Saudi Arabia has seen better days, at least for its storied oil industry. From playing the part of the world’s swing oil producer for decades, ramping up or pulling back production as it saw fit, its power over the oil market has diminished.
Due to the U.S. shale oil boom that caught everybody in the Oil Patch off guard, including most in the U.S., global oil markets have been awash in supply, putting tremendous downward pressure on oil prices, which are off at least 60% since mid-2014.
During the summer of 2014, prices reached $115 per barrel but then started trending downward, reaching $26 in January, bouncing back to the $50s range briefly this year. It’s now hovering in the mid-$40s range.
Saudi Arabia’s quandary, however, can’t be blamed just on massive U.S. oil output — it must also be placed at Riyadh’s door. The Kingdom made the infamous decision in November 2014 to abandon its role of supporting prices and actually increased output, despite a growing supply glut and lower prices.
In fact, Saudi Arabia has been producing crude at record highs; first, to keep prices low to drive more U.S. shale oil producers out of business, and secondly, to protect market share in Europe and Asia, including China’s massive oil market, against Russia (the world’s top oil producer, which is producing crude at post-Soviet-era highs of around 11 million bpd) and against an upstart Iran that is trying to reach pre-sanction oil production levels.
However, despite Saudi Arabia’s game plan to hurt other producers, it has actually hurt itself in unprecedented ways.
Riyadh has been burning through foreign reserve holdings. The Kingdom’s foreign reserve holdings, most of which are believed to be in U.S. dollars, dropped 16%, from the same period in 2015, to $555 billion. This marks a drop of $6 billion from July, and their lowest level since February 2012. Holdings peaked in August 2014 at $737 billion before prices tanked in July that year.
Saudi Arabia has also been running budget deficits. In spite of these problems, Riyadh still refuses to agree to a production freeze or a production cut, despite considerable rhetoric lately, particularly with Russia.
Last year, Riyadh ran a budget deficit of nearly $100 billion due to lower revenue from beleaguered oil prices. The deficit will be reduced this year, but marginally. Riyadh expects a budget deficit of $87 billion for the year. The government has been borrowing domestically and abroad to help reduce the deficit.
News broke two months ago that Saudi Arabia would issue its first international bonds, possibly around $10 billion, while Citigroup C +1.50%, HSBC and JPMorgan Chase JPM +0.80% would be hired as global coordinators for the sale.
Yesterday, Capital Economics said that the bond sale, expected for early October, could be a record-breaking deal for emerging markets, surpassing Argentina’s $16.5 billion international bond sale earlier this year, despite a relatively modest yield that could be as low as 3.5%.
“Saudi Arabia’s upcoming international bond sale has sparked a lot of investor interest and we estimate that the Kingdom will manage to sell its 10-year debt for a relatively low yield of 3.50%-3.75%,” wrote Jason Tuvey, Middle East economist for Capital Economics.
Funds from the sale will help Riyadh adjust to lower oil prices, while avoiding a devaluation of the riyal, its currency. Along with Saudi Arabia, Ghana and Nigeria, also oil producers, will also seek to raise cash from international bond sales.
Of course, another way for Saudi Arabia to offset its budget deficits and raise more revenue would be to reach some sort of OPEC and non-OPEC producers’ agreement to cut production, restoring markets to equilibrium, helping global oil prices finally find a floor, and a so-called “new normal.”
However, if the on again and off again rhetoric of the past few weeks is any indication of the future, global oil markets as well as Saudi state coffers will have a much longer wait.
Let the international bond sale begin.