Saudi Arabia warned on oil strategy by financial crash economist Roubini

'If you look at Saudi Arabia’s response to the low oil price, they’ve reacted to this shock as if it’s temporary rather than permanent'.

Larry Summers (right), former treasury secretary and director of the National Economic Council, speaks at the Arab Strategy Forum in Dubai as Nouriel Roubini,

economist, (centre) looks on with Tom Keene of Bloomberg Business, left.. Ihsan Naji / Al Ittihad
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Saudi Arabia must stop acting as though the oil price decline is temporary, says Nouriel Roubini, the NYU economist credited with predicting the 2008 financial crisis.

“If you look at Saudi Arabia’s response to the low oil price, they’ve reacted to this shock as if it’s temporary rather than permanent,” Mr Roubini said, on the sidelines of the Arab Strategy Forum in Dubai on Tuesday.

“The main lesson is that this shock is permanent, it’s not transitory, therefore you have to adjust to it rather than just financing it.”

Last week, McKinsey, the management consultancy, said that Saudi Arabia would have to cut spending dramatically while encouraging more investment in the private sector than was seen at the height of the oil boom up to the middle of last year.

Brent crude has hit new lows following the Opec meeting where production quotas were scrapped for member states.

Saudi Arabia must press ahead with economic diversification, build a tax base, shrink the public sector and end government spending on subsidies, Mr Roubini said, echoing IMF advice.

“While in the short run you want to finance this shock by spending more, over time you have to cut government spending, you have to cut government employment, cut subsidies and transfers to the private sector, otherwise you’ll have unsustainable public debt over time.”

Mr Roubini gave Saudi Arabia a mixed score for its efforts to defend market share by continuing to produce oil. While the kingdom has succeeded in forcing major producers to postpone investment decisions, which will slow the rate of capacity growth for some years, newer shale gas and oil capacity won’t be significantly harmed, Mr Roubini said.

“The gestation period for shale gas and oil is much shorter. When prices are low you cut back the number of rigs, when prices are high you can increase the number of rigs very fast in a matter of months,” Mr Roubini said. Besides, “technological innovation”, which has “increased the productivity of hydraulic fracking” means that break-even costs for fracking producers are going to fall over time.

“The Saudi strategy of trying to stave off forever the shale gas and oil revolution may not work,” Mr Roubini said.

He said the oil price was likely to recover to about $50 per barrel next year. Demand for the commodity is likely to increase as oil prices remain low, he said, while slower capacity growth means that supply increases would be limited.

The entry of Iran is unlikely to have too large an effect on the market, because “it’s only through major investments that are going to take many years that the productive capacity of Iran could increase over time”, Mr Roubini said.

Mr Roubini earned media plaudits – and, in a New York Times profile, the nickname Dr Doom – after predicting, in autumn 2006, that the US housing market was overdue for a crisis.

Saudi Arabia’s budget plans assume an oil price of about $60 per barrel, Reuters said last week.

But Larry Summers, the former US treasury secretary, who also spoke in Dubai yesterday, suggested that this was too optimistic.

Any Middle East government with a budget that expects an oil price above $50 lacks “a fully viable” plan for the future, Mr Summers said. It’s a “realistic enough” outcome that Gulf states “should have plans that assume that”, he said.

Citigroup yesterday predicted US oil prices could fall into the $20s if storage tanks fill before producers curb their output.

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