News analysis

Saudi Arabia's defiant oil strategy may backfire on several fronts

Saudi Arabia's move to try to keep global oil prices low was intended to hurt its rivals - but experts now say its decision may be starting to backfire.

As oil prices started dipping in 2014 due to record production in the United States and Canada, the Saudis decided to continue pumping more oil to defend their market share - and also to economically squeeze energy-dependent rivals such as Iran and Russia. The events of the past few days - beginning with Riyadh's execution of Shi'ite cleric Nimr al-Nimr - have led some to conclude that Saudi Arabia is a country under stress, and its decision to suppress oil prices has come under intense scrutiny.

"The Saudis have to be careful how long they continue to follow their current strategy, which is akin to walking in a firepit covered in flammable oil," said Mr Nicholas Heras, research associate in the Middle East Security Programme at the Centre for a New American Security.

"The ability of the Saudi monarchy to provide extensive social welfare programmes for its population is closely tied over the long term to its ability to extract revenues from oil. Low oil prices undercut the ability of the Saudis to finance the social welfare system that their population has become accustomed to, and which in many ways limits the spread of dissent in the kingdom."


Saudi Arabia's Shaybah oilfield in the Rub' al-Khali desert. Riyadh depends on oil revenue for its extensive social welfare programmes, some of which have been cut recently. PHOTO: REUTERS

LIVING DANGEROUSLY

The Saudis have to be careful how long they continue to follow their current strategy, which is akin to walking in a firepit covered in flammable oil.

MR NICHOLAS HERAS, research associate in the Middle East Security Programme at the Centre for a New American Security, on Riyadh's refusal to cut oil production.

 

Mr Heras said that although threats of widespread dissent are not an immediate challenge, cracks are starting to appear.

Already there have been cutbacks in social welfare programmes.

A steep cut in fuel subsidies has also sent pump prices in Saudi Arabia shooting up 40 per cent.

Yet, at the last Opec meeting in December, Riyadh continued to push for the oil cartel to keep up production.

A brief from The Soufan Group, a strategic security intelligence firm, made it clear that the Saudis' two- pronged rationale has not changed.

On the economic front, Riyadh is hoping that low prices will drive fledgling US shale oil producers - who require prices to be around US$50 to break even - out of business. That would take the US supply out of the equation when prices start to recover.

On the geopolitical front, it hopes that weakening Russia and Iran will help its efforts in Syria, Iraq and Yemen.Shi'ite-dominated Iran supports Syrian President Bashar al-Assad while Saudi Arabia, the main Sunni power, backs the Syrian rebels . Riyadh also believes that a weaker Teheran will exert less influence on Baghdad and it will mean less support for Iran-backed Houthi rebels in Yemen.

The Saudis also assume that the smaller populations - relative to Iran - in Gulf countries would be better able to weather the economic costs.

Those assumptions are now being challenged.

The International Monetary Fund recently warned that Saudi Arabia could exhaust its reserves in five years if oil remains below US$50 a barrel. Oil prices have crashed from over US$100 a barrel in 2014 to around US$36 today.

Riyadh claims its Budget is predicated on the average crude price being just US$29 a barrel. Those projections include a nearly US$90 billion (S$129 billion) Budget deficit this year despite cutting US$36 billion in spending.

But experts also say turning the policy around is easier said than done. A slow recovery in Europe and a faltering Chinese economy mean global demand for oil is down and a Saudi change in tack may not have the desired effect.

Said Dr Jon Alterman, director of the Middle East Programme at the Centre for Strategic and International Studies: "I don't see any signs the Saudis are reconsidering their unwillingness to cut production... With the current market glut, they see a cut in production drawing down supplies in storage without raising prices. They'd lose both income and market share."

A version of this article appeared in the print edition of The Straits Times on January 08, 2016, with the headline 'Saudi Arabia's defiant oil strategy may backfire on several fronts'. Print Edition | Subscribe