Saudi Arabia’s Big Mess

Oil’s continued plunge is vying with China for the early financial headlines in 2016.

Yet many U.S. investors are missing the most important aspect of oil’s collapse: the dramatic effect oil’s falling prices are having on Saudi Arabia.

In November 2015, I speculated that the Saudis may have to devalue their currency, the riyal, versus the U.S. dollar for the first time since 1986.

Today my prediction looks prescient, as this supposed long-shot, black swan event is now becoming a distinct possibility.

Saudi Arabia’s Gigantic Budget Problem

The low price of oil – caused in part by the Saudis’ market share war – has blown a hole in the country’s budget.

Saudi Arabia announced at the end of 2015 that it ran a record budget deficit of $98 billion. That’s 15% of the country’s gross domestic product. To stem the bleeding, the Saudi government slashed its 2016 budget by 14%, and increased domestic fuel prices by two-thirds, even though it’s still only around $0.20 per gallon.

Meanwhile, the Saudis have also taken other measures to right the ship.

A few months ago, their sovereign wealth fund began repatriating funds from overseas money managers. This served to drain liquidity from global financial markets and hurt stocks. The Kingdom also sold sovereign bonds for the first time since 2007, and plans to sell at least $32 billion in sovereign bonds in 2016.

Finally, the Saudi Arabia announced that parts of its crown jewel – Saudi Aramco – will be sold in an IPO. Of all the recent moves made by the Kingdom, this is surely the most telling.

Saudi Aramco dwarfs any other oil company and will fetch a pretty penny. But it would’ve gotten a lot more if the sale had occurred when oil prices were high. That’s why I think the juiciest parts will not be part of this IPO.

Thinking the Unthinkable?

Even selling part of Saudi Aramco is unlikely to get the country out of the hole it has dug itself into with the oil share war. Bank of America estimates that $30-per-barrel oil will balloon the Saudi budget deficit to nearly $180 billion this year.