Saudi Arabia's Last Weapon In The Oil War

For almost three years, the Kingdom has been using a conventional weapon for fighting the oil war: raising oil output. The logic of using this conventional strategy was quite simple: let higher output crush oil prices, and the Kingdom’s antagonists along the way, as I discussed in a previous piece here.

 Now there’s plenty of evidence that this weapon has hit the target. US oil rigs have been shutting down one after another, and weak American frackers have been going out of business or striving to cope with falling revenues and piles of debt.

Total Oil and Gas Rigs in the United States | Graphiq

Company	Qtrly Revenue Growth	Total Debt	Output Cut
Devon Energy DVN -2.10%	-30.40%	$13.14B	10%
Marathon Oil MRO -0.28%	-50.40	$7.28B	10%
EOG Resources EOG -2.40%, Inc.	-48.20	$6.66B	5%

Source: Finance.yahoo.com; Wall Street Journal

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The trouble is that this conventional weapon has backfired, hurting Saudi Arabia. First, lower oil prices have opened up a big hole in the Kingdom’s fiscal and social budget. Second, they have been draining foreign currency reserves, which are used to defend the riyal‘s peg against the dollar.

The trouble is that this conventional weapon has backfired, hurting Saudi Arabia. First, lower oil prices have opened up a big hole in the Kingdom’s fiscal and social budget. Second, they have been draining foreign currency reserves, which are used to defend the riyal‘s peg against the dollar.

Worst of all is that in spite of raising output, the Kingdom’s oil market share has dropped, according to the Financial Times. The Kingdom’s share, in the U.S., dropped from 17 in 2013 to 14% in 2015.

We all know what that means in a global market: a further erosion of the Saudi Arabia’s market power, and its ability to lead OPEC.

That’s why the Kingdom has no choice but to use an unconventional weapon in the oil war, in my opinion, which is to break the riyal ‘s peg against the American dollar—in essence, let the riyal fall.

That will make Saudi oil less expensive in global markets, help the country regain its market share in the US, and finish up the war against American frackers.

A weaker riyal will further help Saudi Arabia execute on its new strategy of producing and exporting refined products.

The problem is that this weapon will backfire, too, and hurt Saudi Arabia’s economy. The prospect of a lower riyal, for instance, could cause a capital flight. And it could fuel inflation soon after it takes place, widening the Kingdom’s social budget deficit.

That’s why it is the weapon of last resort.