Budget breakeven price to soar in Saudi Arabia

25 June 2012

Riyadh’s increased spending commitments are driving up the oil price it needs to balance its budget, reaching $320 a barrel by 2030

While austerity has gripped Europe for the past year, Saudi Arabia has discovered a fresh profligacy. Unnerved by the uprisings that unseated four regional leaders in 2011 and buoyed by high oil prices, the government announced a massive spending programme in early 2011.

It was the second time in two years that Riyadh had ramped up spending in response to a crisis. In 2009, the government upped expenditure by 14 per cent as a result of the financial downturn. In 2011, spending is thought to have risen by almost 25 per cent as the kingdom desperately attempted to ensure its citizens were not inspired by protests elsewhere in the region.

The combination of government largesse and rising oil production levels is set to drive the country’s growth to about 6 per cent in 2012, according to the Washington-based IMF. This will make the country one of the fastest-growing in the Middle East.

Challenges ahead for Saudi Arabia

The Saudi economy is now one of the strongest in the region, if not the world. Government savings are massive and still expanding. In contrast to most developed nations, debt levels are falling. High oil prices and production levels are driving the economy forwards and loosening credit conditions are helping boost the non-oil sector.

The economy is not growing fast enough to produce sufficient jobs for the kingdom’s growing population

The outlook is not without its challenges, though. The economy is not growing fast enough to produce sufficient jobs for the kingdom’s growing population. Growth is becoming increasingly dependent on government spending. Political concerns, both regional and domestic, also add to the risks ahead.

The kingdom has already been through a significant recovery over the past few years since the global financial crisis. In 2009, as a result of the collapse in the oil price the year before, growth fell to virtually zero. It has since picked up, buoyed by stimulus spending by the government, a recovery in the oil price and rising crude output.

Oil production has climbed from an average of 8.4 million barrels a day (b/d) in 2009 to an expected 9.8 million b/d in 2012, according to the IMF. That, coupled with higher prices, should roughly double oil export revenues to $321bn in 2012, from $163bn in 2009.

Oil sector gross domestic product (GDP) is forecast to grow at about 4.3 per cent in real terms in both 2011 and 2012.

Fortunately for the kingdom, it is not just the oil sector that is growing strongly. Real non-oil private sector growth is thought to have been about 8.3 per cent in 2011, according to the local Jadwa Investment. In 2012, it is forecast to be about 4.9 per cent.

This is helped by the fact that credit growth is finally starting to pick up after contracting slightly in 2009. The figures for March show that private sector credit increased nearly 13 per cent, compared with the same month in 2011.

Deposits in the banking system have also been growing healthily, rising 10 per cent year-on-year in March. As a result, the loan-to-deposit ratio of the banks is now about 78 per cent. This is well below the regulatory limit of 85 per cent and leaves lenders ample room to keep lending over the rest of the year. Overall credit growth in the private sector is expected to be in the mid-teens for the year as a whole. That should have a multiplier effect on government spending and offset the impact of a more constrained market for international funding.

Foreign reserves

Consumers are also feeling confident. Automated teller machine (ATM) withdrawals spiked last year after the government paid public sector workers a bonus of two months’ salary, a move copied by many private sector firms. Withdrawals have remained high so far in 2012, and point-of-sale transactions reached an all-time high in March.

Businesses have also seen an improvement in performance. In the first quarter of the year, profits at listed companies totalled SR25bn ($6.7bn), 15 per cent higher than the same quarter of 2011 and 23 per cent higher than the previous quarter.

Trading volumes on the local stock exchange, the Tadawul, have risen as a result, although they started to dip by April. Average daily turnover is about SR12bn, making the Tadawul one of the region’s most liquid stock markets.

Even with Riyadh’s spending boom, the Saudi Arabian Monetary Agency (Sama) has been building assets fast. By March, the government had saved an extra $29bn, taking its total foreign assets up to $570bn. By the end of the year, this figure should exceed $600bn. Domestic debt is expected to fall to just SR115bn by the end of 2012.

General government gross debt is about 6 per cent of GDP. In comparison, the US’ gross debt is more than 100 per cent of GDP, Italy’s is about 123 per cent and the UK’s is about 88 per cent.

The positive outlook for the short term is tempered by some long-term challenges. Perhaps most seriously, even though current growth levels are relatively healthy, the economy is not growing fast enough to make a serious dent in the high level of youth unemployment.

Riyadh has set out growth targets in a long-term strategy that envisages GDP per capita doubling between 2004 and 2025. To achieve this, the country needs to grow at an average annual rate of 6.6 per cent. It has generally fallen short so far, and that trend is likely to continue.

The IMF’s 6 per cent growth prediction for 2012 is higher than that of many analysts. The UK’s HSBC estimates growth of 4 per cent for the year, and only recently increased that forecast by a full percentage point, largely due to expectations that oil production will remain high for longer than it had anticipated.

Oil price risk

There are also worrying trends in domestic consumption of oil and rising spending. For 2012, the budget breakeven oil price for Saudi Arabia is estimated at $71 a barrel by the IMF. Jadwa Investment estimates that spending will rise 7 per cent a year on average up to 2025, and if domestic consumption trends continue, Riyadh will need the oil price to be $175 a barrel just to break even. By 2030, the level could jump to $320 a barrel. At the moment, the kingdom has been vocal in saying that it believes $100 a barrel is a fair price for oil. Just three years ago, Riyadh said the market price should be $75-80 a barrel.

Spending growth should start to moderate in the future as a result of these pressures. The kingdom also hopes that more of the emphasis on growth can be passed off to the non-oil private sector. In that sense, it is a relief that credit growth in the private sector has finally started to pick up. So far, however, huge government spending packages have actually increased the country’s reliance on the oil sector.

The kingdom is already trying to curtail wasteful fuel consumption and has announced plans to develop the King Abdullah Centre for Atomic and Renewable Energy (KA-Care). The hope is that by investing in renewable sources of energy for domestic use, more oil will be left over for revenue-generating exports. KA-Care has made little progress to date, though it is preparing to invite bids in the third quarter of 2012 for 2,850MW of renewable energy projects.

Politicians are wary of trying to encourage a more efficient use of energy by altering the generous subsidies enjoyed by nationals. In most of the region, subsidises are considered an important part of the social contract between unelected rulers and their subjects, and any changes pushed too quickly risk a backlash.

How a future political transition will be handled and what direction the country will take are also uncertain. The current ruler, King Abdullah bin Abdulaziz al-Saud, is in his mid-80s. Last year, he named Prince Nayef bin Abdulaziz al-Saud as crown prince following the death of Prince Sultan bin Abdulaziz al-Saud. However, Prince Nayef died in June.

Prince Nayef had been taking on more responsibility for running the country and steering its response to the Arab Uprisings. He was seen as key to Riyadh’s involvement in crushing Shia-led unrest in Bahrain. A new crown prince has not yet been named, but the king’s brother, Prince Salman bin Abdulaziz al-Saud, is most likely. Prince Salman became defence minister in November 2011, but was not appointed second deputy prime minister, a role traditionally given to the crown-prince-in-waiting.

A US-led or Israeli attack on Iran in order to thwart its nuclear programme would put Saudi Arabia in an uncomfortable diplomatic position. Its hostility to Iran would make the kingdom a target for reprisals, something at which Tehran has already hinted. While there are currently few signs that any kind of attack on Iran is imminent, it remains one of the most serious short-term risks facing Saudi Arabia.

Cushioned from crisis

Barring this sort of regional conflict, the outlook for the kingdom is relatively benign. The reserves amassed by Sama mean a brief fall in the oil price, as a result of a slowdown in the global economy, will have little impact on short-term spending plans, or growth in the real economy. The Saudi banking sector is increasingly isolated from global trends as a result of the vast local currency liquidity, meaning that even a European bankcrisis will have a limited impact.

The longer-term challenges are far more difficult to avoid. Cutting domestic fuel consumption, reducing reliance on the oil sector, creating jobs, navigating regional tensions and ensuring a smooth political transition will be a much more severe test.

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