OPEC’s leader Saudi Arabia is feeling the heat of its own success at present. By again stabilizing the markets, global oil prices have increased substantially but the pressure is now on. Even though global demand is showing promising signs of improvement, the world’s leading oil nation is struggling to benefit. Higher oil prices have increased not only pressure on OPEC and non-OPEC to consider a more flexible production strategy for the coming months, but members are also vying to gain market share and increase their own production volumes. Riyadh’s policy to carry a majority of the current production cuts has proven to be successful, but if others fail to comply it may find itself in a difficult position. Iran, Venezuela, Iraq, and Libya are looking for any excuse to bring more oil to the market, all at the cost of Riyadh’s market power. At the same time, the future of the Kingdom still depends on increased oil revenues, as government budgets are heavily reliant on black gold. Saudi Arabia is also in dire need of additional financial injections to support its ongoing grand-scale economic diversification plans, aka Saudi Vision 2030. While the scale and cost of the Vision 2030 plan have led to plenty of negative assessments, it has made some unexpected progress in recent months. Several multi-trillion programs have now been introduced to stimulate the implementation of these economic diversification plans. But even at $70 per barrel, oil revenues are not enough to finance the entire thing. To make matters worse, Saudi Crown Prince Mohammed bin Salman (MBS) has already openly stated that Saudi state-owned companies will have to cut dividends to the government to increase overall capital spending. The strategy of cutting dividends to the government will dramatically cut Riyadh’s financial income. MBS reiterated that dividend cuts will also apply to Saudi Aramco, the largest dividend generator for Riyadh, looking at its current $75 billion dividend pay-out. The only way out for the government is to look for higher oil prices in order to increase direct revenue streams. To compensate for lower dividends, Saudi Arabia will be looking to increase oil prices, as this would boost Aramco transfers in taxes and royalties. As there is no other revenue generation option yet for the Kingdom, hydrocarbons will play a pivotal role in Riyadh’s strategy targeting 27 trillion riyals ($7.2 trillion) in domestic spending by 2030.
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The current market situation leaves Saudi Arabia with a very tough decision-making process. To keep Vision 2030’s economic diversification plans alive, additional cash needs to be generated or attracted from global financial markets. At the same time, Riyadh will need higher oil prices to keep its overall revenue base in place, especially when dividends are cut. To keep oil prices high, while demand is relatively weak, and competitors are vying for higher production levels, the Kingdom will have to keep unilateral production cuts in place for a much longer time. Unfortunately for the Kingdom, regaining market share will not be easy once other exporters move in. At the same time, Aramco will need to increase production capacity to bring more production online in a market where demand is expected to weaken in 5-10 years. Until now, Riyadh has been committed to keeping the OPEC+ group stable, even as prices rise and pressure to produce grows. To find the right balance between lower oil production and fiscal benefits from higher prices in this environment is no mean feat.
The overall financial situation of Saudi Arabia is not as bad as some might expect, but some reports are warning of higher debt levels. At present, Riyadh’s answer to lower dividends and hydrocarbon revenues is to cut into the government budget. For 2021 the government budget has been cut by 7%, due to a much higher deficit last year. Figures show that the government deficit in 2020 was 12% of GDP, in comparison to around 4.5% in 2019.
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In its April 8 2021 report “IMF: Weakening fiscal balance sheets biggest concern for emerging markets beyond 2021”, Dutch bank ING states that the Middle East and Central Asia (+3.7%; +3.8%) and Sub-Saharan Africa (+3.4%; +4.0%) will see a more muted recovery in 2021. That said, both have seen upward revisions for 2021 which we can attribute to the oil price recovery and an efficient vaccine rollout in some places. Among the larger economies, Nigeria ( +1.0ppt to 2.5%) and Saudi Arabia (+0.3ppt to 2.9%) are the beneficiaries. Economic success for these countries seems to be linked with oil prices/revenues rather than economic diversification.
When looking at MBS’ latest statements, targeting 10 trillion riyals in government spending between 2021-2030, government budgets will stay extremely high, and the local economy will be state-linked. As ratings agency Fitch said in recent days, to have a balanced budget Riyadh will need an average $76 per barrel oil price, based on a normal budget approach. With possible dividend cuts in place, Fitch expects a budget breakeven price of $60 per barrel is possible. Still, looking at current future spending plans in Saudi Arabia, more non-oil revenues are needed or higher oil prices and production to have a fiscal balance. Additional IPOs are being planned, or the sale of Aramco shares, but this will never be enough to counter financial demands in the coming years.
The other option is to attract more foreign investments (FDI). In 2020 Saudi Arabia received around $5.5 billion FDI, but looking at the plans of MBS, another $500 billion is needed, which is no easy task for the kingdom.
As Saudi Arabia’s hydrocarbon revenues remain low, investments will lag behind. Saudi Arabia is still struggling to shed its rentier-state feathers, also due to the fact that young Saudis are more inclined to work in government than in private sectors due to the higher salaries. The Kingdom’s main curse is that it is too easy to go for additional oil volumes and revenues, an easy win approach but with long-term negative repercussions. Still, OPEC+ members should not rely on current Riyadh’s willingness to take the burden of cuts. If Vision 2030 programs need to be financed, and international financings fail, the kingdom will be forced to tap oil revenues again. International financial markets will be ruthless in demanding repayments in the future. Government instability due to budget gaps and debt repayments are surely not the road MBS should take.
By Cyril Widdershoven for Oilprice.com
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But whether under the banner of Saudi Vision 2030 or Shareek programme spearheaded by Saudi Aramco and SABIC, the diversification is dependent first and foremost on higher oil prices almost doubling current Saudi oil revenues.
Funds from the oil revenues along with domestic and foreign investments will be needed to finance major projects needed to support the non-oil sector of the economy and enable it to help reduce the almost total dependence of the economy on the oil revenues. Without that investment and therefore without higher oil prices exceeding $80 a barrel, the non-oil sector’s contribution to the Saudi economy will remain low and diversification won’t take off.
Moreover, Saudi Arabia won’t be able to attract major foreign investments or borrow from the banks on a grand scale if investors and banks realize that the Saudi government isn’t earning enough to pay back their money with interest with even the possibility of default at the back of their minds.
Therefore, Saudi Arabia’s OPEC+ strategy and its continuation of additional voluntary 1.0 million barrels a day (mbd) cuts might be needed for some time until the global oil demand starts to surge taking with it oil prices beyond $80 a barrel.
OPEC+’s optimism over oil demand recovery this year is justified. The International Monetary Fund (IMF) is now projecting that the global economy will grow by 6% this year almost double the 3.1% growth in 2019 and 4.4% in 2022. The IMF is also projecting that China’s economy will grow by 8.1 this year. Meanwhile, the United States’ economy is showing signs of growth as well.
Only the lockdown measures re-introduced recently in the European Union (EU) are now standing in the way of crude oil prices resuming their impressive surge. However, hopes are growing that the rollout of vaccination in the EU will soon gain momentum.
Still, Saudi Arabia could help its own financial situation by ending its costly and unwinnable war in Yemen thus saving an estimated $70 bn annually , cut the bulk of its arm deals with the United States costing it hundreds of billions of dollars and eliminate the subsidies on gasoline, electricity and water thus saving many billions of dollars.
Dr Mamdouh G Salameh
International Oil Economist
Visiting Professor of Energy Economics at ESCP Europe Business School, London