For well over a year now, the Saudi Government, through their state owned Aramco oil company, has propelled the oil market into a downward spiral. Publicly, they claim a policy of defending market share, namely against North American Unconventional producers who have helped double production in the United States between 2008 and 2014. The unexpected lifting of sanctions on Iran forced the Saudis to double down on the strategy (#ThanksObama for the destabilization). What seemed like a simple solution (worked in the late 80’s) has now turned against OPEC’s leader signaling the potential demise of the royal family and a march towards outright civil war in Saudi Arabia.

For decades now, there have been significant pockets of unrest in the Arabian peninsula.

“Saudi leaders, and society in general, perceived the period of the gulf crisis as a… historical crossroad…” where the kingdom willingly allowed foreign soldiers on to its land to wage war against another Arab nation (Iraq). The country became increasingly polarized between “…fundamentalists who sight to impose a strict Wahhabi value-system on the government and the public.” [pg. 25]vs. more secular western ideals. In effect, the rulers had called upon Christian foreigners to protect the holiest places of Islam.

Now fast forward a number of years to the recent stampede at the Hajj event that left over 700 dead, and 800 injured. Many of the locals continue to build resentment towards the royal family for the handling of event. The opposition groups also used the event to highlight the continued mishandling of the most sacred site and event for Islam.

These growing tensions have only been tempered over the years via domestic spending of a portion of proceeds from the Aramco oil company. All fine until the price of oil plummets  from $120 down to just about $30!

The Saudi social contract calls for a substantial social safety net for its populous, especially those of modest means. Over $30 billion dollars were paid to citizens as the New King came to power in early 2015.

That was all before prices eroded, forcing the royal family to withdraw about $70 billion in foreign reserves to support the region as a budget deficit loomed. Estimates note the total foreign reserves stand somewhere between $650-675 billion. Not too bad, but this can’t go on forever! You can only pay someone for so long before they demand freedom and equality at any cost.

The likelihood of such an event continues to grow as prices stay depressed for longer. Some analysts have made projections that the Saudis will run out of money within the next 5 years. Of course, these analysts published their assessments when prices were closer to $55/bbl.

In all honesty, I don’t think anyone has a good picture as to the total reserves held by Saudi Arabia. Recalling $70 billion last October may just be he tip of the iceberg, but what happens in Q1 of 2016 now when we are at half the price per barrel of crude? There has already been significant talk of reductions in social welfare that may serve as the tipping point for many.

So we have a strong opposition from various groups across the country, and they are becoming increasingly more organized and sophisticated. That’s one challenge, but what about from within the ruling class itself? I was absolutely shocked to hear that a senior Saudi prince has called for a change in leadership – in effect, asking for the King to renounce his throne.  He’s not alone either, there are other royals who want to see a changing of the guard that will turn in their favor.

Add Iran and their destabilization efforts in Syria and Yemen and that gives you a weakened and susceptible Saudi Arabia. Susceptible to either full conflict with Iran or an internal civil war (caused by the people or by royal family members).

With all this out there, what would be a good move for the royal family to sure up their personal reserves and become ready for starting over in a new country? Well, let’s sell a stake in Aramco!

This is where the Economist goes wrong and too heavily emphasizes looking at the buy side of the opportunity. How many banks would want in on the IPO, what would the company be evaluated at (1 trillion they say)…etc. They are missing the fundamental issue here, which is on the seller’s side: why sell? Aramco is an absolute cash cow, what could you gain with the sale?

Well – do they see the writing on the wall? Selling off 5% of a trillion dollar company still comes out to about $50 billion dollars – a nice retirement package for the royals to exit the country and live happily ever after, should there be a new Arab Spring on the horizon.

Oil markets are clearly missing the boat with this potential risk. Any internal turmoil could easily devolve into lowered production outputs if not potential damage to the oil infrastructure.

It’s not completely out of the question – what if there is a 3 million barrel supply disruption based on a conflict – prices would immediately double overnight!

For now, we just wait and see.

References:

  1. Teitelbaum, Joshua. Holier than Thou: Saudi Arabia’s Islamic Opposition – Washington Institute
  2. Hajj Stampede: Saudi Arabia says 700 dead, 800 injured in Mina – NBCNews.com
  3. New King unleashes a torrent of money – NYT
  4. Saudis risk draining financial assets in 5 years, IMF says – Bloomberg
  5. Saudi royal calls for regime change in Riyadh – The Gaurdian
  6. Sale of the century? – The Economist