Low Oil Prices and the War in Yemen Have Left a Huge Hole in Saudi Arabia's Budget

Projecting a record budget deficit of $98 billion in 2015, Saudi Arabia announced a decrease in fuel subsidies on Monday and said it could sell off state assets in the future as the kingdom struggles with plunging oil prices and the cost of its war in Yemen.

The Saudi state press agency said total expenditures were expected to reach 975 billion riyals ($260 billion) during the current year, a rise of 13 percent over expectations. The country's Finance Ministry said that total would fall to 840 billion riyals in 2016, a decrease of 14 percent. But revenue forecasts for 2016 were further downgraded by the government, to only 514 billion riyals, meaning a similar gap in the kingdom's balance sheet could carry through at least through next year.

In a speech carried on state television, Saudi King Salman said the budget "comes in light of lower oil prices and economic and financial challenges on regional and international levels."

"Our economy, with the help of God, has what it takes to overcome the challenges," said Salman, who ascended to the throne in January after the death of his predecessor, King Abdullah.

The price of oil has fallen precipitously in recent years and is currently trading below $40 per barrel, but it still accounts for the bulk of Saudi revenue. Despite the price decrease, Saudi Arabia has until now held off on decreasing its oil output, which is nearly at capacity. Such a move would send a strong message to oil markets, and possibly cause a rise in oil futures. Many analysts believe the current Saudi strategy is to squeeze out other oil producers, including the shale industry in the US, and not give ground on its market share.

Related: Even Saudi Arabia Seems to Understand the Need to Ditch Fossil Fuels

For decades, Saudi oil sales have afforded the country's citizens cash handouts and a rich social welfare net. Energy use in the Kingdom has long been heavily subsidized, but on Tuesday the Ministry of Finance said that would begin to change.

According to figures posted by the Saudi press agency, prices for 95 octane gasoline will immediately rise by 40 percent to 0.90 riyals — roughly 24 cents — from .60 riyal per liter. That price level is still less than half of average gas prices in the US this December, and significantly below what a liter costs in much of Europe.

"Instead of paying pennies they will be paying dimes," said Simon Henderson, director of the Gulf and Energy Policy Program at the Washington Institute.

Henderson said the small increase still sends a significant message to Saudi citizens. Though the kingdom has some of the largest foreign reserves, valued at more than $600 billion, earlier this year the IMF estimated that "large fiscal deficits" amid continued stagnation in oil prices could leave the country cashless in five years. Though most analysts don't foresee Riyadh going broke, it was clear on Monday that the kingdom recognizes the potential damage of an extended period of budget shortfalls.

Watch the VICE News documentary Inside War-Torn Yemen: Sanaa Under Attack:

Henderson added that the Saudi-led intervention in Yemen, entering its tenth month, was adding extra strain on the country's coffers. In its 2016 budget, Saudi Arabia allocated 213 billion riyals (around $57 billion) to defense and security.

"The Yemen war is certainly costing them a lot in terms of bombs and munitions being dropped, but the greatest concern is that Saudi Arabia is pursuing a policy in Yemen which doesn't appear to have an endgame to it other than a military victory," said Henderson.

The intervention is closely associated with King Salman's son, Mohammad bin Salman, who was appointed as Defense Minister by his father earlier this year. Despite scoring some victories against Houthi rebels and their allies in Yemen, the Saudi-led coalition has failed to regain all the territory seized by the predominantly Zaydi Shia militia since 2014. After peace talks this month ended with few substantive results, fighting has resumed with great intensity in many parts of the country. All sides, including the US-supported Saudi coalition, have been implicated in war crimes.

Related: Yemen Peace Talks Continue Despite Reports of Heavy Fighting Near Saudi Border

"It is a very expensive war, and of course no one knows where it's going in 2016," said Anthony Cordesman, the Arleigh A. Burke Chair in Strategy at the Center for Strategic and International Studies in Washington. "Looking at the figures that have been released, it's uncertain that the defense budget includes all the costs of foreign arms purchases that are scheduled. The Saudis may be forced to choose between the war and the arms imports — you only have so much money."

To cover the deficit, the Saudi government is expected to dip into its reserves and tap domestic and international bond markets, where — at least for now — the country enjoys high credit ratings and can borrow at low interest rates.

"It's easy enough for them to raise money — this is okay for a year or so," said Henderson. "But the big overarching question is where is the price of oil going?

"To the extent that the Saudis have been predicting this, they previously anticipated that it would begin to recover later in 2016," he added. "Indeed there has been some Wall Street analysis along similar lines, but how much it will recover by is a big question. My own view is that oil prices will continue to remain weak."

Cordesman said that the Saudis are in some ways better equipped to weather the downturn than other Sunni Gulf countries due to the billions the kingdom has saved over the years. But it also plays an outsized role in the region, where it views the conflict in Yemen as part of a larger rivalry with Iran, who it accuses of supporting the Houthis. Any further retrenchment in oil prices, he added, could threaten recent efforts by the Saudis to support the job market and diversify their economy away from the petroleum industry.

"The problem the Saudis face is not this year," Cordesman said. "But you can't possibly save enough when you are arming to deal with Iran and when you have major domestic pressures, and you are trying to create jobs and housing, and are now dealing with the war in Yemen."

Follow Samuel Oakford on Twitter: @samueloakford