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Saudi Arabia Admits Defeat

“God be with the citizens, we are back to the time of poverty,” wrote Saudi Arabian blogger Rayan al-Shamri on Twitter last week. That’s a bit strong, but he and his fellow citizens are certainly no longer living in the time of plenty. Saudi Arabia is cutting back on all fronts.

The wages of government employees accounted for almost half the the Saudi Arabian government’s spending last year: about $120 billion. And the country’s budget deficit, due to the collapse of the oil price, was $98 billion. So you can see why the government would go looking for some economies in the public sector.

About two-thirds of employed Saudi citizens have public sector jobs, many of which require them to do little beyond showing up on a fairly regular basis. It’s the unwritten contract that the absolute monarchy made with its citizens decades ago, when money was not a problem: you keep quiet politically, and we will subsidise your lifestyle handsomely. But the money isn’t there any more.

A royal decree on 23 September announced that government ministers’ salaries would be cut by 20 percent. Lower-ranking civil servants will have their pay frozen and their overtime payments and annual leave capped. Crown Prince Mohammed bin Salman has announced a plan to cut the public sector to only 40 percent of the working population by 2020. (In the United States it’s 7 percent.)

If this policy sounds a little less than drastic, that’s because the Saudi regime doesn’t dare cut harder for fear of a popular backlash. It cannot afford to let the “time of poverty” come back, and citizens who are used to being coddled and subsidised will define anything short of their current living standard as “poverty”.

So if the regime can’t get its budget spending down much, then it had better start getting the oil price back up before it runs out of money entirely and the roof falls in. This requires an about-turn in the market strategy it has followed for the past two years.

The Organisation of Petroleum-Exporting Countries (OPEC) only accounts for 40 percent of the world’s oil exports, which is marginal for a cartel that seeks to control the world oil price. Moreover, some poorer OPEC members regularly pump more oil than their quotas allow. So Saudi Arabia’s traditional role, as OPEC’s biggest member, was to cut production and get the world price back up when there was a glut of oil on the market.

When the oil price collapsed two years ago, however, Saudi Arabia didn’t do that. The regime was worried that the rapid rise in American oil production, mainly due to fracking, would ultimately destroy OPEC’s ability to set the price of oil. Its response was to pump oil flat out and let the price stay low, hoping that this would drive the high-cost US fracking industry out of business.

That was a foredoomed strategy, because the US government would even subsidise its fracking industry, if it had to, rather than give up on the dream of “energy independence” (self-sufficiency in oil production). In the event, that wasn’t necessary: even with the oil price at rock bottom, American oil production actually grew last year – and by now the OPEC producers are facing budgetary disaster.

At the OPEC summit in Algiers last Wednesday, Saudi Arabia publicly abandoned its strategy. OPEC will cut production by 700,000 barrels a day, starting next month. Saudi Arabia, as usual, will take the biggest share in the cuts – and if this round of cuts doesn’t get the price back up, there will presumably be a further round early in the new year.

The Saudis have even agreed that Iran, their great strategic rival in the Gulf region, can increase its production while everybody else in OPEC is cutting. (Iran, frozen out of the market by the American embargo for so long, has been claiming its old OPEC quota back now that the embargo has been lifted, and until last week Saudi Arabia was resisting its demand.)

A number of things are not yet clear about the new strategy. In particular, how to share the pain of production cuts between the OPEC members has not yet been worked out, so the market is not yet persuaded that these cuts are real.

The world oil price jumped 7 percent on first news of the OPEC decision, but is now back down to about the level it was at before the OPEC announcement. OPEC’s promises about cuts have been broken before. But this time they probably will be kept, because a lot of the producers are truly desperate for a higher price.

So, then, three conclusions. One, Saudi Arabia’s ability to set the price of oil, and OPEC’s power in general, is seriously impaired. Two, the oil price is going back up over the next year or so, though probably not beyond $70 or $80 a barrel. And three, that is really a good thing, because we need a higher oil price to drive the shift out of carbon fuels and into renewables.
To shorten to 725 words, omit paragraphs 3 and 11. (“About…more”; and “The Saudis…demand”)