Saudi Arabia’s Other Major Crisis

With $562-billion in net foreign asset, the second largest oil reserves in the world after Venezuela (according to the latest Opec bulletin), and the second largest oil output in the world after Russia – Saudi Arabia’s future looks rosy and solid.

Indeed, Saudi Arabia has been able to soothe internal tensions and even manage external ones by tapping into its vast reserves thanks to a copious flow of funds streaming through its coffers as oil prices remain in triple figures.

Fast forward into the future and Saudi Arabia may not have the same luxury.

Key challenges facing the Saudi economy could derail its progress, or certainly alter its economic fundamentals, according to Brad Bourland, veteran chief economist at Riyadh-based Jadwa Investment and Paul Gamble, head of research.

Jadwa argues that once the current ‘benign’ decade is over, the Saudi government faces a very different environment unless the current spending and oil trends are changed.

Based on Saudi Arabia’s current spending patterns and its trajectory and changes in the global and domestic energy markets, Saudi Arabia’s breakeven price will rise from a manageable $90.7 a barrel to an astronomical $175.1 a barrel 175.1 and an incredulous $321.7 by 2030, according to Jadwa forecasts.

It is very unlikely that oil prices would reach these levels even after 20 years. But the assumption is that oil prices ease slightly over the next few years before rising gradually with inflation from $90 per barrel for Saudi export crude in 2014. As a result, we expect that the budget will fall into deficit in 2014 and will not return to a surplus through 2030.”

If that were to happen, the government is likely to draw on foreign reserves at least for a few years before it issue domestic debt, and only resort to foreign borrowing as a last resort.

With a budget surplus expected for this year and the following two years, SAMA net foreign assets are likely to rise to over SR2 trillion ($533 billion) by the end of 2013. Even if all subsequent budget deficits are fully financed by drawing down these assets, they will still stand at over SR1 trillion ($267 billion) at the end of 2021.

“On our projected fiscal path, net foreign assets would drop to $100 billion in 2024, after which new debt would be used to finance the deficit. With large budget deficits coming in the second half of the 2020s, the stock of domestic debt would rise quickly, as would the cost of servicing the debt. By 2030 the fiscal position would be very strained,” notes Jadwa economists.


These changes are occurring in the backdrop of lower Saudi contribution to global energy supply. Indeed, the Kingdom’s share of oil supply has fallen slowly and surely from 12% in 1991 to 10% today, according to Jadwa estimates.

New energy sources and improvements in shale gas technologies could curtail demand for oil, even as Saudi Arabia ramps up its own oil production.

The “game-changer” over the next few years could be Iraq, along with Venezuela and Iran, which could ramp up their oil production. Iraq, especially has embarked on an ambitious strategy to ramp up production from 3 million to 12 million of oil per day by 2020.

“We expect the ongoing ramp-up of Iraqi oil, in particular, to be a potential game-changer in the oil market and to have implications for, among other things, Saudi oil capacity and output and the power balance in Opec,” says Jadwa. “Once its output reaches 4.5 million barrels per day, Iraq would be the second largest producer in Opec. If output goes much higher it would have implications for Saudi Arabia’s leading role in Opec.”

Jadwa thinks that the trend of stable to gradually declining Saudi share of global oil output will continue.

“By 2030, if global oil production has grown by 1.4 percent per year and Saudi Arabia continues to capture about 10 percent of global market share, then the Kingdom’s output would be around 11.5 million barrels per day, versus today’s 9+ million barrels per day. This is not a significant change and still well within Saudi Arabia’s existing crude oil production capacity of 12.5 million barrels per day.”

The Kingdom has often asked for ‘security of demandfrom oil consuming countries, suggesting that if they want a stability in supply and prices, then they also need some kind of guarantees that new oil production will find ready buyers.

Saudi Arabia is acutely conscious that new technological developments in shale gas and the arrival of new discoveries and players in the market could erode its expensive and expansive energy infrastructure.

The IEA expects that a jump in new output of unconventional gas (shale gas plus tight gas and coal-bed methane) will result in global gas demand exceeding that for coal by 2025 and approaching oil by 2035. Certainly, Saudi Arabia sees this as a worrying development, given that 85% of its budget is funded by oil revenues.


At the moment, Saudi Arabia finds itself in the enviable position that it could run a deficit of 10 percent of 2010 GDP for the next decade without issuing any debt and still have official reserves of over US$110 billion, estimates Jadwa.

“At the most extreme, and only for the sake of comparison, the Kingdom could finance all likely spending from savings and non-oil revenues without needing to increase debt for two-and-a-half years even if it earned absolutely no oil revenues over that period.”

However, that dream run could well end. Over the years, the Saudi government has made commitments to spend on infrastructure, periodically recruit Saudis in the public sector and then raise their salaries. Apart from a recent spending package of $130-billion to calm Saudi citizens, the government’s current spending had risen $51-billion from 2003 to 2009 and investment spending by $39-billion during the same period.

Unlike investment spending which can be scaled back, current spending involves wage bill which are far more sensitive to changes, especially if they are revised downwards.

The government’s wage bill has increased 76% to $24-billion during 2003-2009, the number of employees has risen by a quarter and several pay increases and inflation adjustments have been introduced.

Of course, all these raises have come on the back of oil prices that have risen from $31.1 a barrel in 2003 to $99.7 by 2008, increasing oil revenues from $62-billion to $262 billion during the same period.

Saudi Arabia’s local energy prices are among the lowest in the world, but it comes at a price. Compared to China ($4.23), U.S. ($3.86), Saudi residents pay 61 cents for a gallon of gasoline.

Potential impacts on the global price of oil aside, if all of the 2.4 million barrels per day consumed domestically in 2010 were priced at $10 per barrel for local consumers (more than what the electricity company and industrial consumers pay but less than our estimate for gasoline retailers), were instead exported, this would have generated additional oil revenue of around $60 billion, on top of the $215 billion received in oil export earnings.

If local oil consumption continues to grow at the same pace that it has over the last eight years, then by 2020 it would reach 3.9 million barrels per day and by 2030 it would be 6.5 million barrels per day. Extending the trend even further, by 2037 domestic consumption would exceed the Kingdom’s current production and by 2043 it would be greater than the Kingdom’s current production capacity of 12.5 million barrels per day.

Worse, the heavily subsidized energy is not being consumed efficiently.

“Between 2007 and 2010 demand for oil in the Kingdom increased by 22 percent, double the growth of the non-oil private sector,” notes Jadwa. “Oil consumption in the Kingdom grew at a slightly faster pace than the rate in China over the period, even though the Chinese economy expanded at almost three times the pace of the Kingdom’s non-oil economy.”

Of course, it does not have to be this way.

Jadwa economist suggests that Saudi Arabia could…
1 …Avoid rapid worsening of government finances if it can alter the trajectory of the current trends of oil production, domestic oil consumption and government spending.

2 …Curtail the growth in domestic oil consumption with adjustments upward to local energy prices, fulfillment of its plans to develop nuclear and solar powered electricity plants, and a series of energy conservation measures.

3 …Gradually lower government spending growth rates, given the many years of fiscal cushion that lie ahead.

4 …Strengthen non-oil revenues by changing taxation policies.

5 …Find ways using its strength within Opec to try to bring its share of global oil production out of the gradual decline it is currently experiencing.

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