beyondbrics

By Kathleen Sullivan of Ergo

From a petroleum perspective, 2011 appears to have been a fantastic year for Saudi Arabia. The country’s oil production soared to over 10m bpd, piling up cash reserves and reducing government debt. Proud holder of the world’s largest proven oil reserves, highest exports, and most spare capacity, Saudi Arabia seems guaranteed the pre-eminent position in world oil markets that it has held for decades.

Yet throughout the past year, threats to the Kingdom’s power intensified. Disruptions in Libyan production cast doubt on Saudi Arabia’s spare-capacity reserves. Fractious OPEC meetings highlighted the Saudis’ increasing tensions with nuclear-armed Iran. Arab Spring uprisings stirred emotions among restive Saudi youth.

Cracks in Saudi Arabia’s traditional position of dominance caused by external forces are starting to show, but the Kingdom’s most pressing concerns — and the ones it must directly confront in 2012 — come from within the country. Growing energy and infrastructure needs, and demands for social reform have curbed Saudi Arabia’s oil exports, increased its exposure to economic volatility, and placed constraints on its cash. Together, these challenges hold the potential to dethrone Saudi Arabia from its position among oil producers.

Most of Saudi Arabia’s domestic problems are linked to its increasing population, which has grown from 15m in 1990 to over 28m in 2011, an annual growth rate of nearly 3 per cent. A rising population has brought increased domestic needs for energy, infrastructure, and desalination. Electricity demand alone is growing at 8 per cent annually, and while Saudi Arabia has large reserves of natural gas that could in theory power electric plants, most gas is associated with oil production and is therefore limited by the Kingdom’s OPEC oil quota.

In the absence of a sophisticated natural gas industry, the Kingdom has turned to oil for its domestic electricity and infrastructure needs, thus placing pressure on its oil exports — the linchpin of the country’s power. This strain on Saudi oil exports limits its ability to flood — or threaten to flood — the oil markets, a tool it has employed in the past to wield power in OPEC and adjust prices in its favour.

As Saudi Arabia’s population has grown, so has its youth, a group that has felt the bite of both underemployment and an acute housing crisis. Combined with a restrictive social environment imposed by the Saudi government, these factors have created a volatile mix resembling that of other Arab countries before their uprisings.

Appeasing this increasingly restive group has grown costly for Saudi Arabia. Closely following the uprisings in Libya, Syria, and Egypt, the Saudi government announced a total of $120bn in social giveaways, a measure that has historically been successful in keeping domestic peace. But in 2012, as nascent democracies sprout up across the Middle East, demands for reform from Saudis will likely grow. Either of the government’s options — pacifying its population with continued welfare or implementing robust reforms — will require increased spending and place further constraints on cash.

At a time when its population has grown more demanding, Saudi Arabia finds itself increasingly dependent on a higher price of oil. The Saudi government has budgeted a $95 break-even price per barrel — $30 more than in 2010. By comparison, the rest of the GCC is expected to break even at approximately $70 a barrel. Even a small recession could drive down the price of oil and plunge Saudi Arabia back into horrific debt levels similar to the ones it faced in 2002. Dependence on higher oil prices will leave Saudi Arabia exposed to greater economic volatility, which lessens its flexibility to flood the oil markets and lowers the margin for error in exploiting its already aging fields.

2012 holds more challenges to the Kingdom’s power over the oil industry — not least of all the possible increased oil production coming from Iraq. Nevertheless, Saudi Arabia’s most serious obstacles remain domestic. The Kingdom must prioritise the development of natural gas and other energy sources in the coming year, and place a greater emphasis on true social reform as opposed to mere largesse. The deterioration of Saudi power is not inevitable, but without action, the country’s long-standing dominance is far from assured.

Ergo is a global intelligence and advisory firm that will soon be releasing a report on the challenges to Saudi Arabia’s historically dominant position in world oil markets.

Related reading:
Saudi Arabia sets lavish spending figure, FT
Saudi Arabia: spend it while you can, beyondbrics
12 for 2012: oil price fall will squeeze producers’ budget plans, beyondbrics