Saudis play chicken

April 4, 2016 10:05 AM

Don’t look desperate. Oil futures fell on Friday after one Crown Prince in Saudi Arabia suggested they would not cut production unless Iran does.

Well, if that is the case, then why even show up to the meeting? The Saudi comment obviously was a negotiating ploy to send a message to Iran that they will agree to Iran increasing its oil production, but at the same time that agreement has to come with some type of limit. The Saudis want to show that, if the players at this meeting do not come to an agreement, then oil prices will falter. Of course, while the Saudis talk tough, the truth is that they need a deal to freeze production as badly as anyone.

Forbes reports the Saudi banks “are having to cope with conditions not seen for several decades and the stock market is down by almost a third over the past year. The tough environment is leading to cuts in credit ratings and warnings of further turmoil to come." Forbes points out that, “a number of reports released over the past few days highlight the range of problems Saudi Arabia is facing. In a report on the Saudi economy released on April 3, local investment bank Jadwa Investment points out that in February, year-on-year growth in money supply turned negative for the first time since 1994 and the total value of bank deposits fell year-on-year for the first time in nearly 22 years.”

They also point out that new data from the Saudi Stock Exchange (Tadawul) adds to the picture of an economy under pressure. In its first quarter performance report, released on April 3, the bourse said the Tadawul All Share Index (TASI) closed the first quarter down 29% compared to the same time last year. Total market capitalization was down by 24% over the same period and the value of shares traded in the first quarter fell by 36%.

Forbes says that the worsening economic conditions are making life harder for many of the country’s banks, which will be facing higher borrowing costs as a result of downgrades to their credit ratings. On March 31, Standard & Poor’s cut its ratings on five of the country’s largest banks, citing the worsening economic conditions as a result of the low oil price. The banks affected were Al Rajhi Bank, National Commercial Bank, Riyad Bank, Samba Financial Group and Saudi British Bank (SABB).

Yet the trouble goes beyond a few problems for a few banks and are affecting the banking system as a whole. The ratings agency has now moved its Banking Industry Country Risk Assessment (Bicra) score for Saudi Arabia from level three to level four. The Bicra scale runs from one to 10, with 10 indicating the banking systems with the highest risks. Forbes quotes S&P as saying that it expects the levels of non-performing loans and credit losses to rise and for banks’ profits to fall as a result of the weak business environment. It says that there will be fewer lending opportunities, alongside higher risks, particularly in the construction and real estate sectors.

It does not sound like Saudi Arabia is in the best position to walk away from a freeze, but talk is cheap. If they come to Doha with the perception that they can still afford to play this game, then they may get better terms on a cap on Iranian oil output.

In the meantime, back in the U.S. the oil sector is still contracting. The U.S. oil-rig count fell by 10 to 362 in the latest week, according to Baker Hughes Inc. The company says that there are 72% fewer rigs of all kinds since a peak of 1,609 in October 2014. They also reported that the number of U.S. gas rigs declined in the latest week by four to 88, which at some point may reduce U.S. gas production, giving justification to the recent rally in the back end of the natural gas curve. The offshore rig count was also lower, coming in at 26 in the latest week, down two from the previous week and down five from a year earlier.  It is only a matter of time before production starts to fall.

This is part of the long-term case for oil, which is at the bottom of a bust cycle. Despite reports that bankrupt companies can continue to produce oil, the truth is it will be at a minimum and will not include the much needed innovation. Skeleton crews, as folks are losing their jobs, do not bode well for future U.S. oil output. That goes for natural gas as well.

About the Author

Phil Flynn is a senior energy analyst at The PRICE Futures Group and a Fox Business Network contributor. Phil is one of the world's leading market analysts, providing individual investors, professional traders, and institutions with up-to-the-minute investment and risk management insight into global petroleum, gasoline, and energy markets.