At the end of last month, Saudi Arabia abolished flogging as a punishment, welcome news to adulterers in Riyadh and Jeddah’s cyber-criminals.
However, the kingdom has other, new and unusual punishments in its arsenal, and the ability to inflict pain on millions in the oil and gas industry without physically lashing a whip.
In early March, state oil company Saudi Aramco announced it would aggressively increase its oil production by two million barrels a day (bpd), after Saudi Arabia failed to reach an agreement on production cuts with Russia.
This triggered a collapse in the oil price and saw American crude being traded at negative prices. Rigs and boats were cancelled around the world (see here) and projects were delayed, suspended or postponed, plunging every sector of the offshore industry into crisis.
Diamond Offshore Drilling announced it was entering Chapter Eleven bankruptcy protection, whilst fellow driller Noble Corp announced it had appointed restructuring advisers (see here), as it sought to cut $25 million a year of shore costs, and announced a loss of US$1.1 billion for the first quarter.
Oil and gas producer Noble Energy announced a loss of US$4 billion for the first three months of the year (here), whilst supermajor ExxonMobil also plunged into the red, and Shell cut its dividend for the first time since the Second World War.
Diversification hasn’t helped
The crisis has even impacted companies that have attempted to diversify away from oil and gas services.
Maersk Drilling and Maersk Supply Services have both implemented widespread redundancies this month, with around 30 per cent of shore staff reportedly being laid off, mainly at the companies’ headquarters in Denmark, despite their efforts to focus on decommissioning (Maersk Decom) and subsea mining (here).
Former Maersk Group compatriot company Esvagt, sold to private equity for US$610 million in 2015, also announced this week (here) that its board of directors and upper management have agreed to a fifteen pay reduction, and its management to a ten per cent cut, whilst other onshore employees have been offered a “volunteer arrangement” consisting of a five per cent pay reduction.
Even the company’s new investments in wind farm support vessels have been hard hit. The Norwegian shipyard Havyard, where Esvagt has contracted three newbuild dynamically positioned service vessels, has required emergency funding from Esvagt, and has delayed delivery of the new windfarm vessels.
U-turn now sees Saudi Aramco cut production further
Now, Saudi Arabia has made a sharp U-turn. The kingdom first brokered an agreement between OPEC and Russia in April to make collective production cuts of just under ten million bpd, around 10 per cent of global pre-Covid demand.
Brent recovered to $30 a barrel, even as coronavirus deaths spiked in the US and Europe. Then, this week, Saudi Arabia announced further cuts to support prices. The kingdom’s energy ministry said on Monday that output would fall to just 7.5m bpd in June, and the government announced that it had asked Saudi Aramco to begin cutting May production below the 8.5m bpd it had agreed with global producers.
This is a massive turn-around. Only on Sunday, March 8, Saudi Arabia had announced that it would increase its production from 9.7 million bpd to 12.3 million bpd.
Clearly, the kingdom is feeling the pain just as much as its foreign oil rivals. On Monday, May 11, Mohammed al-Jadaan, Saudi Arabia’s finance minister, unveiled some sudden and harsh austerity measures, including slashing both the government’s investment and its operating expenditures.
Mr al-Jadaan also tripled VAT, from five per cent to 15 per cent from July, to raise revenue. Despite the obvious hit to the cost of living from the VAT hike, the government said it would also no longer pay cost-of-living allowances to civil servants and state employees, as well taking other measures to reduce government expenses by a total of five per cent. Mr al-Jadaan warned that Saudi Arabia was facing an “extreme crisis” and would need to take “strict and extreme” measures. Ouch!
Falling foreign reserves in Riyadh
The reasons for this abrupt change of policy seem clear. In March, Saudi Arabia’s foreign reserves fell by US$24 billion to about US$470 billion, the largest monthly fall on record.
The Saudi currency, the riyal, is pegged to the US dollar at a fixed exchange rate. However, many analysts expect the Saudi riyal’s currency peg to the dollar would be unsustainable if the kingdom’s foreign reserves dropped below US$300 billion. This would happen later this year if March’s decline in foreign exchange was sustained in subsequent months.
After the last oil slump in 2015, the kingdom’s reserves plummeted from an all-time high of US$726 billion to about US$500 billion, and stabilised there when the oil price recovered. Now the reserves are under pressure again.
As is Saudi Aramco, which reported a 25 percent slump in first-quarter net profits this week, down to US$16.66 billion, compared to US$22.2 billion a year earlier (here). These quarterly results were based on less than one month of low oil prices, so extrapolate the result from March into the second quarter and even the world’s largest and lowest cost oil producer risks a loss.
So, we have seen projects delayed by the company, rigs suspended (such as the jackup Noble Scott Marks) and contractors asked to take deep cuts to their day rates for those rigs and boats which continue working.
Vision 2030 hostage to the oil price
Crown Prince Mohammed bin Sultan had been hoping to use his country’s foreign reserves and the cash flows from Saudi Aramco to transform his country in his Vision 2030 project. This, according to the Financial Times, includes, “a US$500 billion futuristic city called Neom, a high-end Red Sea tourism development and entertainment and sports complex.”
These high-profile efforts now risk being delayed or postponed, as the country lacks the resources to spend on them. Vision 2030 offered the kingdom a future that was free from dependence on oil and from the stifling constraints of Saudi Arabia’s religious conservatism. But it seems the nation can’t escape the shackles of its history so easily. Not without higher oil prices to replenish the state coffers.
Give peace a chance (in Yemen)?
If the Saudi Arabian leadership really wanted to save money, and balance its budget, Prince Mohammed bin Salman might also consider ending the war in Yemen, where his country has intervened against Houthi rebels, rather than chasing drilling contractors for price cuts.
The five years of conflict on its southern border have apparently cost the kingdom US$100 billion (estimate here). In April, the Saudis announced a unilateral cease-fire in Yemen, following extended United Nations-brokered talks and direct contacts between the parties that failed to produce a durable truce or a political settlement.
Last September, the Houthis claimed they were behind missile strikes on Saudi Aramco processing facilities, which temporarily spiked oil prices to over US$70 (see our coverage here – we apologise that our tanker charter rate prediction proved completely incorrect…).
The Houthis want a complete lifting of the Saudi blockade of Yemen and an end to Saudi and UAE military operations in Yemen. The Brooking Institution in the US has observed that amid the calamity of the Covid-19 pandemic Yemen faces a humanitarian crisis: “The country urgently needs to import food and medicine. Roughly 80 per cent of the population — 24 million people — are dependent on humanitarian assistance, and two-thirds are malnourished. Children are especially vulnerable. The Saudi air strikes have targeted hospitals and other civilian sites for five years… One-third of all the air strikes have hit civilian targets including hospitals and schools. Only half the country’s hospitals and medical installations are operating because of the bombing and the siege.”
Read the full account here.
It’s a little bit ironic
Saudi Arabia is no stranger to irony. A rush to increase oil production in March results in a drastic cut in Saudi Aramco’s production in May. Efforts to reduce dependency on oil are halted because oil revenues have fallen. The country abolishes the cost of living allowance for state workers just as it raises VAT by ten per cent. Saudi Arabia claims to be a beacon of Islamic compassion, whilst millions in Yemen face starvation and misery.
Something’s got to give, and the sooner there is stable, long-term strategy emanating from Riyadh, the better. Flogging may be abolished as a criminal punishment, which we applaud, but flogging bad policies also needs to stop.
This anonymous commentator is our insider in the world of offshore oil and gas operations. With decades in the business and a raft of contacts, this is the go-to column for the behind-the-scenes wheelings and dealings of the volatile offshore market.