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OPINION

Saudi faces series of oil-linked challenges

London, November 13, 2013

By John Kemp

Saudi Arabia is just about the only energy producer so far unaffected by the shale revolution. Yet, Saudi policymakers will have to successfully deal with a series of problems by the end of the decade.

Individually, each of the problems should be easy to manage, but in combination they could amount to a "perfect storm" that presents the kingdom's leaders with the most difficult challenge since the collapse in oil prices in 1998.

FINANCIAL FORTRESS

Saudi production of crude oil and other liquids hit a record 11.7 million barrels per day in 2012, according to the US Energy Information Administration (EIA).

Government oil revenues amounted to 1,144 billion riyals ($305 billion), up from 670 billion in 2010 and almost double the figure included in the budget, according to the International Monetary Fund (IMF).

While other energy producers have been hit by growing competition from shale, Saudi Arabia has benefited from output problems affecting the North Sea and other Opec members, which have kept prices above $100 per barrel and enabled the kingdom to increase its market share.

"Saudi Arabia has been one of the best-performing G20 economies," the IMF concluded at the end of its annual Article IV consultations with Saudi authorities in May and June. "In recent years, the government has smoothed oil price volatility and built significant (fiscal) buffers," the Fund found.

Surplus budget revenues have been applied to reduce outstanding debt to less than 4 percent of GDP and build deposits at the central bank of 58 percent of GDP, sufficient to cover 20 months of spending.

A large proportion of the oil receipts has been invested in international financial markets. Net foreign assets of the Saudi Arabian Monetary Agency (Sama) are projected to reach $730 billion this year, almost double the 2010 level, according to the Fund, enough to finance more than three years of imports.

Secure in its indomitable financial position, Saudi Arabia has been projecting its influence throughout the Middle East and North Africa with increasing determination and independence.

In the past two years, Riyadh has played an increasingly high-profile role in regional diplomacy: providing balance of payments support to Egypt's military-backed government, supplying arms and money to opposition fighters in Syria and marshalling support for a tough line on Iran over the nuclear issue.

Irritated at the direction of US policy in the region, Saudi Arabia last month dramatically turned down a seat on the UN Security Council.

PERFECT STORM

North American shale production is expected to continue adding around 1 million barrels per day to oil supplies over the next several years.

Beyond that, massive shale formations in Argentina, Russia, South Africa and in several other countries could go into production on a significant scale by the end of the decade. And large oil and gas finds in deep water off the coast of Brazil and Africa are also likely to start producing by 2020.

Gradual normalisation of relations between the US and Iran and the relaxation of restrictions on Iran's oil exports could add back another 1-2 million barrels per day into the global market. Iraq also has ambitious plans to continue growing its output and challenge Saudi Arabia's market share.

The string of supply disruptions across Nigeria, Libya, Algeria, South Sudan, Syria and Iraq has balanced the oil market and kept prices firm, despite shale, as the EIA explained in a note published in September. But each disruption is also a potential source of new supply if it is eventually resolved.

Saudi Arabia's own growing energy needs threaten to cut the amount of oil available for export. "Domestic energy consumption is likely to continue to rise sharply in the absence of policy reforms," the IMF noted.

"Saudi Arabia has one of the highest levels of energy consumption per capita in the world and one of the lowest prices," the Fund observed. "Low energy prices are one of the ways that oil wealth is distributed to the population."

"International experience with energy price reform suggests that such a policy adjustment will need to be well planned, phased and clearly communicated to the population and businesses."

If domestic energy consumption continues to grow at current rates, it will reach more than 20 percent of output by 2018, up from 16 percent currently, according to the Fund.

Finally, in common with other crude producers, Saudi Arabia faces a challenge from cheap natural gas. Train companies, truckers, ship owners, logistics operators and gas producers are all making a push to use more cheap liquefied or compressed natural gas as a transport fuel, displacing diesel.

While the probability of any one of these developments may be low, so many trends point in the same direction that Saudi policymakers are likely to face a significant challenge.

STRESS TEST

Lower oil prices, reduced exports or both remain the biggest risks to Saudi Arabia's financial position, as the Fund noted.

"The projected increases in the production of unconventional oil in the United States and Canada and the recovery in production in Iraq and Libya could result in a lower path for oil production in Saudi Arabia than assumed ... or a larger drop in oil prices," according to the IMF.

Despite efforts to diversify the Saudi economy over the past two decades, oil still accounts for 80 percent of export revenue and 90 percent of budget revenue.

The Fund complimented the Saudi authorities for reducing short-term volatility in expenditure and prudent budgeting.

Nonetheless, Saudi Arabia needs an oil price of more than $80 per barrel to balance its budget, according to the Fund, and the breakeven price has increased by almost $50 per barrel in the past five years.

In effect, Saudi policy depends on a continuation of high prices and high volumes. Neither is guaranteed, as Saudi policymakers are only too well aware.

The IMF identified a large and prolonged downturn in oil prices (or by extension, volumes) as a low-probability but high-consequence event for Saudi Arabia in its risk assessment matrix.

The Fund considered two scenarios in which oil prices declined and determined that Saudi Arabia's financial reserves would last until 2021-2025 even if it did not adjust spending, which is a considerable safety margin.

Saudi Arabia could endure quite a long period of reduced oil revenues by running down its balances. Nonetheless, it would be risky to put the buffers to the test as confidence would start to ebb long before they were exhausted.

DIVERSIFICATION

The challenge is to achieve the long-promised economic diversification while minimising the impact of higher energy prices on poorer members of society.

The unemployment rate among Saudi nationals is already as high as 12 percent, and demographics threatens to add another 1.6-2.0 million people to the labour force in the next decade.

"Within the labour market, Saudis are primarily employed in the public sector, (while) non-Saudis dominate the private sector," the Fund noted.

Policymakers are working to improve the competitiveness of Saudi nationals in the labour market through education improvements, "aiming to raise the productivity of Saudi workers and their ability to access high-paying private sector jobs".

Employment quotas and a de facto minimum wage for Saudis working in the private sector are all designed to boost private sector hiring.

But the bottom line is that Saudi policymakers must display exceptional leadership successfully to adjust to increasing competition from other energy producers and rising internal energy consumption at a time when the economy requires major structural reforms.- Reuters

(The author is a Reuters columnist. The opinions expressed are his own.)




Tags: economy | Saudi | Oil | challenges |

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