Saudi Arabia’s brutal six months: a mix of bad timing and big mistakes

It’s been a humbling half-year for Saudi power. Though the coronavirus pandemic has ravaged oil demand and the public listing of Saudi Aramco came at a terrible time, the Kingdom has made several mistakes that have made the situation worse: the oil price war worsened the oil glut, the IPO was less than the Crown Prince wanted, and the prospect of winning the war in Yemen increasingly unlikely

Scott McKnight – April 25, 2020

The last half year has been brutal for Saudi Arabia, the world’s largest oil exporter and whose sprawling and hyperconservative government relies on about 70% of oil receipts for its financing. Although the Covid-19 pandemic has led to a catastrophic collapse in oil demand and punished what was supposed a coming-out party with the initial public offering (IPO) of Saudi Aramco, this article argues that some of Saudi Arabia’s misfortunes were of its own making: its month-long price war strategy backfired, exacerbating the oil glut and exposing the limits of its influence over the world oil market; the IPO of Saudi Aramco, the crown jewel of the Saudi economy, occurred just before the pandemic shuddered big parts of the global economy and turned out to be much smaller than the Crown Prince’s wishes; and the five-year-long war in Yemen has devolved into a quagmire and made Saudi Arabia neither safer nor more influential in Yemen or the region.

The oil price war

The widespread coronavirus-induced stoppages have absolutely decimated oil demand. For the month of April, nearly 30m barrel per day (bpd) of oil demand has been eliminated from its totals at the end of 2019. In anticipation of this demand collapse, Saudi Arabia proposed cuts of 1.5m bpd at the so-called ‘OPEC+’ meeting in Vienna on March 6, a sum that was laughably short of what was needed. After Russia rejected the proposal, Saudi Arabia opened the taps and produced at maximum capacity, hitting a record 12.3m bpd at the end of March.

The choice to launch an oil price war needs to be put into context. For the last five years, Saudi Arabia has been cutting its own production to stabilize prices, while other producers, including Russia as well as non-OPEC producers like Canada and the many ‘frackers’ of the United States, increased output and gained market share at the Kingdom’s expense. That must be acknowledged.

The five-week-long oil price war served its short-term objective It induced not only Russia but the world’s top- and middle-tier oil producers to discuss and eventually agree to production cuts over the Easter weekend. That part makes the flooding of the market seem like a ‘masterstroke’, as Antoine Halff, chief oil analyst at the IEA has argued.

But if the collapse in oil demand was the inevitable outcome of the unforeseen—and unforeseeable—global pandemic, and thus outside of Saudi Arabia’s control, the ramping up production was very much within the Kingdom’s purview. Saudi Arabia, in launching its war for market share, greatly contributed to the supply side of the double shock, or what McNally called the ‘black swan’ event.

With restrictions of travel and industrial activity still widespread across the world’s biggest economies, the oil market suffering a series of ‘micro-bottlenecks’ and storage rapidly filling, the market is on the brink of an unprecedented crisis—and one to which Saudi Arabia has contributed and exacerbated.

The Aramco IPO: It couldn’t have come at a worse time

The public listing of Saudi Aramco, the crown jewel of the Saudi economy and world’s most profitable company with $111.1bn in yearly net income in 2018, finally occurred after years of delays and negotiations over the company’s valuation. What was supposed to be a celebration of the Kingdom’s reforms and grand modernization project instead has taken place just before world oil prices have plummeted.

But this masks the serious concerns about the IPO that preceded the coronavirus-led global economic crisis. Saudi Aramco, though formally a national oil company in that it is state-owned and in service of the Kingdom’s objectives, features a unique genetic makeup, being the love child of some of America’s biggest and most efficient oil companies, including Chevron, Texaco, Exxon and Mobil (then separate), among others. (The name Aramco is an amalgam of ‘Arabia’ and ‘America’ and ‘company’). Likewise, before the oil price war, Aramco produced about 10m bpd, or about 11% of world oil, and also monopolizes the largest reserves in the world, including several absurdly generous fields that help explain the company’s unparalleled profitability and extremely low lifting costs (about $3 per barrel).

The Kingdom, now under firm guidance of Crown Prince Muhammad bin Salman (or MBS, as he’s popularly known in the West), has sought to harness Aramco’s deep pockets and technological knowhow to diversify away from an oil-dependent economy. While MBS personally wanted a valuation at US$2 trillion for the floating of 5% of the company, even big banks and countless Western consultants, all jostling to be contracted to prepare the listing, nevertheless saw that figure as excessive. Instead, their estimates ranged from $1.1-1.5 trillion, a mind-boggling sum and still enough to make it the world’s largest IPO (passing Alibaba in 2014), but one that fell short of MBS’s expectations. The crown prince, apparently livid over that consensus, instead opted to list 1.5% of Aramco’s shares for $1.88 trillion on the Tadawul, the Saudi exchange.

Source: Moody’s, Bloomberg

Why were Western investors unwilling to go along with the MBS’s $2trn valuation? For one, oil prices have remained anemic for the past five years, hovering in the $50-60 range. Second, the stigma of investing in an oil and gas company—even if the world’s largest and most profitable—contradicts the rise of ‘green’ finance, the ESG (environmental, social and governance) discourse and inevitability of tighter carbon-limiting legislation. Indeed, some have argued that Aramco’s listing is a sober recognition that we’re heading toward a global economy where fossil fuels are less dominant than today. Aramco’s purchase of a $15bn stake in Reliance, a petrochemical giant, indicates that while the oil for the combustible engine may be nearing its end, petrochemicals are not as easily replaceable and may represent a haven for investment.

Prince Abdulaziz bin Salman (left) in Vienna in July 2019, with Khalid Al-Falih (right), long-term face of Saudi policy and go-between at OPEC. Source: Agence France-Presse

Third, the September drone strikes on a massive Aramco processing facility, allegedly done by Shia rebels (known as Houthis) with Iranian backing (more on that below), reminded the investing community of the security risks of a region where oil and geopolitics dangerously mix.

The drone attacks of 14 September 2019 on the Saudi Aramco oil processing facilities at Abqaiq and Khurais in eastern Saudi Arabia.

Finally, there are questions over political interference in the company, especially from MBS himself, the micromanager and ruthless practitioner of realpolitik, who outmaneuvered dozens of contenders to succeed his 84-year-old father (hence his title of Crown Prince). This became evident to the West from the dismemberment of Jamal Khashoggi, Saudi journalist and critic of the regime. MBS is widely seen as the reason for the appointment of Prince Abdulazziz bin Salman, an MBS loyalist (Prince Abdulazziz is MBS’s half-brother) to serve oil minister in September, replacing Khalid Al-Falih, the architect of Saudi oil policy and interlocutor between Saudi Arabia and OPEC.

Since its listing in mid-December, the share price of Aramco has dipped from its peak of 38 to 30 Saudi rivals. This minimal decline, given the bloodbath to oil company stocks in other markets, may be less an indication of objective market confidence in the company than the mix of coercion and patriotic sentiment from domestic investors as well as MBS’s unspoken guarantee to not let the share price fall too low.

Saudi’s quagmire in Yemen

The third factor that has exposed the limits of Saudi power is unquestionably the most self-inflicted of the three. On April 8th, the Saudi government announced the unilateral ceasefire in Yemen, citing Covid-19 as the reason. The war in Yemen, meant to demonstrate the Kingdom’s ability to project power beyond its border—even if in a neighbouring country that is also the poorest in the region—has dragged on for five years with nothing but blood and devastation to show for the enormous treasure that the Kingdom has expended on the effort.

Several reasons have prompted the Kingdom to push for some Nixonian ‘peace with honour’. First, the United Arab Emirates (UAE), key ally in the Saudi-led coalition, drew down troops since last August. UAE special forces, weathered from their Afghan experience fighting alongside ISAF forces, were vital to the ground effort. By contrast, the Saudis have executed an air war, which has contributed to the rampant destruction of Yemeni infrastructure, including hospitals and schools, and deaths of some 100,000 Yemenis. The UN considers the Yemeni situation the worst humanitarian crisis, with three-quarters of its 28m needing some kind of humanitarian aid.

Second, the Saudis have hosted the exiled Yemeni government since its overthrow in late 2014. But it’s unclear how the Saudis would be able to return this exiled leadership to power and how popular it would be if that somehow came to pass.

Third, despite the carte blanche given by the Trump administration to the Saudi war effort, including several presidential vetoes to continue arms sales to the Saudis, the Houthi rebels with Iranian backing continue to make headway, leaving the prospect of a victory for the Saudi-led coalition—itself extremely fragmented—even less likely than before.

Conclusion

The last half year has revealed the limits of Saudi power, a process that has been a mix of terrible fortune as well as the Kingdom’s own doing. The ramping up of oil production, a trusted tactic to bring order to the oil market, this time has only exacerbated the crisis in oil markets, adding to a lake of oil that has no place to go and few end-users to burn it. The Aramco IPO, after years of delays, was a limited version of what MBS envisioned and came about at no worse time. That part may be forgiven. When the global economy recovers—however many years that may indeed require—Aramco will still be enormously profitable. The ceasefire in Yemen has been the starkest display of Saudi impotence and a textbook example of the difficulty of translating oil wealth into military power (what political scientists call ‘fungibility’). The coronavirus pandemic has provided a cover to push for peace in Yemen, though there are no guarantees that the anti-Saudi forces are willing to stop, likely making the brutal half-year for the Kingdom even worse.