During the past year the economies of oil producing countries have been dealt a fatal blow. Saudi Arabia suffers from various structural challenges to its economy. Its debt rose from 142 billion Riyals in 2015 to 316 billion Riyals in 2016, according to the Kingdom’s Ministry of Finance 2017 Budget Report.
The government has curtailed subsidies and provisions that the Saudi public has grown addicted to, salaries have been slashed and holidays curtailed. As reported in the Financial Times, Jason Tuvey, Middle East economist at Capital Economics observes, “Saudi consumer spending growth is slowing sharply, and forecasts that it will settle at about 2-3 per cent through 2018.”.
Venezuela’s situation is even more dire. Inflation is soaring to dangerous levels. According to the IMF, inflation is expected “to top 1640% in 2017.” The state oil company, PDVSA, is suffering from losses and recently missed a $404 million bond payment to global investors. To a great extent, this is due to the fall in global oil prices. But why do resource rich countries such as Saudi Arabia and Venezuela suffer despite their tremendous oil wealth?
As Warren Buffet once sagely observed: Do not put all your eggs in one basket. These countries, it seems, have committed this one great mistake. According to international relations and macroeconomics theorists, the trouble lies in what is called the oil-based Rentier Economy: The dependence of one country on a single commodity subject to so many economic factors beyond their control and hence inevitably leading to very volatile state societies.
Countries like Libya, Nigeria and Iran, while rich in natural resources such as crude oil and natural gas, do not always benefit from commensurate cash inflows. Militancy, social and political unrest are some of the key features in countries that have been fighting the ‘Dutch Disease’ and contending with the inherent structural weaknesses of these countries’ ‘rentier economies.’ The key idea behind this concept is very simple. The elites, the politicians and people with influence control the natural resources’ production to the parties in search of such products. What follows is an outcome that facilitates both governments and resource consumers, maximizing their benefits to the exclusion of the common masses. Related: Why A Trade War Won’t Derail U.S. Energy Exports To Mexico
Many research papers have concluded that among rentier states over-dependence on oil exports leads to macroeconomic disturbances. As one research paper notes: “economies that are richly endowed with natural resources tend to grow slowly and there exists a negative and significant relationship between natural resource abundance and economic growth.” And in addition to these macro-economic challenges, corruption also tends to rise in such economies which is largely due to the fact that all resources are controlled by a certain class or group of people and as a consequence accountability is very low if not non-existent. “The greed inherent with rent-seeking behavior prevents national savings” and leads to a “bloated bureaucratic apparatus, oversized public works, and poor state management of rents leading to low productivity in the economy” the same research paper quotes. This concentration of power is similarly exhibited by national oil companies – such as Venezuela’s PDVSA and Mexico’s Pemex – which not untypically suffer from the same weaknesses.
These issues have led many countries to revamp their economic model. Saudi Arabia’s Deputy Crown Prince, Muhammad Bin Salman, announced in April 2016 a National Transformation Plan under the Kingdom’s Saudi Vision 2030. Under this plan, the Saudi Economy will attempt to diversify its economic base and therewith reduce its dependence on oil revenues. Showing significant farsightedness, Saudi Arabia may be on the right course as, even after the recent Vienna Oil deal, the prospects for long-term oil prices – and therefore the Kingdom’s economy – remain unclear. Many analysts are of the view that it can take up to one year for inventories to come down and the substantial effects from the deal to be visible. Experts have suggested a number of reasons behind the likely challenges to oil prices reaching the $60 a barrel mark. U.S. production is expected to increase which may offset OPEC initiatives.
Nevertheless, the Saudi move has been welcomed and appreciated by many analysts. This trend of diversification is not limited not only to oil-producing countries. Recently the global oil majors may have also begun to perceive the potential danger of their firm’s long-term dependency on oil. ExxonMobil, Total SA and others are buying stakes in other businesses and investing in renewable energies. Royal Dutch Shell plans to divest $30billion of their assets in an attempt to restructure. “Global solar capacity is projected to double by the end of 2018, and wind power will increase by 50 percent”, Bloomberg reported.
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But with a few notable exceptions, the broader economic conditions in rest of the Middle-East and among other oil dependent economies remain unchanged. Libya is mired in a state of civil war. Iraq enjoys a tenuous peace but has not established the long-term governmental structures to sustain growth leading to prosperity. Venezuela is sinking into economic collapse. Russia remains mostly dependent on oil and natural gas exports to support its economy. According to observers, with the exception of Mexico which is struggling to implement sweeping energy reforms, these countries have no will and no concrete long-term plans to diversify.
Rex Preston Stoner, a U.S. based senior energy consultant with more than twenty-five years’ experience in the global energy sector notes that, “There is a glimmer of hope on the horizon for certain oil-producing countries. The United Arab Emirates is instituting substantial reforms to its economy although it is not burdened by the massive bureaucratic institutions that typically hinder innovation and change. Argentina has potential, as well, provided it can overcome global investors’ concerns about its broader macroeconomic goals.”
The transition is difficult for countries that have relied on oil and gas production over the past century. And it is apparent that in this world of continuous change adaptability is the key to success and yet the question remains: Have these countries learned a lesson from the oil bust and, if so, do they have the economic structures in place to diversify and grow?
By Osama Rizvi for Oilprice.com
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