The Curious Case Of Revealing Saudi Arabia's Treasury Holdings

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by: Kirk Spano

On Monday, May 16, the U.S. Treasury revealed for the first time the amount of government debt held directly by Saudi Arabia. The amount reported was $116.8 billion, which is far less than many expected. Interestingly, the accompanying chart from Bloomberg shows that direct Saudi Treasury holdings have been on a steady rise upward in the past decade.

The relatively low amount of direct holdings, in light of Saudi Arabia's recent threat to sell three-quarters of a trillion dollars of U.S. assets, suggests that the country holds substantial debt in non-direct accounts. The amount was roughly half of what all OPEC oil-producing nations held directly in aggregate in U.S. Treasuries. The United Arab Emirates were second at $62.5 billion and Kuwait third at $31.2 billion.

If we presume Saudi Arabia has more U.S. Treasury debt, which appears to be a near certainty, it is held similarly to how China holds some of their debt through third-party custodial accounts. China is widely believed to hold foreign reserves through accounts in Belgium.

The question that comes to my mind on why this information was finally released is: Why now? While there was a request for information made by Bloomberg, there have been many requests made over the years, to no avail.

Back in December 2014, six months after I predicted the fall in the price of oil (but not nearly the extent), I suggested that the U.S. and Saudi Arabia were some sort of strange bedfellows with regard to the oil markets.

One of the things I suggested was that the U.S. was asserting itself with Saudi Arabia over the 9/11 attacks, which were largely staged through the support of Saudi Arabians. It is my belief that when George W. Bush stated that fighting terrorism would be a "long war," he meant far more than what most people believed.

This is how I see the sequence of events:

  • After 9/11, George W. Bush invades Iraq and removes the barrier named Saddam Hussein that we had placed between Iran and Saudi Arabia. Installing Saddam Hussein and supporting his conflicts against Iran was designed to prevent Iran from threatening our alley at the time, Saudi Arabia.
  • By 2005, the U.S. has shale drilling operations beginning to drill across several plays.
  • By 2010, U.S. shale is starting to make a significant impact on oil markets, and President Obama does nothing to slow them down, as many pundits predicted.
  • In summer of 2012, the Tesla (NASDAQ:TSLA) Model S is introduced, representing the first consumer pitch for electric vehicles. This was a shot across the Saudi bow.
  • By 2013, U.S. shale is so prolific that U.S. imports of OPEC oil have plunged.
  • In 2014, Saudi Arabia abandons oil price targets and increases oil production.

Here is where many people I believe make a mistake. It is not Saudi Arabia acting on their own to destroy American shale oil - it is impossible to destroy the shale industry. The oil is there, and it only costs about $6-7m per well to extract it. The oil can be drilled in small projects or big, and on a relatively tight time schedule. It can even be inventoried for future extraction with "DUCs" (drilled but uncompleted wells).

It is true that much of the oil industry has gone bankrupt; however, that is not going to prevent shale oil drilling from rebounding when oil prices rise. Companies will just drill with new shareholders in place or as private companies. What is going to happen, though, is that drilling will have to be done out of free cash flow or with very conservative financing. Why conservative financing? There is very little aggressive financing left after the pounding that banks and other investors have taken. This will keep production relatively sensible going forward, or at least not as "drill baby drill" as it had been.

The oil segments that Saudi Arabia has crushed at least intermediate term and maybe forever are deepwater and oil sands. Both of those types of drilling require large lead times and major capital commitments that take over a decade to breakeven from financially. There is even less financing for these sorts of projects left than for shale after the major carnage that has occurred.

According to CAPP (Canadian Association of Petroleum Producers), projections for the Canadian oil sands have fallen dramatically going forward and are likely to continue declining as new projects are shelved. CAPP had predicted that oil sands production would grow from 2.1mbd to 5.3mbd by 2030, but that is now cut to about 4mbd after a series of project cancellations from companies, including Suncor (NYSE:SU) and Royal Dutch Shell (RDS.A, RDS.B).

The estimate is likely to continue falling with CAPP's 2016 forecast, as well as the reality that the Keystone XL pipeline, which was vital to further oil sands development, will likely never be built.

Deepwater drilling has not been spared either. We have seen companies such as Apache (NYSE:APA), ConocoPhillips (NYSE:COP) and Devon (NYSE:DVN) completely cancel all deepwater drilling going forward. Exxon Mobil (NYSE:XOM) and Chevron (NYSE:CVX) have also reduced offshore drilling. In addition, oil lease sales for 2016 and 2017 in the U.S. Arctic and Atlantic regions have been cancelled outright by the U.S. government.

According to Wood Mackenzie, at least $400 billion of deepwater projects have been cancelled since 2014, and many other projects have been delayed. Those projects, I believe, are in danger of cancellation as well if Saudi Arabia increases production in the short and intermediate term.

So what does this all have to do with releasing the Saudi Arabia U.S. Treasury data? Well, consider this: What if the petrodollar doesn't matter to us much anymore?

For decades, the United States and Saudi Arabia had a special relationship based upon mutual interest. What if now the relationship is not so mutual? Certainly, we want some things from Saudi Arabia. I think one of those things is to destroy the oil sands and deepwater oil industries. We want that for three core reasons.

The first reason was that cheap oil and gas were just the stimulus needed to help the U.S. economy recover in recent years. While I am in a small group that believes in "slow growth forever" for the economy going forward, it was clear that monetary policy alone was not enough to keep the U.S. and the world out of a depression. While I expect a recession by decade end, cheap oil helped the world get on more solid footing.

The second reason is so that in the last decades of oil-fueled cars, the United States can sell some of its oil at what are sure to be higher prices in a few years once depletion whittles down deepwater production that doesn't get replaced. To be sure, oil shale isn't gone - it's just retrenching for the stretch run. As we have covered in our forum, there are several companies we are very interested in, and they aren't the majors.

The final reason is Barack Obama's environmental legacy. By flooding the world with oil, Saudi Arabia has effectively guaranteed that oil sands and deepwater oil are dramatically reduced over time. The electric vehicle will kill that oil eventually. We could also wonder about Elon Musk's dramatic advancement of the Model E timeline and if there is some government prodding there, but that's for another post.

Ultimately, releasing the Saudi Treasury data was done most likely because we just don't care to hide it anymore. There is no longer a benefit to be had or a promise to keep. As far as we're concerned, either Saudi Arabia toes the line we set going forward or they can buy weapons from somebody else to fight Iranian-backed rebels.

There might even be a benefit to releasing the data, as the mystery around it potentially made it harder for us to manipulate our currency - I'm not sure which direction, maybe both. Keep an eye on the data and the dollar, there might be a trade in that somewhere.