After US President Donald Trump’s tweet about discussing an agreement with Saudi Arabia to pump an extra two million barrels a day, speculation about the immediate future of oil continues to haunt boardrooms and the market.
The previous OPEC agreement to keep oil prices at a steady level ranging between $60 and $80 USD a barrel may have been engineered by Saudi Arabia and Russia working in tandem, but its greatest impact will almost certainly be seen in the Kingdom’s oil (and post-oil) policies. With Trump’s tweet, the US sought to shock the market as a warning to upcoming energy sanctions against Iran.
Weaning away from oil is a primary goal of Saudi Crown Prince Mohammed bin Salman’s Vision 2030. This Saudi plan seeks to transition the country to a diversified economy for the first time in its modern history. Until that future economy takes shape, however, the outlook for oil and oil prices have a direct impact on the Kingdom’s ability to carry out its reform efforts. That fact makes maintaining market stability critically important.
Despite Trump’s tweet, Riyadh continues to reach out to its erstwhile foes in Moscow to secure that stability. Saudi oil minister Khalid Al-Falih and his Russian counterpart Alexander Novak also produced a number of ancillary pledges, from deepening bilateral oil and gas cooperation and promoting oil and gas as key components in the global energy mix. Together, they have made ROPEC – that is to say Russia and OPEC – a reality.
This bilateral cooperation marks a significant shift in the politics of global oil, but the two countries can’t entirely stabilize the market on their own. While both the Russians and the Saudis want to carefully increase global production, their plans had to overcome a contentious back and forth at OPEC’s summit in Viennabefore winning acceptance. Going into the summit, Iran, Iraq, Algeria and Venezuela all made clear they opposed a production increase.
Even if Russo-Saudi cooperation has won over the other oil producers, there are still global market realities to contend with. The ROPEC deal comes just as American sanctions on Iran and fluxuating political and economic conditions in Venezuela, Nigeria, Libya, and Iraq threaten to weigh on the global oil supply. Washington hopes other nations will join its call to drop out of the 2015 nuclear deal, thereby isolating Iran through crippling sanctions. In reality, Tehran will find buyers for its oil and the Iranian economy will slump along despite the sanctions and its own massive structural problems.
If the pressure convinces Iran’s leaders to restart their nuclear program – or if other geopolitical events like the Qatar standoff create a sense of regional instability – the new ROPEC agreement will only go so far to keep prices manageable. This is the reality of the global oil trade: hot-button issues will invariably produce spikes or drops in prices, with each short to medium term fluctuation impacting Saudi Arabia’s budget and expenditures and shaping the pace and scope of Saudi economic performance. The main purpose of Vision 2030 is to help Saudi Arabia step off that roller coaster and built a more stable, predictable economic model, regardless of twitter talk.
Whatever the price of oil today, tomorrow or next year, Saudi Arabia must remain committed to its market reforms and privatization initiatives to break the cycle. Higher oil prices provide welcome financial cushion, but if the reduced budgetary pressure causes the Saudi leadership to lose focus on economic changes, the country as a whole will remain highly exposed to future shocks.
The leadership is currently sticking to the script. The IMF determined Saudi Arabia is making “good progress” in implementing reforms to help spur economic growth. The Saudi government’s commitment to wide-ranging economic and social reforms to transform the economy has helped reassure investors, as have the promising economic figures coming out over the past few months. Growth is expected to pick-up by the end of 2018 and accelerate thereafter. Saudi Arabia’s gross domestic product (GDP) is estimated to rise to 1.7 percent from a contraction of 0.7 percent in 2017. The economy will accelerate further in 2019 to 1.9 percent growth, as oil output increases in accordance with the agreements between Saudi Arabia and Russia over production.
The economic math is simple, if ironic: Saudi Arabia needs oil revenues to build a post-oil economy. High prices translate into job creation, which is the centerpiece of the Crown Prince’s reform efforts. Lower oil prices will conversely slow down those reform efforts especially to parlay investments in other opportunities in the energy field, including renewables and carbon capture and storage (CCS).
As Saudi Arabia moves towards a non-oil economy, it will also have to start allocating its budget accordingly, setting more money aside for projects unrelated to the energy industry. How much money and for which projects will be determined based on the scale of reform measures and the sense of urgency that comes with the transition to renewable energies and the need to provide jobs for young Saudis. Saudi Arabia is targeting a balanced budget by 2023; the price of oil is going to be a major factor in reaching this important fiscal objective.
The greatest challenge may be breaking with a long tradition of past failures. Previous Saudi reform efforts have stalled on a number of different fronts, largely because of a combination of fluctuations in oil price and an excessive focus on major, nationwide projects such as the Six Economic Cities. This time, the Crown Prince and the Saudi government should stay focused on the course of mixing supply and demand to build up other sectors of the Saudi economy as the global energy market shifts because of pending Iran sanctions. The more the Kingdom invests in its post-oil future, the sooner it can look forward to the day when the price of oil will no longer make or break the pace and scope of Saudi reform.