Saudi Arabia offers the largest bond auction with yields of 1.35%


Saudi Arabia offers the largest bond auction and announces partial selling off Saudi Aramco’s stock as the budget deficit is increasing. Has the Saudi Oil strategy backfired?

25th October, Orbex – Saudi Arabia held the largest bond auction from the emerging markets last week. The Kingdom offered $17.5 billion in bonds on the international markets, usurping the previous record of $16.5 billion bond sale from Argentina in April this year. The country has a sovereign credit rating of A1 from Moody’s investor services.

Saudi Arabia’s bonds, sold in dollar denominations came with a five-year maturity, yielding 135 bps or 1.35%. It is higher than the US treasuries and the 10-year notes. Here is why Saudi Arabia offers the largest bond auction.

Saudi Arabia: Facing record budget deficits

Saudi Arabia Government Budget Deficit to GDP Saudi Arabia Government Budget Deficit to GDP

The bond offering could not have come at a better time as the kingdom is seen grappling with a record high budget deficit. Official records show that Riyadh had generated a budget deficit of $98 billion last year, which is about 15% of its GDP and this year’s projections put the deficit around $87 billion.

Many experts believe that the budget deficit problem is just getting started, largely thanks to years of low oil prices amid high production. Regional analysts say that diversification is essential to curb Saudi’s over reliance on oil and also the subsequent subsidies programs that need to be reined in as well as overspending on financing regional wars.

Saudi Aramco IPO expected to raise $2 trillion in capital

Saudi’s crown prince, Mohammed bin Salman had previous unveiled sweeping plans to end Saudi’s “addiction to oil.” As part of his plans, the crown prince informed that the state owned Oil Company Saudi Aramco, valued around $2 trillion is expected to sell 5% through an IPO. The sale is expected to raise the capital to the public investment fund to nearly $2 trillion from approximately $160 billion.

“We will not allow our country ever to be at the mercy of commodity price volatility or external markets,” the crown prince said, speaking to journalists.

Further reforms are expected including a cut in take-home pay and reducing subsidies on social and welfare programs which were hitherto supplemented by revenues from Oil production.

Has the Saudi Oil strategy backfired?

Much of the deficit comes from lower oil prices, a dilemma of its making.  When oil prices were starting to get oversupplied in 2014, OPEC’s largest oil producer surprised the world by continuing to pump oil at record levels instead of scaling back production. The decision that was announced in November 2014 has since then sent oil prices crashing, losing over 60% as a result. The purpose behind the decision was to drive the cheaper US shale oil producers out of the markets considering the higher breakeven levels. But instead, shale oil produces trimmed their costs while managing to drill more oil from existing wells and lower production costs to bring the breakeven levels lower.

Goldman Sachs released a forecast a few weeks ago where the report noted that US shale oil production could increase as much as 700,000 bpd by the end of 2017 which would wipe out the production losses from the previous three years.

The fact that the kingdom itself now needs higher oil prices is evident by the compromise struck on the sideline of the Algiers Summita few weeks ago. In contrast to the Doha deal which saw bickering between Saudi Arabia and Iran on production cuts, the kingdom was willing to give concessions to countries including Iran, Algeria, and Libya among others while committing itself to lower production levels.

The next general OPEC meeting is scheduled for November 30th, and so far Russia has affirmed itself to lowering production levels while staying hopeful that other countries will join ranks.

A failure to reach an agreement on production cuts would not bode well for oil prices and the markets at large. For one, OPEC and non-OPEC oil producers will only have the incentive to lower their production levels if Saudi Arabia is willing to take the first step. With oil production in Saudi Arabia already at record highs and the country facing budget deficits, the question is whether OPEC’s largest oil producing nation is willing to walk the talk.

About the contributor

This article was written by John Benjamin, Analyst at Orbex – an AtoZ Approved Forex Broker.

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