February 5th, 2015
In his first royal decree, Saudi Arabia’s newly crowned King Salman announced two-month bonuses for state employees, pensioners, students, and recipients of social service programs (that is, everyone in the country with a Saudi passport).
It adds billions of dollars' worth of spending to a budget already hit hard by falling oil prices. How far, and for how long, will Saudi Arabia short-sell its main source of revenue?
When the Organization of the Petroleum Exporting Countries (OPEC) initiated its “price war” last year, Saudi Arabia’s resources minister Ali Al-Naimi suggested that lower crude prices would help spur demand in a still-fragile global economy. Of primary concern, however, was the long-term economic security of the Saudi state. Gulf monarchies are funded by hydrocarbon receipts that comprise upwards of 80% of government revenue. None is more dependent on oil than Saudi Arabia, particularly in the long term given that extensive oil reserves are anticipated to see the kingdom through to 2050.
It is clear that OPEC, under Saudi leadership, is not committed to low prices for any longer than it will take to push out other players and restore global market share. Thus moves to slash global oil prices are not so much an altruistic gift to global economic growth, but a clever short-term strategy to recover market share from private energy players in North America who are operating on tight margins and require high prices.
How low can oil go?
Predictions of a US$60 (A$77) and even a US$50 floor for oil prices have come and gone. Al-Naimi has remained adamant that OPEC will not cut production even if oil plummets to US$20 a barrel.
However, a decrease of more than 80% from 2014’s peak price of US$115 a barrel would hit the Saudi bottom line hard. Khalid al-Fahil, president of the state-owned oil firm Saudi Aramco, says the current price of US$45 is already too low.
It is certainly too low and too late to balance Saudi’s budget, which is projected to reach a record deficit of US$38.6 billion this year (and that’s before we factor in the royal generosity of granting everyone a 14-month salary).
The deficit is a reflection not only of low oil prices but of systemic spending increases over the past four years. After the wave of regional protests known as the Arab Spring, the late King Abdullah increased public salaries by 15% and dedicated US$66 billion for the construction of low-cost housing.
Similarly, neighbouring Oman increased its unemployment benefit by 40% (which temporarily surpassed the minimum wage until this too was raised) and promised to create 40,000 new public-sector jobs. In the United Arab Emirates, wage increases in 2011 and 2012 nearly doubled salaries in some health, judiciary and education sectors. Qatar rewarded its government employees with a 60% pay rise, and its military personnel with a 120% increase.
While some forms of state expenditure to quell unrest were temporary – such as cash, bonuses, and loan amnesties – others such as public-sector expansion have permanently enlarged state budgets. This is significant given that more than half the working-age population in the Gulf is employed in the public sector (compared with 10% in the OECD). As part of the rentier state social contract, employment provision comes on top of already hefty state expenditure on health, education and housing, as well as subsidised petrol, electricity, water and food. Consequently, Gulf countries such as Oman have seen their budgets increase by 122% between 2010 and 2013.
As a result of these measures, all Gulf oil states need far higher oil prices than they did just five years ago. Saudi Arabia requires around US$95 a barrel to balance its budget, while Kuwait and Qatar need about US$71 to break even. Oman requires US$105 (up from US$59 in 2010) and, as a non-OPEC member, has expressed frustration with the policy.
In it for the long haul
Perhaps the question should not be how low can the price go, but for how long?
The International Monetary Fund recently predicted that most Gulf states could sustain sizable deficits for at least the next five years. Saudi Arabia, for instance, has a vast sovereign wealth fund of more than US$750 billion which should provide something of a cushion. However, these figures may be revised downwards given that energy investments have tumbled.
In the interim, the greatest loss could be foreign direct investment (FDI), which Gulf countries court with great enthusiasm in an effort to diversify their economies. FDI in Saudi Arabia had been in decline since the Arab Spring, reaching only US$9 billion in 2013, down from US$29 billion in 2010. It was expected to rebound, until now.
In the second of his royal decrees, Saudi King Salman announced the retention of key ministers in finance, labour, oil, and national defence posts. As Al-Naimi is continuing in his role as petroleum and minerals minister, the strategy to maintain high production and low prices seems set to remain in place too. The next OPEC meeting is scheduled for June. By then, Saudi Arabia may have lost almost US$80 billion relative to its 2013 oil export receipts.
Government employees could be waiting a while for the next bonus. Meanwhile, motorists around the world are still enjoying theirs.