Saudi Arabia has decided not to cut oil production in response to falling prices because it determined this was in its long-term economic interests. Saudi Minister of Petroleum Ali al-Naimi has consistently held that Saudi oil policy is motivated by a desire to defend market share and to drive the least efficient producers from the market.
Naimi’s logic certainly stands up to scrutiny. Saudi Arabia’s extremely low cost of oil production, its spare capacity, and its abiding interest in profiting from its enormous reserves govern Riyadh’s rational market strategy, marked by an unwillingness to cut production. Low production costs and excess capacity together make Saudi Arabia’s calculus very different from that of other producers. If and when Saudi decisionmakers decide to introduce some of the kingdom’s nearly 3 million barrels per day of additional oil, they stand to make a great deal of money, whatever the price. In the meantime, by preserving its status as the only swing producer, they ensure Saudi Arabia maintains considerable power in oil markets.
The harm done to Riyadh’s geopolitical rivals has been a nice ancillary benefit, but it was not a central motive, despite what analysts and even heads of state—such as Iran’s Hassan Rouhani—have argued. The claim that the Saudis would cripple their main source of revenue in order to punish Iran and Russia is a dubious one at best. Throwing away billions of dollars in the faint hope of achieving distant foreign policy goals directly translates into much less money for salaries, subsidies, and development projects. And as Fahad Nazer has pointed out, if the Saudis were targeting their enemies, the timing also makes little sense.
The decision not to try to keep oil prices high is indeed a big bet. But the Saudis had few pragmatic policy options. Cutting production would only allow the Russians and others a free ride, encourage new production, and thereby depress prices further. So instead the Saudi leadership, confident that oil prices will recover relatively quickly (that is, within two or three years) and that the government can manage the effects of reduced oil revenues, chose door number two.
Nonetheless, low oil prices are a glaring reminder to Saudi officials that they must get serious about diversification efforts and begin to implement real spending and labor reforms. Yet they do not imply the implosion of the Saudi economy or the collapse of the state. Indeed, the Saudi government can withstand several years of low oil prices, but in the long run it will confront major challenges unless major reforms are enacted. Yet the big question is when: if the price of oil settles in the $50-$60 range—as analysts at most major banks are predicting—and the Saudi government can implement even moderate reforms, then it may be several decades before the kingdom faces a serious fiscal crisis.
Without a doubt, a sustained period of significantly reduced revenues would require the Saudis to find creative ways to cut spending. But the government will delay cuts to salaries and subsidies for as long as possible. For the time being, the 2015 budget indicates that the government is willing to keep spending, even on capital projects, in order to maintainconfidence in the Saudi economy. Interestingly, while absolute spending has risen dramatically since 2002, and especially since 2011, it has remained steady as a percentage of GDP (between 30 and 35 percent) since the early 1990s.
Many analysts have paid lip service to Saudi Arabia’s privileged financial position, but its vast reserves are not fully appreciated by most. The government could run a deficit of $38.6 billion—the projected amount for 2015—every year for over a decade before its reserves dry up. Although nobody expects spending to remain flat, Saudi Arabia could certainly borrow if needed, as the country has the lowest debt-to-GDP ratio in the G20. This is to say nothing of the potential to increase returns on foreign holdings. Minister of Finance Ibrahim al-Assaf recently rejected calls to establish a sovereign wealth fund to more aggressively manage Saudi reserves, which are thought to be invested quite conservatively. But if the Saudis wanted to try to make money, the returns could be substantial and would therefore improve the kingdom’s finances.
Within Saudi Arabia, there are open calls for transparency, good governance, and economic diversification. There is also a healthy dose of skepticism about whether the Saudi government is pursuing the right approach. Managing public perception will be key for the Saudi government. So too will expanding the role of the private sector in the Saudi economy, as public spending will eventually be scaled back.
In several years and with the benefit of hindsight, the Saudi decision to maintain production will be considered either brilliant or boneheaded. But for now, it seems to be a strategic one that just might be the Saudis’ best bet.