most.
Little Suriname, just next door, is in a similar position. Libya, which would need an improbable oil price of about $180/barrel to balance its own budget, is looking very shaky. Russia requires about $100/barrel, and Kuwait at least $80/barrel, in order to do so much as break even, and they are clearly not going to get it for some time. Nigeria had some reserves from the good times, but these are now at least half gone and dwindling rapidly. And we think Alberta has it bad!
Saudi Arabia has never been big on courting friends, but, as whole countries go under in their pursuit of profit, they have ventured beyond the pale. Long a pariah socially and politically, they are now a pariah economically and commercially. Only time will tell just how far the country will take this reckless brinkmanship, and how much suffering and hardship it will cause in the meantime.

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