Saudi Arabia’s VAT Hike Proves the Oil Price Rally Is About to Crash

May 11, 2020 10:59 PM UTC
Saudi Arabia has introduced new austerity measures in the wake of the oil price collapse, a sign that the recent recovery will be short-lived.
  • Saudi Arabia has tripled value-added tax and suspended some allowances following the oil-price collapse.
  • The country’s budget deficit in Q1 2020 rose to nearly $10 billion.
  • For its books to balance, the kingdom’s breakeven oil price is over $70.

Saudi Arabia ranks highly among the countries that are heavily dependent on oil. When oil prices are high, times are good for both the government and citizens. But when oil prices fall, the pain is felt across the board. That’s the situation Saudi Arabia now finds itself in as Brent crude hovers around $30.

To shore up the kingdom’s finances, Riyadh announced austerity measures and tax increases Monday, including a tripling of the value-added tax (vat) to 15% from 5%. Slightly over two years ago, VAT was non-existent in Saudi Arabia. Most residents still pay 0% income tax to this day.

Starting next month, though, Riyadh will also suspend the cost of living allowance given to state employees. The allowance of around $267 was introduced for public servants two years ago to offset the rise in living expenses.

Source: Twitter

Saudi Arabia’s Problems in Three Words – Overreliance on Oil

As of January, the U.S.-Saudi Business Council estimated that in 2020 Saudi Arabia would generate 62% of its revenues from oil. At the time, Brent crude oil was forecast to average around $60 per barrel. Oil production was forecast to average 9.8 million barrels per day.

Brent crude futures are now trading at around $30.

Next month, Saudi Arabia’s average daily production is projected to fall to 7.492 million barrels a day. With prices and output well below forecast, Riyadh’s financial state of affairs is dire.

Oil already accounts for 50% of Saudi Arabia’s GDP. The budget deficit for the first quarter amounted to $9 billion. After falling for four consecutive years, the deficit is now in an uptrend.

Saudi Arabia’s budget deficit has been falling since 2016, but this year the pattern will be broken. | Source: U.S.-Saudi Business Council

Can Oil Recover Enough to Support the Kingdom’s Budget?

While oil prices have surged from April’s record low, Saudi Arabia’s actions are indicative of what has been clear all along–the rally will be short-lived.

Brent crude fell below $20 in April before recovering above $30. | Source: TradingView

For Saudi Arabia to balance its books, the price of oil needs to be at $76.10 per barrel, according to the International Monetary Fund. From current levels, oil prices need to go up nearly 150% for Riyadh to balance its budget.

More Coronavirus Cases, More Bad News for Saudi Arabia

Even as economies around the world start reopening, the demand for oil remains relatively low because of weak demand and a persistent glut. Balancing the books will get worse for Saudi Arabia as fears of a second wave of coronavirus emerge.

After easing lockdown measures, China reported five new cases of the novel coronavirus on Sunday. That’s the highest since early March, a month where China reported no new domestic cases of the virus.

Source: Twitter

A new wave of infections has also been reported in countries that were being applauded over their handling of COVID-19. That includes Germany and South Korea.

This can only mean one thing: The oil glut will persist for a long time. And so will the low prices. And Saudi Arabia’s budget woes.

Disclaimer: The opinions expressed in this article do not necessarily reflect the views of CCN.com. The author holds no position in oil at the time of writing.

Sam Bourgi edited this article for CCN.com. If you see a breach of our Code of Ethics or find a factual, spelling, or grammar error, please contact us.

Last modified: June 12, 2020 10:31 PM UTC

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