Saudi Arabia hangs on with cheap oil—but for how long?

Hasan Jamali | AP

Workers at an oil facility near Riyadh, Saudi Arabia.

Mark the date on your calendars: Aug. 28, 2018.

That's when Saudi Arabia goes broke.

Or at least that's the date according to one model of the oil-rich nation's reserves, crude production and the price of oil. If crude stays around $40, America's Middle Eastern ally will run out of money on that date. Obviously, that assumes no other changes in fiscal or monetary policy. But regardless, it's an exercise that helps show exactly how important the price of oil is, and why Americans who value Middle East stability would want to see an increase in oil.

Without a recovery in the oil market, nations face huge budgetary shortfalls and increased political volatility over the coming years. Small, rich nations like Qatar and Kuwait likely have enough cash reserves to ride out the storm for a very long time, but poorer OPEC members like Libya, Iraq and Nigeria face potentially explosive situations.

Somewhere in the middle of that mix is Saudi Arabia, at once rich and at the mercy of the oil market. Crude accounts for about 90 percent of total export value and around 80 percent of total government revenue.

Saudi Arabia needs the price of oil to rise—and quickly, according to data put together by the "Big Crunch." "With the market still oversupplied and key producers pushing exports to record levels, that reset looks increasingly imperiled," researchers at RBC Capital Markets wrote in a recent note.

Brent crude, the international benchmark for the price of oil, dipped below $43 this week, down 57 percent from 12 months ago. The shale drilling revolution in North America and softening demand from China have contributed to declining oil prices. Also on the supply side is continued high production from OPEC nations. The basic tenets of supply and demand would seem to call on producers to cut production in order to drive up prices.

But the Saudi authorities bet the bank last winter that by maintaining high production levels despite a falling price per barrel—and by pressuring other OPEC members to do the same—they could use the dropping price of oil to shut down their upstart rivals in Russia and North America. But that appears to have been a mistaken assumption; while the drilling of new North American wells has slowed in recent months, existing wells have continued operating and even increased output.

"It is becoming apparent that non-OPEC producers are not as responsive to low oil prices as had been thought," the Saudi Arabian Monetary Agency said in a recent stability report. "This requires more patience on OPEC oil producers and a willingness to maintain steady production until the demand catches up with the current supply levels."

In other words, keep pumping and selling oil at rates far below the nation's break-even point—the minimum price where Saudi Arabia needs oil in order to meet its budget requirements. The country has oil reserves of around 270 billion barrels, according to the U.S. Energy Information Administration. That means that at current production levels of just under 10 million barrels a day Saudi Arabia could keep pumping for almost 75 years.

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But with crude oil selling for around $40 a barrel, it would run out of cash reserves long before that. According to the Big Crunch's model, Saudi Arabia could burn through its entire $655 billion currency reserves by the end of 2018 if oil prices don't rise. Researchers at Barclays reached a similar conclusion, based on a scenario analysis of Brent prices at $50 a barrel. "Without fiscal adjustment and assuming no issuance of debt, Saudi Arabia's government deposits and FX reserves would be eroded by 2019," the investment bank wrote.

Even oil priced at $60 a barrel won't prevent Saudi Arabia from draining its reserves, unless it takes actions to cut costs.

Our model assumes the kingdom will keep up its promise to maintain production levels and marginal costs of drilling. Granted, it's theoretical and relies on a number of assumptions like maintenance of the real exchange rate and continued production levels. But it underscores the severity of the Saudi budget.

Indeed, the situation for Saudi Arabia has become so dire that it had to sell $4 billion of bonds in the past year, the first time it's sold that much debt in eight years. "We expect to see an increase in borrowing," Fahad al-Mubarak, head of the SAMA, said in July, according to the Financial Times. And Saudi authorities are reportedly looking to cut $102 billion in capital spending in response to the drop in oil prices, according to Bloomberg.

Still, public spending remains high in historical terms. The Saudi government—like many in the Middle East—increased public spending in the past few years in an attempt to stave off dissent during the Arab Spring. Public expenditures in 2015 are forecast to break 1.2 trillion Saudi Arabian riyals ($321.8 billion) in 2015, almost twice 2010 levels, according to research from Barclays.