Tuesday, January 5, 2016

Saudi Arabia: At the Brink of Falling into Economic Quick Sand



For the first time since they became a world oil producing powerhouse, Saudi Arabia is facing intense and challenging pressure simultaneously from several areas that threaten not only the citizenry’s way of life, but its critical role in an increasing hostile region as well as globally.

The dynamics of world energy and the Middle East are changing rapidly and fundamentally. Although the new Saudi leadership has aggressively undertaken measures to meet those challenges, these may be too little, too late.

For decades the Saudi government has heavily subsidized housing, health care, fuel ($0.50/gallon), electricity $0.01/kwh), and other generous benefits -essentially a systematic massive underwriting exercise  - creating a spoiled society, to keep their citizens at most socio-economic levels content and quell discontent. These short-term tactics worked rather well particularly as a stop-gap during the 2011 Arab Spring.

The Saudi government has never faced a steadily growing political and economic dilemma with respect to demographics. About two-thirds or 18-20 million, of the population is under 25 years old, creating meaningful jobs for Saudi youth is challenged by skyrocketing costs. One of these key costs is health care because the population is living far longer than the average 40-45 year lifespan of the typical Saudi in 1970. Additionally this young population is restive for change specifically personal freedom of expression within the framework of their culture, albeit not a western democracy.

The Saudis are the world’s 6th largest energy consumer despite a population of only 30 million which makes the economic figures sobering. The Saudis government face a series of daunting long-term economic dilemmas namely low oil prices and tepid global demand resulting in an historical oil glut and increasing production from their chief competitors namely Russia, Iraq and the US (not to mention the upcoming crude exports).

Because of these tectonic shifts an ever greater amount of its estimated current 10.3 million/bbls day production is dedicated to its voracious domestic demand. This demand includes the burning of oil instead of natural gas or coal with inefficient power plants. The Saudis must to produce 8 million bbls/day to collect natural gas that comes out of the ground with oil critical to power residential and industrial needs. For example, air conditioners consumed 70% of electricity use in 2013 and oil is the base fuel for the desalination of water.

Additionally, the lack of refineries means that they must import refined products at international prices because its refineries can’t produce enough of it to satisfy domestic demand. In fact, because of the domestic demand for gasoline, diesel and jet fuel has grown 60% since 2005, the trend has converted the Saudis into a net importer of these fuels. In an expensive but necessary long-term project to meet the increasing domestic consumption needs, Saudi Arabia has a new $22 billion joint venture with Dow Chemical for the construction of several refineries costing $12 billion each. Their completion may be too late.

Exacerbating the problem even the quality of oil has declined resulting in the production of less desirable heavier, sour crudes which are sold cheaply on world markets. Furthermore, there have been no new significant discoveries of oil reserves. For these reasons, the Saudis are highly reluctant to cut.

Historically Saudis’ foreign reserves have cushioned short-term crises. Despite an estimated foreign reserve of $640 billion, this confluence of on-going and longer term issues are draining their reserves faster than projected. In fact this past October the Saudis spent $7 billion of foreign reserves to cover domestic economic shortfalls. To temper this burn rate, the Saudis have dipped into the international debt markets for the first time in decades. Despite possessing burgeoning surpluses for decades they’ve procrastinated and lost numerous opportunities to diversify an oil-dependent economy.

Politically, the greatest threat is internal featuring a potential volatile mix of power struggles amongst the royal family rifts, the clerics, and the young tigers biting at the bit, and a restive, alienated youth. Because it’s a closed society, determining the depth, breadth and intensity of such power struggles is difficult to ascertain.

The short-term forecast is favorable. Saudi Arabia is the most politically stable country in the region and will continue to remain an important, though not as dominant swing producer, and is welcome to continued energy services investments. The Saudis have a long, deep relationship with world banks and energy services firms and still maintain low production costs and robust foreign reserves.

The national oil company ARAMCO is a case study model of efficiency the perfect corporate utopia in a sea of impending chaos. It’s an oasis of a corporate culture representing what Saudi Arabia could or should be but isn’t: a dynamic, superbly run corporation of professional men and women, Sunni and Shia, foreigners and Saudis. Investments to maintain and upgrade facilities, yet the challenge of meeting increasing budgetary needs in a prolonged low oil price environment.

On the other hand the long-term prognosis does not bode well. The demographic changes will continue to put upward pressure on Saudi finances and, according to the IMF, at this burn rate may run out of cash in 5 years making it a debtor country. Even if oil prices magically rebound overnight to $100/bbl, Saudi Arabia’s economic problems would only get delayed because low oil prices have exposed their vulnerability and raised overall risk.

Politically Iran, like today’s Saudi Arabia, was a monarchy from 1925 to 1979 until it was overthrown by religious extremists. In an eerie parallel the Saudis have a restive population angered over corruption and lack of political participation. However what makes the Saudi situation more unstable than the Iranian Revolution is that unlike a stable Cold War environment and high oil prices, the Saudis are surrounded by failed states, plunging revenue because of low oil prices and supporting an expensive protracted war in Yemen.

The Saudis have oil and money but neither can buy more time to swiftly arrest such a powerful confluence of changes. Government planning is one thing, implementation is another because it requires, changing their citizens’ hearts & minds – their mindset. Theirs is an entitled population who is spoiled during many decades of subsidies and who may be highly resistant to the reduction or even elimination of these subsidies despite the onerous economic consequences.

Should any extended or extreme civil unrest or turmoil occur Saudi Arabia will still produce oil but like present-day Iraq, with a weak government, sectarian strife and continued robust oil production regardless of the leadership. An extreme scenario would see an Iranian-style implosion with the emergence of a new leadership that is hostile to the West, perhaps only politically but would control its oil in the manner that Russia controls gas exports to Western Europe – on a whim.

 Copyright Indo-Brazilian Associates LLC 2016.  All rights reserved.

Indo-Brazilian Associates LLC is a NYC-based global advisory service and think tank with connections at the highest levels specializing in international investment, political and security risk assessments. International business is increasingly complex featuring a highly mobile professional class in all corners of the globe. We provide you the tools to successfully negotiate cross-culturally in your global business endeavors. Tell us about your challenges.  We'll get you on the "Short List".

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