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The Kingdom Goes Broke: The Saudi Aramco IPO And A Hilariously 'Crude' Debacle

Unfolding before your very eyes is the most spectacular example of a country cutting its nose off to spite its face the modern world has ever witnessed.

In 2014, Saudi Arabia put itself on the path to bankruptcy.

The scramble to clean up the 'oil spill' - if you will - is set to create the largest IPO in history.

Behold! Unfolding before your very eyes is the most spectacular example of a country cutting its nose off to spite its face the modern world has ever witnessed.

Who knows why exactly the Saudis decided to deliberately kill the golden goose in late 2014 by catalyzing not only a precipitous decline in crude (NYSEARCA:USO) prices but also a further sell-off in the broad commodities complex (which hit a 21st-century low last year).

Conventional wisdom holds that the kingdom decided to go to war with ascendant (if cash flow negative) U.S. shale producers in order to "preserve market share." That explanation has been parroted ad nauseam. And while there's almost undoubtedly some truth to it, you should be wary of any account that has been repeated so often as to become the consensus.

A more nuanced explanation says Riyadh had a number of political considerations in mind when the kingdom chopped off its own hand (that's the Wahhabist version of shooting oneself in the foot).

As The New York Times put it last year, there are "ancillary diplomatic benefits" to keeping oil prices low. That's a nice way of saying "oil prices can be used as a geopolitical weapon."

There are number of possible political advantages Riyadh might have hoped to derive from "temporarily" suppressing crude. First, as mentioned previously, the Saudis might have hoped they could pressure the Russians into abandoning their support for the Alawite government in Damascus. That didn't work. Second, and perhaps more importantly, Riyadh might have anticipated (or might have simply "known" via diplomatic channels to the White House) that come hell or high water, the Iran nuclear accord was going to get done because like it or not, Obama's legacy comes before Saudi and Israeli security concerns in the grand scheme of things. If that's the case, the move to crush crude might have been a preemptive attempt to undermine Iran's production ramp.

The truth is probably some combination of the above (i.e. some conflagration of economic and political fires the Saudis thought they saw burning on the horizon). Unfortunately, for Riyadh, they lost all control of prices and watched in horror as the crude train careened off the tracks, crashed, and promptly exploded triggering a swift drawdown of the SAMA war chest and unheard of speculation against the three-decade-old riyal peg.

Have a look, for instance, at the explosion in implied vol for the riyal that unfolded over the latter half of 2015 (the left pane is FX reserves):

(Chart: BofA)

And that's just the SAMA and SAR situations.

By the end of last year, the fiscal situation had turned into a complete joke. That is, the deterioration was so dramatic, it became laughable. Here's a pair of graphics from Deutsche Bank which show the budget gap and the debt-to-GDP projections (note: the deficit turned out a little better than DB's -19% projection, but when you're talking double-digit budget gaps, -16% isn't much better than -19%):

For those unfamiliar with how all of this fits together, here, roughly speaking, is how this works. The government employs pretty much the entire country...


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