(Bloomberg) – Saudi Arabia’s decision to extend its oil production cuts – part of a so far largely unsuccessful attempt to raise prices – could trigger an economic contraction in what was the country at the fastest growing in the Group of 20 last year.
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It would be a sharp turnaround for the $1 trillion economy, which jumped nearly 9% in 2022, helping Crown Prince Mohammed bin Salman invest tens of billions of dollars in everything from sports to tourism and new cities.
The boom was propelled by record gross production of around 10.5 million barrels per day and average prices of $100 a barrel as Russia’s invasion of Ukraine rattled energy markets .
With a global economic slowdown now weighing on demand for crude, Riyadh is cutting production this month and down to just 9 million barrels a day, a level the kingdom has rarely reached in the past decade. This move did push prices up, but only slightly. Brent is trading around $78.50 a barrel, down almost 9% this year.
The reduction in supply will be a drag on the world’s largest oil exporter. The economy will fall 0.1% this year if the government increases output in September and 1% if it stays the course for the rest of 2023, according to Bloomberg Economics.
“The Saudi cut could be costly,” said Jean-Michel Saliba, Middle East and North Africa economist at Bank of America Corp.
The US lender’s base case scenario is for growth to slow to 0.9%. But it predicts a contraction of 0.6% if supply cuts are not reversed this year. A drop to that level would make Saudi Arabia the worst-performing economy in the G20 after Argentina, according to Bloomberg surveys.
Non-oil growth
Some analysts are optimistic gross domestic product may rise even if the cuts remain in place until 2024. Amy McAlister of Oxford Economics sees GDP rising 0.3% in this scenario.
And the non-oil economy – where the vast majority of Saudis are employed and which the crown prince’s Vision 2030 plan aims to transform – remains vibrant. Private companies outside the oil industry increased their orders at the fastest rate on record in June, according to a purchasing managers’ index.
“This is the sector that really matters for job creation and corporate profits,” said Ziad Daoud, chief emerging markets economist at Bloomberg Economics.
The government says the non-oil economy is likely to grow 5.8% this year.
“The transformation and diversification of the Saudi economy under Vision 2030 is focused on non-oil GDP,” a Saudi finance ministry spokesperson said.
Still, falling petrodollars have pushed the kingdom’s budget into deficit and could force it to borrow more.
There are already some signs of this. The government has sold $16 billion in Eurobonds so far this year, despite interest rates rising as the United States and other central banks battle inflation. While Saudi officials said it was partly aimed at refinancing existing debt, it’s more than the kingdom has issued in 2021 and 2022 combined, according to data compiled by Bloomberg.
below break-even point
Many energy analysts, as well as Saudi Arabia itself, expect the oil market to tighten by 2023 as demand in China and India increases. In such a scenario, prices would likely increase. Goldman Sachs Group Inc. sees crude jump to $86 a barrel by December.
For now, prices are well below what Saudi Arabia needs to balance its books. The International Monetary Fund, in its latest projection, pegged the breakeven oil price this year at nearly $81 a barrel.
That, however, is based on production of 10.5 million barrels per day. It also excludes spending by the sovereign wealth fund and other state entities on Prince Mohammed’s so-called giga projects, including the new city of Neom. The break-even point climbs to nearly $100 a barrel when this is taken into account, according to Bloomberg Economics.
Oil flows remain crucial for Saudi Arabia, despite all its diversification efforts since the launch of Vision 2030 in 2016. The raw material accounted for 80% of exports in 2022. This figure is 93% when chemicals and Plastics, mostly crude-derived, are included, according to Bloomberg Economics’ Daoud.
“Judging from the performance of the past seven years, progress in this area is still lacking,” he said of diversifying the economy.
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