Download Saudi Arabia, a kingdom built on oil, plans a future beyond it

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Saudi Arabia, a kingdom built on oil, plans a future
beyond it
Ever since oil was discovered in the Arabian desert in 1938, Saudi Arabia has
been the world’s premier petro-state and the dominant force within the
Organisation of the Petroleum Exporting Countries (Opec).
Flush with oil revenue, the country has had neither income taxes nor corporate
taxes while bestowing on its people heavy subsidies for food and fuel. And the
royal family has built spacious palaces at home while buying swanky houses
abroad in places like London and yachts in the south of France.
But now the oil-rich kingdom wants to look beyond oil. The crash in crude oil
prices that began in 2014 has left the country with a gaping budget deficit. And
while oil prices have recovered, climate activists have tried to bring the end of the
hydrocarbon age closer and many analysts have predicted the approach of “peak
demand” that would mark the end of a long climb in global oil consumption.
The 31-year-old deputy crown prince, Mohammed bin Salman, son of the king, has
set out to reinvent the Saudi economy by the year 2030. His plan, called Vision
2030, would foster new private businesses, improve education and trim the budget
deficit by cutting subsidies and introducing a 5 per cent value-added tax.
Most startling of all: The government has proposed selling off a chunk of its crown
jewel, the state-owned oil company Saudi Aramco. The company, which for
decades was in the hands of four big US oil companies and whose nationalisation
became a powerful political symbol, is widely believed to be worth as much as $1
trillion to $2 trillion; its share offering could be the biggest in history. And many
analysts think the secretive giant holds closely guarded secrets such as the true cost
of a Saudi barrel and the size of payments made to the royal family.
Many of the reforms in Vision 2030 have been discussed before, but they suddenly
seem pressing. The kingdom’s population has soared 50pc since 2000, with large
numbers of young people unemployed. The government has been borrowing
abroad to cover domestic spending, which spiraled upward when oil prices were
high. In March, it set terms for a multibillion-dollar Islamic bond, which gives
investors a return while complying with the Muslim prohibition of interest.
And costs are believed to have soared on the war in Yemen, where Saudi Arabia
has backed the beleaguered president, Abed Rabbo Mansour Hadi. Military
spending makes up a quarter of the official budget, and analysts say the true cost of
the Yemen fighting could be concealed in a supplemental appropriation.
“It’s all about stability,” said Bassem Snaije, a financial adviser who teaches
Mideast economics courses at two major French universities. “Vision 2030 sounds
like a positive project, but I would call it Obligation 2030. Extremely high oil
prices over a number of years allowed them to build in a spending system. When
oil prices came back down to a more reasonable level, they were burning capital
faster than they were breathing.”
Ultimately, Mohammed wants the kingdom to be able to run a balanced budget and
more balanced economy — without counting oil revenue, which in 2015 accounted
for 72.5pc of government revenue.
“Vision 2030 comes as a response to challenges that we are facing in the medium
to long term,” said Mohammed al-Jadaan, who became the Saudi finance minister
in November. “We need to come up with something different that basically ensures
that by 2030 we are independent of our current dependence on oil only. It also
comes as a response to a young population that is looking for a better lifestyle, a
better footprint in the world.”
Jadaan, who was in Washington for the International Monetary Fund spring
meetings, added that “there are significant opportunities that we are not tapping.
Maybe it’s about time we started figuring it out.”
The Saudi government has used the IMF meetings to carry on a public-relations
campaign, a tall task for a nation that does not treat women equally, where the
extremist clerical establishment is strong, where executions are sometimes carried
out by beheading, and where political opposition is tightly controlled and often
suppressed.
The Saudis, who differed with President Barack Obama over human rights and his
unwillingness to intervene militarily in Syria, have reached out to the Trump
administration. Prince Mohammed had lunch with President Donald Trump in
March. CIA Director Mike Pompeo’s first trip abroad was to Saudi Arabia, where
he was given an award. Defense Secretary Jim Mattis traveled to Riyadh this past
week.
In a speech at the US Chamber of Commerce last week, Secretary of State Rex
Tillerson, the longtime chief executive of ExxonMobil, said that the Trump
administration is looking for deals for US companies in Saudi Arabia and that he
had met several times with the Saudi ambassador.
The Vision 2030 plan is packed with targets. There are 755 “initiatives” for the
national transportation program alone, Majed Bin Abdullah al-Qasabi, the Saudi
minister of commerce and investment, said at the Center for Strategic and
International Studies. Jadaan noted that the plan calls for doubling the number of
tourists, including pilgrims to Mecca, by building a new railroad between Mecca
and Medina, and a new airport.
The Public Investment Fund, which will become a more active sovereign wealth
fund, has unveiled plans for a new entertainment city the size of Las Vegas south
of the capital, Riyadh. It would feature a Six Flags theme park and a safari park, an
effort to get Saudis to vacation in the country instead of abroad. The Financial
Times reported that in a bid to bolster the popularity of the deputy crown prince the
government allowed the popular Saudi singer Mohamed Abdo to perform publicly.
He sold out four concerts — though they were for men only.
But in the United States, much of the attention has been focused on the initial
public offering for Saudi Aramco.
Pavel Molchanov, energy analyst at the advisory firm Raymond James, has called
Saudi Aramco a “complete black box” and in a note to investors a year ago said
that “if they are truly willing to open the doors . . . that will mark a colossal policy
shift.”
Investors are champing at the bit to know Saudi Aramco’s true crude oil
production costs, believed to be in the mid-single digits per barrel because of the
nature of their prolific reservoirs. They also wonder what the kingdom’s true
maximum production capacity is, an important component of calculating how
much spare capacity there is for world markets. Saudi officials have pegged
reserves at 266 billion barrels — a figure that has changed little even as the country
has remained the world’s largest exporter.
There have already been some changes in anticipation of greater transparency. The
government disclosed that Saudi Aramco had been paying an 85pc tax rate and
20pc royalty rate, and that it was cutting the tax rate to 50pc to make it more
attractive to investors.
The most sensitive issue of all is the unanswered question of how money is
allocated and delivered to the House of Saud and its many princes.
Jean-Francois Seznec, who teaches at Georgetown University and has worked
extensively on banking and finance in the Middle East, says that his own theory is
that oil receipts are all paid to an account at Chase Bank, a relationship that goes
back half a century to the Rockefeller family. Chase is now part of JPMorgan.
From there, the money that belongs to the family is transferred to Switzerland and
elsewhere according to instructions given to only one or two people. He estimates
the payments to be in the range of 5 to 7pc of oil revenue. Then the rest is paid to
Saudi Aramco accounts, he said.
The Saudi finance minister Jadaan said, “There is no income that goes anywhere
but the treasury. Everything else gets out from the budget.”
Seznec believes that one item holding up the Saudi Aramco IPO might be these
payments, but that without the IPO the entire Vision is endangered.
“I think it’s vital to any kind of efforts to modernise the economy,” he said. “The
key is to make sure transparency is imposed at all levels — especially for the
biggest company in the kingdom — so you can ask the population to make
sacrifices.”
A year later, investors are still waiting.
The kingdom appears to be serious. It has hired investment banker Ken Moelis,
who began his career at Drexel Burnham Lambert and whose clients have included
casino tycoon Steve Wynn, Bain Capital and the Chinese conglomerate Dalian
Wanda. The Financial Times quoted a rival who dubbed Moelis “Ken of Arabia.”
“I actually think that being able to be a shareholder in Saudi oil assets is a pretty
attractive thing for a lot of folks in the energy industry,” said Sarah Ladislaw,
director of the energy and national security program at the Center for Strategic and
International Studies.
Chinese companies, eager to curry favor with a reliable source of crude, are likely
to buy significant portions. China is the kingdom’s top trade partner. Ladislaw
noted that even if oil demand drops, production costs are so low in Saudi Arabia
that investors could still make money.
That modifies the risk of the price of oil, which has lurched over the past nine
years from a high of $147 a barrel in 2008 to a low of less than $27 a barrel in
2016.
In a speech at Columbia University’s Center on Global Energy Policy on April 14,
Saudi Aramco’s chief executive Amin Nasser predicted a rebound in prices in the
medium term. He said that since 2014, $1tr of oil and gas investments had been
deferred or canceled and that the volume of conventional oil discovered in the past
four years was half the amount discovered in the previous four years. The supply
required for the coming years was “falling behind,” he said.
“There can be little or no doubt that the future direction of the market is upward,”
he said. Asked whether demand was peaking, Nasser said, “Our belief is that peak
demand is not in sight.”
That might work out well for Saudi Arabia as it mulls when to launch its IPO.
Jadaan said that the initial public offering would be launched both on Saudi
markets and one or more international ones. Asked about estimates that the
government would initially offer about 5pc of the company, Jadaan said, “It could
be more, it could be less or it could be more.”
What will the kingdom do with the proceeds of a Saudi Aramco stock sale?
Jadaan said the money would go into new investments, such as mining, which the
government believes can turn into a huge industry.
“We have a mining industry that is significantly underutilised. Because we had the
oil we didn’t have to do much about that,” he said. He said the government could
act as an “anchor investor” to ease investors’ qualms and do some initial research
into projects.
The money could also go into helping meet new targets for renewable energy. Last
week, the government announced a target of building 9,500 megawatts of
renewable power capacity by 2023, up from virtually nothing now. Thirty utilityscale solar and wind projects will be developed over the next decade as part of a
broader $50 billion program aimed at diversifying the electricity mix and freeing
up for export oil now used for electricity generation.
The energy minister said at an industry conference that 10pc of the domestic
electricity mix will come from renewables by 2023.
Whether Mohammed bin Salman’s grand plans can win popular support remains
unknown.
“There are some real barriers to their overall goals in terms of converting the
economy and moving it away from reliance on oil exports,” said Gregory Gause, a
professor at the Texas A&M University.
The private sector, for example, has been growing in recent years and employment
has risen by a million jobs from 2004 to 2014, but businesses are mostly hiring
foreign workers, not local ones.
And cutting subsidies and raising taxes have rarely been popular planks.
Jadaan said that half the country has been registered to receive welfare payments
large enough to cover a portion of the increases in electricity and gasoline prices
from cutting subsidies. And besides, the government needs revenue from
somewhere.
“We can’t sell gasoline at prices less than water prices,” said Qasabi, the Saudi
commerce minister. “I think the time has come to correct this.” — Bloomberg/The
Washington Post Service
Published in Dawn, April 23rd, 2017