The party in Riyadh may be winding down. After years of what can only be described as a fiscal gusher, Saudi Arabia is facing a sobering reality: the tab has come due. The kingdom’s spending spree, fuelled by high oil prices and a vision of post-oil diversification, is hitting a wall. And for global oil markets, the hangover could be severe.
Let’s start with the numbers. Saudi Arabia’s budget deficit is widening at an alarming clip. The International Monetary Fund projects the kingdom will run a deficit of nearly 2% of GDP this year, and that’s with oil prices hovering around $80 a barrel. But here’s the rub: the kingdom’s break-even oil price – the price needed to balance its budget – has soared to over $100 a barrel. That is the highest in over a decade. The reason is simple: spending. Crown Prince Mohammed bin Salman’s Vision 2030 has been a whirlwind of mega-projects, from the futuristic city NEOM to luxury tourism ventures on the Red Sea. These are expensive ambitions, and the bill is mounting.
Now, the kingdom is tapping debt markets with increasing urgency. After years of relying on its sovereign wealth fund, the Public Investment Fund, to finance projects, the government is now issuing bonds at a rapid pace. The yield on Saudi sovereign bonds has crept higher, reflecting investor unease. And here’s where the oil market comes in. Saudi Arabia has long been the swing producer, the stabiliser of global markets. But if the kingdom’s fiscal position continues to deteriorate, its ability to maintain that role could be compromised.
Consider the implications. If Riyadh needs higher oil prices to fund its spending, it could become more aggressive in its output cuts. The market has already seen this play out. The recent extension of voluntary cuts by Saudi Arabia and its OPEC+ allies has kept prices elevated, but at the cost of market share. The United States, meanwhile, is pumping at record levels, taking advantage of the price floor that OPEC+ is creating. This is a classic case of the prisoner’s dilemma in action. Each producer wants high prices, but the incentive to cheat is powerful.
But there is a darker scenario. If Saudi Arabia’s fiscal situation becomes truly unsustainable, it might be forced to flood the market to generate cash. That would be a repeat of the 2014 price war, which sent oil prices crashing and broke the budgets of many petrostates. The difference this time is that Saudi Arabia has deeper pockets, but those pockets are not bottomless. The Public Investment Fund has assets of around $700 billion, but much of that is tied up in illiquid investments.
Let us not forget the geopolitical angle. The United States wants lower oil prices to tame inflation at home and weaken Russia’s war chest. Saudi Arabia wants higher prices to fund its domestic agenda. These two desires are increasingly at odds. The recent chill in US-Saudi relations has made coordination more difficult. The days of the ‘oil for security’ deal are fading.
For investors, the message is clear: buckle up. Volatility in oil markets is likely to increase as Saudi Arabia’s fiscal constraints become more apparent. The kingdom’s break-even price is a canary in the coal mine. If it continues to rise, expect more erratic production decisions from OPEC+. The era of predictable oil markets may be coming to an end.
In the City, we like to say that price is what you pay, and value is what you get. Right now, the price of oil is being distorted by fiscal desperation. The value, however, is becoming harder to gauge. Investors should watch the Saudi bond market for signs of stress. If yields spike, it will be a signal that the kingdom’s spending spree is truly hitting a wall. And that signal will reverberate through every oil-dependent economy on the planet.
