Saudi Arabia, the world's mightiest oil power, is throwing in the towel.
Mohammed bin Salman, the deputy crown prince, has vowed to treat the lethargic, oil-obsessed kingdom to an economic revolution. His plan – "Vision for 2030" – would do away with oil as the country's lifeblood and bring in a diversified private sector economy. It calls for the initial public offering of Saudi Aramco, potentially valuing the world's biggest oil company at more than $2-trillion (U.S.).
We can debate forever whether the prince, who has emerged as a young royal to watch, will succeed in his mission. The better question for the global oil industry, especially the high-cost producers like Canada, is what the prince's plan says about long-term oil prices.
Here's a guess: If the Saudi oil gurus were convinced oil prices would go back to, say, $100 a barrel, and stay there, the country would put the revolution on hold indefinitely. Why risk years of economic adjustment pain and social upheaval if high prices would guarantee that the cash gusher will remain intact for another few decades?
Oil consultant and analyst Olivier Jakob of Switzerland's PetroMatrix thinks the prince's economic overhaul plan is bearish for prices.
In a note published this week, he said "the plan can be taken as Saudi Arabia realizing that oil prices will be lower for longer and that the global economy is moving to a new post-carbon era."
There could be another motive, though this one seems less credible. It says the Saudis fear the United States is losing interest in the Middle East in general and Saudi Arabia in particular, allowing an ascendant Iran to emerge as the dominant power in the region. The Iranians control the Strait of Hormuz – the choke point between the Persian Gulf and the Gulf of Oman – through which most of Saudi's seaborne oil exports pass. The Saudis and the Iranians don't much like one another and the Saudis may fear that the day will come when its oil tankers can't get through the strait, so wiser not to base your entire economic future on a single product that needs to be floated out of the country.
The theory that Prince bin Salman's economic diversification plan is based on his belief that the high-price era is over might seem far-fetched. Brent crude, the international benchmark, has been on a tear. In January, it reached a low of $27. On Friday, the price was $48 – a four-month gain of 77 per cent.
The bull case says the price will keep rising because two years of low prices stimulated demand and crimped U.S. oil production. The U.S. Energy Information Administration expects total American crude production (dominated by shale) to decline to 7.9 million barrels a day in the third quarter from 9.1 million in the first quarter of this year. Skepticism about the speed of the transition to electric cars and surging demand all over the world for SUVs support the bull case, as does the slow but steady economic recovery in the euro zone.
The bear case says the recent price surge was partly driven by the weak U.S. dollar and that once it strengthens, the price will reverse course. It is supported by the desire of Iran and Iraq to expand production, and Russia's desire not to trim its own production. The bear case also rests on the theory, promoted with religious fervour at the Paris climate change conference in December, that the oil era is coming to an end and that, for the sake of the planet, it must end soon, before we all fry to death. Fuel subsidies are being reduced or eliminated everywhere.
The most compelling near-term bearish argument is that U.S. shale oil will come surging back if the price rises another 10 bucks or so.
The shale producers have been crunching costs, dropping their break-even point. At $30 a barrel, shale was doomed; at $60 or higher, drilling will come back.
The Saudis appear to be betting on the bear case and are fully aware that it demands the rollback of the welfare economy. Almost half of Saudi gross domestic product and about 80 per cent of exports comes from fossil fuels.
The International Monetary Fund calculates that Saudi Arabia's fiscal break-even in 2016 demands an oil price of $67.70 a barrel – well above the current price. The IPO of 5 per cent of Saudi Aramco might raise $100-billion, enough to buy the country some time to make the transition to a private sector market economy, but only some time.
If the deputy crown prince is right, the high-cost producers – the Alberta oil sands, the deep offshore wells – and the fragile oil states like Venezuela and Nigeria face a whole lot of pain. His ambitious fix-it plan for the Saudi economy suggests he is playing it safe. His bet does indeed seem to be lower for longer.