Can Saudi Arabia Overcome Its Oil Addiction?

by Karen Boman, Senior Editor

Former U.S. President George W. Bush once described the United States as being addicted to oil. But apparently, we’re not the only country that has had this problem. Saudi Arabia – which previously  led OPEC to freeze production, sending oil prices plummeting and traumatic tremors through the global oil and gas industry – is seeking to end its own oil addiction.

Deputy Crown Prince Mohammed bin Salman, who is overseeing Saudi Arabia’s economy, unveiled “Vision 2030,” which seeks to raise non-oil revenue in Saudi Arabia’s economy from $43.6 billion in 2015 to $160 billion by 2020 and $267 billion by 2030.

“We will not allow our country ever to be at the mercy of commodity price volatility or external markets,” Reuters quoted Prince Mohammed as saying in an April 25 news article.

It shouldn’t come as a surprise to see Saudi Arabia make this move.  Middle Eastern oil exporters lost $390 billion in revenue last year due to lower oil prices, and are expected to lose approximately $500 billion this year, according to an IMF report. Saudi Arabia has long used its oil wealth to support its population through welfare programs and handouts. However, this plan is not sustainable in the long-term, meaning Saudi Arabia will need to create economic opportunities for its population, particularly its young people.

Still, it’s strange to hear the prince talk about not ever wanting to be at the mercy of commodity price volatility. It’s the same thing that many in the U.S. oil and gas industry, following massive industrywide layoffs and brutal paring of budgets, have wished for.

I actually think Saudi Arabia’s plan to wean its financial dependence on oil is a good one. From a common sense standpoint, a diversification of revenue sources could help the country weather oil price volatility better. However, I believe this process will take time. After all, petroleum wealth is what brought modern Saudi Arabia into being. And Saudi Arabia’s problems are not just due to low oil prices, but due to government spending. Not only has Saudi Arabia increased defense spending for its war in Yemen, but its spending on handouts and pensions for government employees totaled $32 billion in 2015. The fact that the Saudi Arabian government employs 90 percent of the population also means that its budget balance is highly sensitive to oil price fluctuations. Saudi Arabia will need to ensure it creates the right incentives for foreign investment and reducing state ownership to ensure its diversification plan succeeds.

Saudi Arabia’s plan is not just about diversifying revenue streams, but changing Saudi Arabia’s fundamental social structure. In exchange for oil wealth, Saudi Arabia’s citizens have pledged “popular submission to absolute monarchial rule,” Reuters reported on April 27.

The country has long controlled its population by sharing its oil wealth through subsidies and other offerings. But this wealth comes with a price: the oil curse, a phenomenon where oil wealth leads to authoritarianism, economic instability, corruption, and violent conflict, according to a 2011 article in Foreign Affairs by Michael L. Ross. Ross is a professor of political science at the University of California Los Angeles and author of the 2013 book, “The Oil Curse: How Petroleum Wealth Shapes the Development of Nations.”

The nationalization of oil assets in the 1960s and 1970s, rise of independent oil companies, and formation of OPEC resulted in oil wealth shifting from major oil companies to Middle Eastern governments. This shift allowed autocrats to come into and remain in power. For the citizens of these countries, this shift proved to be a mixed blessing, Ross notes. Autocrats used oil wealth not only to answer calls by its citizens for social change, but found it easier to keep their countries finances secret, and to lavishly fund their armed forces. This has halted progress towards democracy in Middle Eastern countries.

This trend holds true today, Ross told me in a recent interview. Countries with significant amounts of oil and gas wealth still tend not to democratize, particularly in the Middle East. The only country bucking this trend is Tunisia, which has little petroleum wealth.

Could Saudi Arabia’s announcement also lead to social changes, such as allowing women to drive? I asked Ross whether he thought Saudi Arabia’s announcement would result in a shift in its government. He told me that in countries where a large private sector exists, more space for civil society exists. The presence of a civil society allows for greater movement towards democratic freedoms.

“That said, it’s very difficult for countries with the kind of oil and gas wealth you see in the Gulf States to make significant progress towards economic diversification, particularly into private sector activities,” said Ross. “It’s easy for people to underestimate the obstacles created by the Dutch disease – the negative economic impact resulting from a sharp inflow of foreign currency, leading to currency appreciation that makes a country’s other products less price competitive for export — to economic diversification.”

It’s extremely expensive to produce things that could otherwise be imported and that are competitive internationally outside of oil and gas sector,” Ross told me. “The economic diversification in the traditional sense of developing new industries that can produce tradeable goods will be a very steep hill for Saudi Arabia to climb.”

On top of that, Saudi Arabia is a difficult place for the private sector right now, Ross noted. It would mean a pretty dramatic reorientation of the way the private sector operates there. In most cases, the time it takes for a drop in oil prices to impact at country politically varies depending on the countries. It depends on the size of the country’s stabilization funds or savings funds, Ross said.

To conclude, Saudi Arabia’s plan to diversify its economy is a needed step. I’m interested to see how it’s executed, and how it will reshape the not only its economy but its society.

 

 

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