From black gold to the 21st century

Andrej Bacholdin is in his penultimate year of studying BSc Economics at UCL. He comes from Prague, Czech Republic. Andrej is also an avid follower of current events and has started his own economics and politics blog (www.milleconomist.wordpress.com).

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The oil price began its momentous, and largely unforeseen, collapse in June 2014. After nearly five years of stability, by November the price had fallen 40%. With the exception of a few short-lasting rallies and periods of false stability, the decline continued until January 2016, when Brent Crude reached $26.55, the lowest level in 10 years.

Few were prepared. The Russian ruble lost more than 50% of its value; Nigeria’s central bank abandoned the naira’s peg to the USD. But, while still unbeknownst to the outside world, Saudi Arabia was also nearing disaster.

Last spring, the IMF predicted Saudi Arabia’s reserves could last the country for at least five years of low oil prices. To the handful of insiders in Riyadh, the situation could starkly be any different. Saudi’s burn rate of $30 billion a month meant that, at that rate, the country would be bankrupt within just two years.

Yet the story of Saudi Arabia’s survival, and indeed future, began long before the events that grabbed the world’s attention. And much of the story revolves around one man.

Prince Mohammad bin Salman, nicknamed MbS, is Saudi Arabia’s Minister of Defence, chairman of the Council of Economic and Development Affairs, deputy prime ministers and 2nd in line of succession. Western diplomats call him Mr. Everything. He is also 31 years old.

The late King Abdullah and MbS had a delicate history, with the King banning his nephew from setting foot into the Ministry of Defence, apparently for his disruptive and power-hungry tendencies. But they also a shared a crucial interest: to rid Saudi Arabia of its dependence on oil.

For 80 years, oil was for Saudi Arabia what democracy is for the UK. Plentiful oil revenues provided the basis for Saudi’s social structure: absolute rule by the Al Saud family, in exchange for generous public spending, all legitimised by the Wahhabi religious establishment.

Two years before his death in 2015, King Abdullah tasked MbS to prepare a plan on reducing the economy’s dependency on oil as well as change the country’s entire social construction. When MbS’s father, King Salman, assumed power in 2015, he gave his son unprecedented control over the state oil monopoly, Ministry of Defence, national investment fund, and economic and foreign policy. In practice, MbS is currently the power behind the throne.

So when Saudi Arabia began heading for bankruptcy, MbS swiftly reinstated strict spending limits, tapped debt markets and cut the budget by 25%. Disaster, for now, was averted. However, Saudi Arabia’s transformation goes far beyond surviving until the next oil price spike.

Saudi oil policy, under the prince’s guidance, has broken with decades of historical doctrine as the leader of OPEC. In April, an OPEC-Russia production freeze was cancelled after the deal was already agreed; MbS intervened because Iran did not want to freeze its production. In fact, according to him, he does not care if oil prices rise or fall. “$30 or $70, they are all the same to us,” he said in an interview with Bloomberg Businessweek. If they rise, that means more cash for nonoil investments. If they fall, Saudi Arabia, as the world’s lowest-cost producer, can regain market share.

In June, Saudi Arabia unveiled the National Transformation Program, a plan to reshape the country’s economy. Its goals, such as tripling non-oil revenue and creating 450,000 private-sector jobs by 2020, are ambitious. But so are the measures, which include the introduction of a value-added tax, cuts in public utility subsidies, and levies on luxury goods and sugary drinks. That is not to say the days of generous Saudi spending are over; there are, as yet, no plans for income taxes and, to cushion the impact of a slowing economy, poorer households are directly given cash handouts. The government is also exploring a possible IPO of Saudi Aramco, the national oil company. Valued at up to $3 trillion, Saudi Aramco would be larger than Apple, Google, Microsoft and Berkshire Hathaway combined.

However, transforming the Saudi economy is impossible without transforming its society. The country can’t thrive if half the population is severely constrained in daily activities. The prince has hinted that he would support increased rights for women, who can’t drive or leave their home without a male relative’s permission. “We believe women have rights in Islam that they’ve yet to obtain,” said the prince. According to a former senior US military officer, MbS commented, “If women were allowed to ride camels [in the time of the Prophet Muhammad], perhaps we should let them drive cars, the modern-day camels.”

Another social problem hindering the prince’s ambitious economic plan is getting young people to work in the private sector. Youth unemployment stands at about 30%, and few are willing to sacrifice their cushy public-sector jobs for more demanding private firms; many, however, may not have a choice given the large public-sector budget cuts. A greater challenge is increasing the attractiveness of Saudi workers. Until now, the Wahhabi religious establishment has supplied the Al Saud family with political legitimacy, in exchange for clerical control over education and the judiciary. Most Saudi youths are underqualified due to an education largely based on religion.

And here lies the greatest challenge: MbS’s relatively liberal views (he recently broke the Ramadan fast while on a visit to the US) risk sparking a collision with the Wahhabi clerical establishment. The prince may be seeking other sources of legitimacy from his own generation, but in a country surrounded by extremism both outside and within, any religious tensions are perilous.

There is no doubt Saudi Arabia still faces an uphill battle. This quarter, the non-oil economy has, for the first time since 1980, slipped into a technical recession. But, with $581.3 billion remaining foreign exchange reserves and a highly ambitious and forward-looking leadership, Saudi Arabia is better positioned than most oil-producing nations. If successful, Saudi Arabia would serve as a model for its Gulf neighbours and other oil superpowers, notably Russia and Malaysia. Perhaps, the black gold’s importance to countries’ economies has already plateaued.

 

Image source:

Glover, Peter C., and Michael J. Economides. “OPEC Fracked – The Commentator.” OPEC Fracked – The Commentator. S.M.A.R. S.r.o., Web. 17 July 2016.

 

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