Pink Petro Staff

The Oil Price Crash Could Be The Best Thing That Happens To The Saudi Arabian Economy

Blog Post created by Pink Petro Staff on Nov 23, 2015

Forbes: Tim Worstall

It’s obviously extremely odd to assert that a crash in the oil price could be good for the economy of an oil producing nation. Yet, in the longer view, this could well be true, given the existence of what we call Dutch Disease. This is just a short hand for the pernicious effects upon an economy of relying upon the exports of a natural resource. Effectively, that natural resource becomes so profitable to do and everything else so unprofitable that there’s very little economy other than that natural resource. That’s not good for the long term health of a place and ending that situation could therefore be beneficial for that long term.

There’s two parts to this:

  • There is a time-lag effect. Shale cannot keep switching to high-yielding wells forever. Their hedging contracts are running out. The US energy department expects a further erosion of 600,000 b/d next year, but this is not a collapse.
  • By then Opec will have foregone another half trillion dollars. “What is winning supposed to look like for the Saudis? Can they really endure another year of this?” said Ms Croft.
  • Opec can certainly bankrupt high-debt frackers but this does not shut down US shale in any meaningful way. The infrastructure and technology will remain. Stronger players will move in. Output will bounce back as soon as oil nears $60.
  • Shale frackers will respond with lightning speed to any rebound and create a permanent headwind for Opec over years to come, or a sort of “whack-a-mole” effect, contrary to warnings by the IEA this week that Mid-East producers may regain their 1970s stranglehold once rivals are cleared out.

The strategy of using pricing power to knock out the competition just isn’t going to work. Because that sort of economic strategy depends upon being able to regain the lost money through higher prices after that competition has been vanquished. And there’s a reason why economists think this strategy is used a lot less often than politicians, anti-trust law or the general public think it is used. Because there have been very few to no successful instances of its use. Even Rockefeller’s Standard Oil kept on driving prices down after achieving that near monopoly for fear of the competition that would spring up if they didn’t. And here fracking can be turned on again in a few months, at low cost per well, as soon as the price rises again. So, the strategy of trying to destroy the competition just isn’t one that’s going to work.

Not going to work in a conventional sense that is. But there is another possibility:

 

 

 

  • Saudi Arabia’s currency regime is at risk of blowing up if oil prices fall further and the US dollar spikes higher, Bank of America BAC -0.23% has warned.
    The Saudi strategy of flooding the world with oil in a bid to drive out rivals may be hard to square with the country’s fixed dollar-peg, which is increasingly under scrutiny by currency traders as the US Federal Reserve prepares to raise interest rates.
  • “The crucial point is what happens to the Saudi riyal. Saudi Arabia’s foreign exchange reserves still provide an ample buffer, but they have been falling fast,” said Francisco Blanch, the bank’s energy strategist.
  • “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,” he said.

And that’s where the Dutch Disease argument comes in. The current peg is an attempt to avoid some of the effects of the disease. For if you are reliant upon exports of a natural resource then the foreign currency flooding in to pay for it is going to drive up the value of your own currency. That’s exactly what happened to Holland when they found gas fields. And it’s also the reason why Norway’s oil money is always kept outside the country: to stop a high krone strangling domestic industry. For of course a high currency rate makes your exports very expensive and your imports very cheap.

But imagine that this plan goes wrong for Saudi. And they then abandon that currency peg: the guess is that this could mean, from the current rate, as much as a 30 or 40% fall in value. And that would simply do wonders for the domestic economy of Saudi Arabia. All imports would become more expensive thus driving their substitution with domestic production. And anything domestically produced would now become that much cheaper on the global market. It would be a wonderfully stimulative program for domestic industry. Heck, Saudi Arabia might actually start to have a proper domestic economy, one that actually produces stuff that people desire to consume.

OK, yes, this is all rather speculative and certainly long term. But assume that the oil price battle is one that the Saudis cannot win, and that then they have to remove the currency peg, then this would lead to a massive boom in the productive capacity of the non-oil part of the Saudi economy. To the great benefit of all those people who would rather like to get a decent job if only Saudi actually had a domestically productive economy.

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