Oil prices have slumped in recent weeks. Brent fell from close to $88 per barrel in early July to $71/bbl in early September. Growing worries about the impact of slower economic growth in China and the United States on the demand for oil have offset the production outage in Libya and periodic concerns about potential supply disruptions from a broadening conflict in the Middle East. OPEC+ (formed in 2016 and comprised of members of OPEC and 10 other oil-exporting countries) announced on September 5 that it will delay production increases that had previously been planned to start in October until December, but this has had no impact on oil prices. For Saudi Arabia, a sustained drop in oil revenue that lower prices entail is particularly unwelcome given its need to finance the ambitious Vision 2030 reform plans.

Oil Market Uncertainties

Oil prices surged following Russia’s invasion of Ukraine in February 2022, reaching close to $120/bbl for Brent. Prices have since declined and have recently been trading at $71/bbl.

While global oil demand has rebounded strongly since the coronavirus pandemic, higher oil production in Brazil, Canada, Guyana, and the United States has added considerably to global oil supply over the same period. With the prospect of excess supply developing, OPEC+ acted to significantly cut production starting in late 2022 to keep the market in balance and underpin prices. Saudi Arabia has accounted for a significant share of these production cuts. At 8.8 million barrels per day in June, its oil output was well below its recent peak of 11.1 mb/d in August 2022. Indeed, Saudi production is currently at its lowest level since 2007 abstracting from periods of major global economic crisis, and the kingdom has lost market share.

Oil Market Outlook

Forecasts from OPEC, the International Energy Agency, and the Energy Information Administration differ on the outlook for global oil demand. OPEC is the most optimistic, projecting a 2.1 mb/d increase in oil demand in 2024 and a further 1.8 mb/d increase in 2025. The IEA and EIA project more modest increases of 1 mb/d and 1.1 mb/d, respectively, in 2024 and 1 mb/d and 1.8 mb/d, respectively, in 2025.

All three organizations project a significant slowing in non-OPEC+ supply growth this year and next, from 2.4% in 2023 to a range of 1.1% to 1.8% in 2024-25. The EIA and IEA provide projections for OPEC+ supply in 2024 and 2025 (OPEC does not). Both organizations expect OPEC+ supply to increase in 2025, although neither appears to build in the full production increases that OPEC+ has announced.

Averaging the demand and supply forecasts of the three organizations is a simple way to generate a baseline oil market scenario. This approach suggests that while demand growth will likely exceed supply growth in 2024 on average, this will reverse in 2025, particularly if OPEC+ proceeds with plans to boost production.

The market environment may be less favorable than this “average” scenario suggests. First, global growth is likely to remain subdued during 2024 and 2025, even if major central banks ease monetary policy as expected. China and Europe are grappling with long-standing structural problems, economic policy uncertainties are elevated in the United States ahead of the November presidential election, and geopolitical tensions and conflict continue to undermine confidence. Historically, global growth at the levels projected by the International Monetary Fund for 2024 and 2025 has been associated with oil demand growth that is more in line with the IEA projections than with those of OPEC. Second, the projected slowdown in non-OPEC+ output growth may be less pronounced than forecast. Third, the full implementation of the output increases announced by OPEC+ would see additional supply above that assumed by either the IEA or EIA coming to the market in 2025. Demand in line with the IEA forecast together with higher supply by both the OPEC+ and non-OPEC+ groups would result in a significant demand-supply imbalance in 2025, with negative implications for oil prices.

2014 Revisited?

It is now 10 years since the oil price crash of 2014. After three years of moving in a range of $100/bbl to $125/bbl, Brent oil prices fell to just under $100/bbl in September 2014. The decline then quickly gathered pace with prices plummeting to $50/bbl in January 2015 and eventually a cycle low of near $30/bbl in early 2016.

The steep price decline caught nearly everybody by surprise. Four factors contributed to the price drop. First, global oil supply was boosted by the rapid growth in U.S. output. Second, growth in global oil demand slowed during 2011-14 following the strong rebound in 2010 after the global financial crisis. Third, inventory levels increased during 2014. Fourth, these factors were magnified by revised expectations about OPEC’s response to declining prices. In May 2014, a statement by Saudi Arabia’s then oil minister, Ali al-Naimi, that “$100 is a fair price for everybody – consumers, producers, oil companies” had seemed to confirm that OPEC would adjust production to maintain prices at around $100/bbl. When the November 2014 OPEC meeting failed to deliver production cuts despite the drop in prices to $80/bbl, these expectations were quickly adjusted.

Today, there are similarities and differences to 2014. Non-OPEC+ supply has grown strongly in recent years and global oil demand appears to be weakening. There are also differences. The high inventory levels evident in 2014-15 are not yet apparent, while OPEC+ communication has been careful not to give any indication of the group trying to support a specific price target. Nevertheless, the experience of 2014 shows how quickly the oil market situation can change.

Oil and Fiscal Policy in Saudi Arabia

The Saudi government has made considerable progress in diversifying revenue sources in recent years particularly through the introduction of the value-added tax. Non-oil revenue now accounts for close to 40% of total government revenue. Nevertheless, this still means that there is a heavy reliance on oil revenue in the budget. Oil revenue is received by the government through three channels: royalties (levied on oil sales); corporate income taxes (with different tax regimes for upstream and downstream activities and gas); and dividends that are paid by Saudi Aramco to all shareholders (the government currently owns 81.5% of the company). In the first half of 2024, dividends accounted for about one-half of the total revenue paid by Aramco to the government. The Public Investment Fund, which holds a 16% equity stake in Aramco, also benefits from the dividends paid by Aramco.

A sustained downward move in oil prices would have a significant negative impact on the government budget, albeit less than it would have a decade ago because of the more diversified revenue base. The Saudi government does not publish the oil revenue projections that underlie its budget numbers. However, a recent IMF report on Saudi Arabia projects oil revenue of 760 billion riyals (around $200 billion) in 2025 on the back of an average oil price of $77.80/bbl and average production of 9.7 mb/d (the IMF projections assume that OPEC+ fully implements its planned production increases).

A back-of-the-envelope calculation suggests that if oil prices were to average $70/bbl in 2025 instead of the $77.80/bbl assumed by the IMF, oil revenue would be 5% lower. If production remained at 9 mb/d and oil prices averaged $70/bbl, revenue would be 9% lower than projected by the IMF. Both calculations assume that Aramco maintains its dividend at the 2024 level in 2025 despite the drop in its income. If the dividend is reduced because of pressures on cashflow caused by lower oil income, the hit to government revenue would be larger. The estimated revenue impact across these different scenarios ranges from 1% to 4% of gross domestic product and could result in a fiscal deficit in 2025 of between 4% and 7% of GDP unless offsetting measures to reduce spending or increase non-oil revenue are taken. PIF finances would also be affected by any reduction in the dividend paid by Aramco.

Difficult Decisions Ahead

The announced two-month delay in OPEC+’s planned production increases has not had a material impact on the oil market. While oil prices could recover quickly if there is a significant supply disruption in a key exporting country or the U.S. Federal Reserve delivers a large interest rate cut, additional weak data from China or the United States would keep downward pressure on prices.  Further price weakness would then turn attention to whether, rather than restoring production to the market, OPEC+ needs to implement further cuts. Such cuts, however, may be difficult to agree upon given that some OPEC+ members are already overproducing while others want to increase production because of the significant investments they have made in expanding capacity.

The risk of lower oil revenue is of concern for Saudi Arabia’s budget and broader public sector spending program. A modest and short-lived drop in oil revenue could comfortably be managed given the strong government balance sheet. A longer period of much lower oil revenue, however, would force some more difficult decisions to be made about spending priorities and whether new sources of non-oil revenue need to be tapped to finance the kingdom’s ambitious spending plans.