RIYADH: There is widespread understanding that with oil prices around $100 per barrel, Saudi Arabia's oil wealth is providing vast revenue inflows, enabling a strong fiscal position with low government debt and high government savings. This wealth is particularly timely as the government has increased spending and cash transfers to Saudi citizens in the wake of the broader "Arab Spring", according to a report prepared by Jadwa Investment Research Department.
For the near term, Saudi Arabia is likely to continue to receive oil revenues in excess of its spending needs, with the oil price needed to balance the budget currently about $20 per barrel below the actual price.
Not widely realized, however, is that three major trends, if continued on their current and most likely paths, portend a much more difficult energy and revenue future for the Kingdom. These trends are:
- The Kingdom's domestic consumption of oil (and gas) is rising very sharply, reducing the amount of oil available for export. Low domestic prices-oil is sold in Saudi Arabia at between 3 percent and 20 percent of the global price-mean the efficiency of oil use is worsening. Consumption is growing at about twice the rate of nonoil GDP growth.
- Saudi government spending is likely to continue rising at an annual pace of 7 percent or more, with ongoing reliance on oil revenues as the primary revenue source.
- Saudi oil output has not risen significantly in 30 years, and in our view is unlikely to rise on a sustained basis over the next decade or more.
The Jadwa report said combination of these trends would leave only sustained sharp rises in oil prices to meet fiscal needs. "While we think prices will continue to rise, we do not think they will rise at the rate required to meet the 'breakeven' price for the budget. Indeed, a decade-long plateau in oil prices, as the market has previously experienced, would likely lead to a rapid deterioration of the Kingdom's future fiscal position," the report added.
Today the world consumes approximately 88 million barrels per day of oil. Of this, Saudi Arabia produces around 9 million barrels per day and OPEC provides a total of 29 million barrels per day (33 percent of total world consumption). Global consumption grows at about half the pace of global GDP growth, or typically 1.5 to 2.0 percent per year. With the global economy still emerging from recession the International Energy Agency (IEA) forecasts that global oil demand will grow by an average of 1.3 percent per year for the next five years, equivalent to 1.1 million barrels per day of oil per year.
Behind these broad numbers several powerful trends are apparent in global oil consumption, the Jadwa report said. First, oil has largely conceded the market for electricity production to natural gas, coal, and nuclear. Second, there is a clear shift in the growth in oil demand from West to East. Over the past 20 years, Saudi exports to Asia have grown from one-third to two-thirds of total crude oil exports. This trend is likely to continue, due to both the high growth in consumption and Asia's commitment to oil-based transportation in the future.
The global oil resource base is abundant at almost 9 trillion barrels of conventional and non-conventional crude oil (such as extra heavy crude oil, shale oil and tar sands), according to the US Geological Survey. These various types of oil become economically recoverable under various oil price scenarios, but basically, at sustained prices of over $80 per barrel, many of the unconventional sources can be, and currently are, profitably produced. At current global output of 88 million barrels per day, 9 trillion barrels of oil would represent about 280 years of supply.
Saudi Arabia has supplied a surprisingly stable percentage of total global oil output over the past 50 years, averaging around 10 percent, the report said. During the oil market gyrations of the 1970s and 1980s, when disruptions and price spikes were frequent, Saudi output ranged from 16 percent of the world total in 1980 (offsetting lost Iranian oil during the Iranian revolution), to 6 percent in 1985 when Saudi Arabia, as OPEC's "swing producer", swung production to as low as 2 million barrels per day. Over the last 20 years, Saudi Arabia has experienced a fairly steady decline in its share of total global oil output from 12 percent in 1991 to 10 percent today.
"We say above 'surprisingly' stable because oil analysts have for many years forecast that the world would require more Saudi oil output in the future than has actually ever been the case. New oil discoveries, technology, increasing efficiency of oil use, geopolitical events and changing oil policies all have contributed to lower actual need for Saudi oil than thought previously. The tendency has been to overestimate the global demand for oil, underestimate the growth in supplies outside the Middle East, then assume that Saudi Arabia, with its vast oil reserves of over 260 billion barrels, would fill a growing gap that actually never materializes," the Jadwa report said.
"We think a most likely scenario is that the actual trend of stable to gradually declining Saudi share of global oil output will continue. By 2030, if global oil production has grown by 1.4 percent per year and Saudi Arabia continues to capture about 10 percent of global market share, then the Kingdom's output would be around 11.5 million barrels per day, versus today's 9+ million barrels per day. This is not a significant change and still well within Saudi Arabia's existing crude oil production capacity of 12.5 million barrels per day."
The Jadwa report said, while oil consuming countries have rightfully worried about security of supply, in recent years Saudi officials have often spoken of their need for "security of demand". The Kingdom spends a substantial amount of money building and maintaining oil production capacity that provides a cushion to meet growth in demand and an ability to offset lost supply in cases of disruption, as is happening today in the case of Libya.
The past decade provides a good example of the difficulty of matching global demand expectations with Saudi oil capacity additions. With the global economy booming in the early 2000s, the Kingdom embarked on a plan to lift oil output capacity from 10 million barrels per day to the current level of 12.5 million barrels per day. Just as the expansion was being completed, the global economy sank into recession, oil prices collapsed and demand contracted. As a result, Saudi unused capacity from 2009 until the recent loss of Libyan oil has been around 4 million barrels per day versus a publicly-stated policy commitment of 1.5 to 2 million barrels per day.
"As global consumption rises, we think it likely that Saudi policy will be to maintain a spare capacity cushion that tracks a percent of the global total, rather than a constant fixed number. Thus, while potentially producing 11.5 million barrels per day by 2030, we think Saudi Arabia would also seek to have an unused capacity cushion of 2.5 to 3 million barrels per day at that point as well, reflecting the same percentage of the global market as a 2 million barrels per day excess capacity today," the Jadwa report said.
Should Saudi oil production rise only gradually over coming years then price becomes the important factor in determining whether oil revenues satisfy the country's needs. Saudi officials stated that they were uncomfortable with prices as WTI was rising above $100 per barrel, and have also suggested that a reasonable price is between $70 and $90 per barrel. In general though, Saudi officials avoid stating a specific price target and prefer to emphasize that their policy is to monitor the fundamentals of supply and demand and ensure that the global market is adequately supplied with oil.
It has become popular to reduce the oil revenue needs of oil producing countries to a "breakeven" price for oil. This is perhaps a reflection that with this year's unrest across the Arab world, the need for adequate immediate oil revenues has become one of the most important of the several drivers of oil policies in oil producing countries. With this in mind, Jadwa says we now turn our attention to fiscal issues in Saudi Arabia, focusing on the role of oil in Saudi Arabia's government finances.
The Kingdom is currently in a remarkably strong fiscal position owing to the prudent use of recent budget surpluses. Recent surpluses have been used to repay much of the domestic debt that was built during the years of budget deficits and to raise foreign assets. While many countries in the world are striving to cut debt, Saudi Arabia's debt is very small and its vast foreign assets provide a huge cushion in the event of a fall in revenues. For example, the Kingdom could run a deficit of 10 percent of 2010 GDP for the next decade without issuing any debt and still have official reserves of over $110 billion, the report said.
High oil prices are the reason for the transformation in the Kingdom's balance sheet. But they have also enabled a surge in government spending. History shows that it has been challenging for the government to moderate the growth in spending, regardless of the oil price environment. Government spending growth averaged 13 percent per year between 2003 and 2010. In 2003 the government ran a budget surplus of SR36 billion ($10 billion) with an average price for Saudi export crude of $28 per barrel. In 2009, the budget was in deficit (SR86 billion; $23 billion) even though Saudi export crude averaged $62 per barrel.
According to the Jadwa report, some of the growth in spending is attributable to a surge in spending on infrastructure. However, infrastructure spending only accounts for around 30 percent of total expenditure. Spending on the government wage bill increased by 76 percent (SR91 billion; $24 billion) between 2003 and 2009. In contrast, the Kingdom has made major savings in interest payments on government debt, as the debt was repaid. However, there is limited scope for similar savings elsewhere in the budget.
Jadwa expects government spending growth to average about 7 percent per year over the next 20 years. This is only about half the rate of spending growth of the past decade, but in line with spending growth over the past 20 years, which includes a full cycle of both high and low oil price periods and is more representative of what we are likely to see over the next 20 years.
Three important trends come together to pose a significant challenge to Saudi Arabia's continued dependence on oil revenues. Jadwa has addressed two: The Kingdom is likely to experience only a very gradual increase in production of crude oil, and the government's spending will continue to rise at a rapid pace and rely primarily on oil revenues. The third of these trends is that the country's domestic consumption of energy, especially oil, at very cheap prices, is also likely to continue to rise rapidly, sharply reducing the amount of oil available for export. Combined, these trends paint a picture of significant future challenges for the Kingdom.
Oil consumption is rising rapidly in Saudi Arabia, the report said. Domestic use of oil averaged 2.4 million barrels per day in 2010, up from 1.9 million barrels per day in 2007 and 1.6 million barrels per day in 2003 according to data supplied by the government to the Joint Oil Data Initiative (JODI). Total domestic consumption of petroleum products (which includes refined products and natural gas as well as crude oil) was 3.2 million barrels of oil equivalent per day in 2009, according to the Ministry of Petroleum and Mineral Resources.
While it is natural that as a country develops its energy consumption rises, where the Kingdom differs from the norm is that it has become less efficient in its use of energy. In recent years the deterioration in energy efficiency worsened. Between 2007 and 2010 demand for oil in the Kingdom increased by 22 percent, double the growth of the non-oil private sector. Oil consumption in the Kingdom grew at a slightly faster pace than the rate in China over the period, even though the Chinese economy expanded at almost three times the pace of the Kingdom's nonoil economy.
The key reason for the rise in consumption is very low energy prices. Energy priced at such low levels does not encourage conservation or penalize inefficient use. Very low prices also necessitate high spending on the construction and maintenance of related facilities, such as water and power plants. Reform of domestic pricing policy is an important way to tackle the rising consumption of energy and improve the efficiency with which it is used.
"We have combined our forecast of the trends outlined above-slow growth in Saudi crude oil production, fast growth in government spending and rapidly rising domestic consumption of oil-to derive detailed projections of government finances and breakeven oil prices for each year until 2030. These show that the Kingdom's fiscal position is reasonably comfortable for the next 10 years, before potentially worsening sharply by the end of the 2020s," the Jadwa report said.
Jadwa estimates that the breakeven oil price required to balance actual government revenue with actual government expenditure will not rise above $100 per barrel (for Saudi export crude) until 2017 and will stay below $120 per barrel until 2021. Since prices seem likely to be close to this area for the period, it appears that Saudi Arabia has about a decade where it will only need to run relatively small budget deficits that would not dent foreign assets too greatly.
Beyond that, however, the breakeven price begins to rise rapidly. By 2025 Saudi Arabia would need $175 per barrel to balance actual revenues to expenditures, and by 2030 the breakeven price would reach in excess of $320 per barrel. By then oil export volumes would be around 1.5 million barrels per day lower than domestic oil consumption.
Of course, the rapid worsening of government finances can be avoided if the trajectory of the current trends of oil production, domestic oil consumption and government spending are altered. Saudi Arabia could curtail the growth in domestic oil consumption with adjustments upward to local energy prices, fulfillment of its plans to develop nuclear and solar powered electricity plants, and a series of energy conservation measures. Government spending growth rates could be gradually lowered, given the many years of fiscal cushion that lie ahead. Changes to taxation policies could strengthen nonoil revenues. Finally, the Kingdom could find ways using its strength within OPEC to try to bring its share of global oil production out of the gradual decline it is currently experiencing, the Jadwa report added.
© Arab News 2011
