News that Saudi Arabia is considering selling shares in state oil major Saudi Aramco reflects profound change in the kingdoms long-term economic strategy.
It is inspired by the view that the world is entering an era in which crudes dominance of world energy markets will be challenged by unconventional hydrocarbons including shale oil and gas, renewables, and nuclear power. Energy consumers will have increasing choice. The result will be intensifying competitive price pressure on oil.
Its price is permanently on a lower trajectory and there is little oil producers, including Saudi Arabia, will be able to do about it. Even if Saudi Arabia, Iran and Iraq reach a production agreement as part of an Opec deal to lift prices, this will be a temporary solution if it makes their oil uncompetitive.
The kingdom is seeking to turn to its advantage what appears to be an existential challenge: oil at or below $50 a barrel for the foreseeable future. This requires the application of policies that address four issues.
The first is the role of oil producers group Opec. Saudi Arabias Petroleum & Mineral Resources Minister Ali al-Naimi told the Middle East Economic Survey (MEES) in a seminal interview published in December 2014 that the kingdom aims to ensure efficient oil producers, and Saudi Arabia in particular, do not lose market share to high-cost ones.
This is not a tactical reaction to the growth in US shale production. It is a strategic commitment, as Al-Naimi explained.
But, as a policy for Opec and I convinced Opec of this; even [Opec secretary-general Abdullah] al-Badri is now convinced it is not in the interest of Opec producers to cut their production, whatever the price is whether it goes down to $20 a barrel, $40 a barrel, $50 a barrel, $60 a barrel, it is irrelevant, Al-Naimi was quoted as saying.
This is a position that Al-Naimi has not retreated from. It is evidence that the kingdoms policy is to defend its market share, which involves increasing production year-on-year regardless of what happens to price.
The second objective is restructuring the Saudi economy and government spending to ensure they are consistent with long-term low oil prices. The overarching goal is to reduce the kingdoms dependence on producing and exporting hydrocarbons.
This will require policies that promote domestic and foreign private sector investment in manufacturing and service sectors where the kingdom has a comparative advantage. These include mining and minerals processing; transport and logistics; tourism industries, particularly those that support pilgrims visiting the kingdoms holy sites; and social services, including education and healthcare.
The greatest obstacle to developing non-oil activities is the low domestic energy price, which leads to disproportionate investment in energy-intensive businesses and wasteful consumption. That is why higher domestic fuel, electricity and water prices announced at the start of January are about more than stabilising the governments finances. They are essential if the kingdoms economy is to be weaned off oil and gas.
The third is the Saudi budget. The government accumulated more than $600bn in foreign assets in the 10 years up to 2014. But this was a by-product of exceptionally high oil prices and not the result of clever financial management. Riyadhs fiscal planning has been lamentably poor. Spending has exceeded the budget on average by more than 20 per cent since 2003.
Last months 2016 budget statement included a commitment to greater control over public spending and aligning it with a medium-term view of likely income trends rather than what the oil price will do in the short term.
This task will involve curbing the independence of spending departments and developing credible government accounts, including estimates of public assets.
The budget statement also commits the government to cutting current spending, particularly on wages, and increasing the efficiency of investment in public schemes.
Reducing energy subsidies is a key element in this process. The fall in world oil prices automatically closes the gap between domestic and international energy prices, but further increases in fuel and power prices are almost certain.
The fourth policy is adjusting the kingdoms import bill to reflect the sharp fall in export earnings due to the lower oil prices. Boosting non-oil economic activities will help, but one of the biggest sources of import demand is the presence of about 10 million foreign workers. The government aims to cut the number through Saudisation and action to increase labour productivity. This will also serve the goal of creating sustainable, private sector jobs for Saudi citizens.
Aramco has a central role in addressing all four issues. It has exclusive responsibility for supporting Saudi oil production and price strategy; its domestic services are vital for the kingdoms non-oil sector; its income and spending directly affects the budget; and it is the largest non-state employer of Saudi Arabians.
No other organisation can make a larger contribution to the kingdoms ability to deal with oil prices that will be lower for longer. But Aramcos capacities, in turn, will have to change in four ways.
First, its role as both player and referee in the home market will have to end. This involves maximum independence from the Petroleum & Mineral Resources Ministry, regulator of the Saudi energy market. Much of this process was completed in April 2015, when the chairmanship of Aramco was removed from the kingdoms oil minister. No representative of the oil ministry now sits on its board.
Second, there will need to be an end to Aramcos position as sole supplier of oil and gas to domestic markets, a measure that will offer consumers an alternative and increase price competition. Saudi Arabia has experience of competitive reform in the petrochemicals market, where new companies were allowed to compete with Saudi Basic Industries Corporation (Sabic), originally a monopoly.
The initial opportunity is to promote competition in petroleum retailing and distribution. The government can also allocate upstream concessions to new entrants in under-developed areas of the kingdom and unconventional hydrocarbons.
Third, Aramco needs greater freedom to raise capital, including equity finance. The firm is the kingdoms largest corporate and project finance borrower. The proposal to sell shares opens the door to new long-term funding options.
Finally, 100 per cent state ownership of the company should end. This will counter charges that Aramco is effectively an arm of the government, an issue restraining its capacity to operate and invest in some jurisdictions, notably in the US.
This is a complex agenda that has implications for every energy consumer in Saudi Arabia and practically every energy-importing nation on earth.
It will not be delivered quickly or soon. But the budget of 2016 and the Aramco share sale plan signal the kingdom is taking the important first steps in a journey that will permanently change the Saudi economy.