Changing Oil Outlook Challenges Saudi State

Saudi Deputy Crown Prince Mohammed bin Salman

Saudi Deputy Crown Prince Mohammed bin Salman

By David Gernon

Photograph of Mohammed bin Salman courtesy of AWD News

Saudi Arabia has long been a stable force in the tumultuous Middle East. Buoyed by its immense oil reserves and intact succession line, the country has managed to survive with a relative calm inside its borders, even as chaos reigns in the rest of the region. Much of the country’s legitimacy and stability can be traced back to two things: its status as protector of the two most holy sites in Islam and its ability to heavily subsidize its population through the soaring price of oil.

Recently, however, as the kingdom struggles to deal with enormous crowds making pilgrimage to Mecca and with oil prices lower than they have been in years, cracks are appearing in the once-venerable Saudi armor.

Saudi Arabia’s relationship with the rest of the Middle East has waxed and waned over the years. It often butts heads with Iran. In addition to their sectarian differences, both have competing claims as the legitimate representative of the world’s Muslims and, more fundamentally, disagree how to govern them. Iran’s revolution in 1979 was popular and anti-monarchist, which is in sharp contrast to the Saudi monarchist model. An Iranian-style theocratic uprising would be a threat to the Saudi monarchy.

Several incidents over the past decade have heightened the Saudis fear of an uprising. The Arab Spring protests illustrated the tenuous hold many autocrats in the Middle East had on power. The way it swept from nation to nation, spreading through grassroots campaigns on social media, appeared particularly worrying to the rulers of Saudi Arabia. Fortunately for the House of Saud, the price of oil averaged over $87 that year, allowing them to placate the public with expanded subsidies and government programs.

Additionally, its main rival for regional supremacy, Iran, stood as a world pariah for years, due to a nuclear program regarded as suspicious by much of the international community. But now, after the landmark nuclear deal signed last year, Iran is re-emerging on the world stage– much to the chagrin of Saudi Arabia.

Several events around the New Year heightened these tensions. On January 2, Saudi officials executed 47 people, including prominent Shia cleric Nimr al-Nimr. Nimr was vocally supportive of the anti-government protests in 2011 in the kingdom’s Eastern Province, where most of the country’s Shia population lives. The Shia have long complained of marginalization at the hands of the Sunni government.

That same day, Iranians stormed the Saudi embassy in Tehran and later set it ablaze. The next day, the Saudi foreign minister announced the country was cutting diplomatic ties to Iran after the violence at its embassy in the Iranian capital.

The Hajj, the Muslim pilgrimage to Mecca, has also caused several high profile incidents in the past decade. For example, last fall over 2,000 pilgrims–including many Iranians–died when a stampede broke out during the Hajj. Such incidents have caused some to question the Saudis rights to custodial guardianship of the two most holy sites in Islam: the Al-Masjid al-Haram n Mecca, and Al-Masjid an-Nabawi in Medina. Originally, and still a great deal to this day, Saudi Arabia derives much of its legitimacy as a state from its religious credentials; it is even sometimes referred to as “the Land of the Two Holy Mosques.”

However, economic concerns have created the largest increase on Saudi fear. The country’s current budget crunch has been brought on by unforeseen low prices of oil and an ongoing war in Yemen, lasting for longer and costing far more than Saudi generals originally thought. In mid-2014, prices were over $100/barrel; today that number is less than $45.

The petroleum sector accounts for roughly 80 percent of budget revenues. It is home to 18 percent of the world’s proven oil reserves. The government deficit expanded mightily in the last year, to 14.8 percent of GDP in 2015 from 2.3 percent in 2014.

In response, late last year, the kingdom unveiled plans to cut expenditures and raise sharply domestic fuel prices to help cope with the lower price of oil. Other measures include smaller subsidizes for energy and other utilities for its citizenry. Many citizens take the government’s largess for granted; in fact, Saudis do not even have to pay any income tax. This cut in subsidies risks a severe backlash, as its citizens are accustomed to cheap utilities.

The citizens of Saudi Arabia may have to get used to the idea of more expensive energy, however, as the price of oil looks set to remain low for the foreseeable future. The reliance on the oil industry for its budget, along with the country’s expensive and protracted war in Yemen, cast a gloomy outlook for the economic future of the kingdom. Indeed, earlier this month, the Fitch, a ratings agency, downgraded the country’s credit rating in a move which signaled growing global concern over the state of the Saudi economy. This downgrade follows similar moves from Standard & Poor’s and Moody’s, the two other main, international ratings agencies.

However, Saudi Arabia has taken steps to diversify its economy beyond the petroleum industry. Since King Salman ascended the throne last year his son Muhammed bin Salman, the young and energetic deputy crown prince, has eagerly taken steps to reform the country’s planned economy. Perhaps the most promising of these reforms involves an IPO for Saudi Aramco, the state-owned oil giant which is perhaps the world’s most valuable company. Prince bin Salman has proposed listing the shares on the country’s domestic stock exchange; the firm would almost certainly be the largest publicly traded company in the world. Just last week, bin Salman reportedly chose JPMorgan to prepare the IPO. Internal politics play a major role in the proposed reforms, as Prince bin Salman has gained influence at the expense of once-powerful oil minister Ali al-Naimi–which is in a way fitting, given the Prince bin Salman’s hope for a less oil-driven economy.

Towards that end goal, Prince bin Salman on Monday unveiled his plan, called Saudi Vision 2030, to wean the country off oil over the next decade and a half. The prince declared Saudi Arabia will become a financial center and an investment powerhouse. The two most consequential plans outlined involve the aforementioned IPO for Saudi Aramco and the creation of the world’s largest sovereign wealth fund, which will eventually reach $3 trillion and is intended to replace over time the falling oil revenue. In addition, further reductions in energy subsidies were proposed, with the impact on lower-income families cushioned by direct cash transfers. Additionally, the plan calls for new fiscal policies to enable education reform and jobs for the underemployed youth of the country.

Other steps bin Salman has encouraged include entering the housing market in a Fannie Mae-type hands-on role by the end of the year. The Housing Ministry hopes this will not only help address the housing shortage for the kingdom’s expanding population, but also help boost the productivity of local developers and attract international ones, as well.

Saudi Aramco’s public offering is part of a larger plan of bin Salman’s, which involves creating a $2 trillion sovereign wealth fund to help wean the country off oil. One only needs to look at the plight of Russia or Venezuela to see the dangers of not diversifying an economy for a rainy day. Many countries have struggled to diversify beyond their oil-dependencies. Perhaps the young prince can deliver where others have failed.

This article was updated with details of Prince bin Salman’s Monday announcement on Tuesday, 10:00pm.

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