John Kemp: Saudi Arabia's
dwindling oil revenues
"The oil price decline is expected to have a large, permanent component,"
according to the IMF.
Saudi Arabia faces profound challenges to its economy and political system as a result of the slump in oil prices, which will test the skill of the country's ruling elite unless oil revenues recover in the next two years.
Despite frequent official statements over the last four decades about the need to diversify the economy away from dependence on petroleum, Saudi Arabia's economic outlook remains bound up with the price of oil.
Gross domestic product per capita almost doubled in real terms between 1968 and 1978 thanks to the surge in oil prices during the 1970s ("World Development Indicators," World Bank, 2015).
But it halved during the early 1980s thanks to the combination of falling prices and a declining export market share, and then stagnated between 1987 and 2002.
Saudi Arabia did not experience renewed growth in real GDP per capita until 2003 when a sustained rise in oil prices and to some extent higher export volumes began to lift the economy ( tmsnrt.rs/1nA8Apa ).
Between 2003 and 2013, real GDP grew at a compound average rate of 6.1 percent per year, up from just 2.2 percent between 1993 and 2003, according to the World Bank.
The last slump in prices, during the late 1990s, prompted much talk about the need for economic diversification as well as administrative and political reform.
During the subsequent oil boom, however, the impetus to make difficult structural changes to the economy, society and government dissipated.
Real GDP per capita rose by more than 40 percent between 2003 and 2014, almost entirely thanks to the bonanza in oil revenues, and reforms were postponed.
Saudi Arabia remains one of the most commodity-dependent economies in the world, and its dependency has been increasing, according to the United Nations Conference on Trade and Development.
Petroleum exports accounted for 98 percent of the country's merchandise export earnings in 2012/13 and more than 46 percent of GDP ("State of Commodity Dependence," UNCTAD, 2014).
Comments from policymakers about the need for deep structural changes must be placed in the context of 40 years of failed efforts to move the economy away from reliance on oil earnings.
OIL AND THE STATE
Oil wealth has been an essential element of the Saudi system almost since the foundation of the modern country in 1932.
Saudi Arabia's economy remains dependent on massive revenues from the export of crude oil and downstream refined products and petrochemicals.
The country's political system rests on a social compact between the ruling elite and the population in which is based in part on the distribution of oil revenues.
It is no accident the memoir of Frank Jungers, the former chairman and chief executive of Saudi Aramco, published in 2013, was subtitled "how Aramco and Saudi Arabia grew up together".
The Arabian American Oil Company, later renamed Saudi Aramco, has arguably been the single most important instrument of nation and state-building.
The company's official history states simply: "the story of the evolution of Saudi Aramco and the unparalleled oil and gas resources it has developed ... is indivisible from the story of the development of Saudi Arabia itself, which was fuelled by the development of those very resources".
The official history notes the oil industry and the state are "intertwined" and Aramco played a key part in "nation building" ("Energy to the world: the story of Saudi Aramco", 2011).
Shifting the economy, society and political system away from dependence on oil revenues is therefore an incredibly tough and complicated challenge, but it has never seemed more necessary or urgent.
The popular and romantic image of the country abroad is of one that is home to a small number of desert-dwellers sharing a vast amount of oil wealth, but if that was true in the 1950s and 1960s, it is no longer true in the 2010s ( tmsnrt.rs/1nA8UEF ).
Saudi Arabia's population has surged from just 3 million in 1950 and 9 million in 1980 to 21 million in 2000 and 28 million in 2010 ("World Population Prospects," United Nations Population Division, 2015).
More than 45 percent of the population now lives in metropolitan areas of more than 1 million, according to the World Bank ("World Development Indicators," 2015).
Saudi Arabia is an increasingly urban and modern society. Electricity consumption per capita has more than doubled since 1991. Total energy consumption per capita has doubled since 1986.
Saudi Arabia is also a young and fast-growing society. Nearly 30 percent of the population is below the age of 15 and 97 percent is below the age of 65. Population growth has been 2-3 percent per year since 1992.
Saudi Arabia needs to create large numbers of new jobs to absorb the huge number of young people reaching working age each year (which explains the government's focus reducing expatriate labour and "Saudisation" of the workforce).
The kingdom also has substantial military commitments. There were a quarter of a million armed forces personnel in 2013. Military expenditure accounted for almost 11 percent of GDP in 2014, according to the World Bank.
Plunging oil prices and revenues present a serious challenge for the state and society, just as they did in the 1980s and 1990s.
(FINITE) FINANCIAL RESERVES
Unlike other big oil exporters with large and growing populations, such as Iran, Iraq, Venezuela and Nigeria, the Saudi government built up large financial reserves during the boom.
Net foreign assets peaked at $737 billion in August 2014, which gives the state time to organise a longer and smoother transition.
"Oil exporters will need to adjust their spending and revenue policies to ensure fiscal sustainability," the IMF concluded last year but "countries with larger buffers can adjust more gradually so as to contain the negative impact on growth" ("Regional Economic Outlook: Middle East and Central Asia," IMF, Oct 2015).
To the extent the downturn in oil prices is cyclical and expected to last no more than another 2 or 3 years, the Saudi state could in theory rely on its foreign reserves and wait for an eventual upturn.
But to the extent the slump has structural characteristics because of the shale revolution and/or is cyclical but expected to last for another 4-10 years, the state and economy must eventually adjust to reduced oil revenues.
"The oil price decline is expected to have a large, permanent component," according to the IMF.
That may or may not prove true, but the reserves will not allow the state to postpone adjustment indefinitely.
Reserves have fallen rapidly, from $737 billion in August 2014 to $636 billion in November, a drain of almost $7 billion per month. As oil prices sink even lower, the drain is accelerating.
Saudi Arabia has tried to extend the life of its reserves by issuing more domestic and foreign currency to fund government operations, but in the end it is the net position that matters.
Moreover, Saudi Arabia needs large reserves to back its long-standing but now probably overvalued currency peg against the U.S. dollar. Reserves are vital to maintain confidence and forestall capital flight.
It is impossible to know what minimum level of reserves is needed to maintain confidence, but $200-300 billion is not an unreasonable estimate. Saudi Arabia could not allow reserves to drift towards zero.
The government budget has swung from a substantial surplus of 12 percent of GDP in 2012 to a projected deficit of almost 20 percent of GDP in 2015, according to the IMF ("Article IV Staff Report" Sep 2015).
The situation is sustainable for another 1-2 years but not another 3-5, one reason policymakers are seeking to accelerate reform by raising fuel prices and talking about introducing a value added tax, cutting government spending and privatising some state owned assets.
There is no doubt a new generation of leaders is serious about reform, but the changes would represent big changes to a 70-year old model, so the difficulty should not be underestimated.
John Kemp is a Reuters market analyst. The views expressed are his own. Petroleumworld does not necessarily share these views.
This commentary was originally published by
Reuters on Jan. 21, 2016. Petroleumworld reprint this article in the interest of our readers.
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