Monday, Saudi Arabia's oil minister tried for a second day to "talk up" oil prices by stating the the Kingdom was willing to work with OPEC and non-OPEC producers to stabilize the market. Prices rebounded after his statements. However, his words couldn't stop a reversal in oil prices when it was announced that stockpiles had grown at the Cushing, Oklahoma oil hub.This made for a volatile day in crude futures.
The message by Oil Minister Ali al-Naimi was the same as Friday: The oil market was unstable, and that all oil producers needed to work together to stabilize prices. He also said that the cutback in exploration would come back to haunt some countries, as output in old oilfields fall. MarketWatch reports market analyst Naeem Aslam as saying "If the Saudis do not deliver what they have said... we could see the oil price dropping below the $35 level."
Can Saudi Stand The Pain of Low Oil Prices?
Some analysts take these back-to-back statements as a sign that Saudi Arabia is hurting from the low oil prices it has helped cause. Their idea last year was to force the burgeoning US shale fracking industry into bankruptcy to reduce the supply of oil. While there has been a shakeout in the oil patches of North Dakota and Texas, the companies sitting on large reserves have been able to trim costs.
This is forcing the Saudis to endure low oil prices for longer than they had anticipated. The pain from supporting two wars against Shiites (Syria and Yemen) and keeping social services at a high level have strained the Royal bank account. Some traders are eyeing the possibility that the Saudis may have to give up their fight for market share, or devalue their currency's peg to the US dollar.
The peg of the Saudi riyal to the US dollar has been a handicap in their fight against Russia, Iraq, and Iran for market share. If the Saudis were to abandon the riyal's peg to the dollar completely, the days of the "petrodollar" may be at an end. Bank of America analysts note the repercussions of such a move: “A depeg of the Saudi riyal is our number one black-swan event for the global oil market in 2016, a highly unlikely but highly impactful risk." The Telegraph reports that speculators are already circling, noting "The 12-month riyal forward contracts – watched by experts for signs that traders are betting on a collapse of the peg – has spiked violently to 535 from just 13 points in June."
The appreciation of the dollar has not only affected oil prices, it's wreaking havoc in the Saudi economy. This is forecast to get worse when the US Federal Reserve raises interest rates. A rate hike will strengthen a dollar that is already at eight-month highs even more.
Worst of All Worlds - A Currency Squeeze Play
The nightmare scenario for Saudi Arabia is a devaluation of the yuan as China struggles with an economic slowdown, at the same time the Fed raises interest rates. Oil prices are likely to collapse in this situation. BoAML energy analyst Francisco Blanch notes “Should Brent crude oil prices drop to $30, we estimate the foreign exchange reserve drain could accelerate to $18bn per month. Saudi Arabia may face a critical choice: cut oil supply, or de-peg.”
Even if the Saudis survive in the short term, as soon as oil prices rise, the shale companies will pop back up like mushrooms after a rainstorm. Sometimes the winning move is to change the game. A devaluation of the riyal might lead to the domestic Saudi economy to actually diversify to replace expensive imports, rather than live off oil revenue.
The opinions and forecasts herein are provided solely for informational purposes, and should not be used or construed as an offer, solicitation, or recommendation to buy or sell any product.