Saudi Oil Price, the Global Economy and Correcting Media Economists

The hysteria surrounding Saudi Arabia’s increase in oil production and a subsequent drop in oil price to the mid-eighties and possibly lower is non-sensical. It’s nearly as bad a media reaction as if oil prices had moved the same amount upwards. Reports in the media have focussed on the possible political machinations of such a ‘dastardly’ move and the economic effect on oil producing countries not least of which is Saudi Arabia. Personally, the first thing that comes to my mind is that oil has dropped around 30% in the last few months and that is great news for the global economy and the world’s population. Why aren’t people rejoicing?

I blame what I call the media economists. I’m not saying that these people don’t understand economics, but even if you have a Nobel prize in economics but are more interested in media attention, then you’re going to spin things. In this article I’m going to present some ideas that are at the least worthy of consideration and public debate. They might even be correct.

The main arguments being made against Saudi in terms of motivation is that they are trying to punish Iran, Russia and the US shale oil industry. I am not a foreign policy specialist but I have to say that I have never seen Saudi take action like this against anyone. Second, although I have read in the press about problems in the Saudi – Iran relationship, I have never heard of problems with Russia. And I promise you that China is going to be happy about the price of oil.

The public analysis going from two sovereign states to an economic sub-sector of the US (shale oil) reeks of selective comparison. Why is the analysis of lower oil price not made with respect to its effect on the whole US economy? I’m pretty sure that unless you hold shares in shale oil companies you would be a happy American that oil dropped 30%. I’m guessing here, but I would estimate that means more than 99% of Americans are happy with oil prices lower.

But the Saudis are destroying shale oil thus increasing America’s dependence on foreign oil, I hear you say. Maybe it was Fox News saying it. Anyway, oil is fungible. Saudi oil price goes down, and that is why shale oil prices went down. Saudi oil price goes up, and shale oil prices go up. What I call the Fox News (FN) Hypothesis simply does not make sense. Another way to see why the FN Hypothesis is flawed is to follow the money. Who benefits financially from high oil prices in the US? Not just the shale oil investors I previously discussed, but the whole energy sector in the US. I wonder if they have lobbies that are powerful enough to influence the media and others? I’m strapping on my helmet and body armour.

The most entertaining part of the media economists’ analysis of Saudi is that, according to them, oil prices have reached, or are below, budget break even and that this spells doom for the Saudi economy. This simplistic analysis assumes that the Saudi government’s decisions are static  regarding net revenue and completely ignores the capital account deficit (don’t be alarmed, a capital account deficit is a good thing).

Starting with the national income statement, the first issue is what type of budget does Saudi have? I would argue that it is massively expansionary. This means that there is plenty of room for adjustment without having to scale back on government services and benefits. Similarly on the revenue side, if Saudi were to return to production levels that it has recently held, how fast will oil prices stabilize to their historical levels? I believe that economists call this the supply/demand curve. They must have misplaced it when analyzing the Saudi budget.

Now onto the national balance sheet, or what economists call the capital account. Saudi has no external debt, and negligible internal debt. It has massive external assets. How important is this? Well, depending on which numbers you want to believe, Saudi can function with zero oil revenue by drawing down on its external assets, predominantly US Treasuries, for about 3 years. This doesn’t even take into account any borrowing or change in the expansionary budget to a neutral budget.

So why are the media economists painting the opposite picture? Is their need for media attention so great that they are willing to fabricate a completely new picture? Maybe. Or maybe they live in countries that have not saved for decades, where sovereign debt is a huge mountain crushing their economies, where spending consistently outstrips revenue and the economy has been shattered by irresponsible bankers and borrowers. In such a scenario it is understandable that large revenue deviations are dangerous.

But that is not Saudi Arabia. The Saudi financial system was not traumatized. Saudi government spending remained within income limits. National savings were built up. The Saudi economy is strong and safe. I don’t know if the Saudis are managing the price of oil, but if they are then my bet is that they know what they are doing, and they know it better than anybody else in the world.

After all is said and done, the global economy just got a massive boost. Let’s enjoy it.

You may also enjoy two related articles on oil: Saudi Oil Price Redux and Oil: Through the Looking Glass.

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