The Effects of Lower Oil Prices on the Economy of Saudi Arabia

The Effects of Lower Oil Prices on the Economy of Saudi Arabia.

The Effects of Lower Oil Prices on the Economy of Saudi Arabia

Introduction

The global drop in oil prices has had different effects on various countries around the world depending on the country’s position as either an oil producing or oil-consuming country. According to the IMF (2015), the fall in global oil prices has had a positive outcome in countries where the lower oil prices have been passed on to consumers. The positive outcomes are such as increased real income for consumers as well as a lowered cost of living. The low prices have also contributed to reduced prices of goods and services that depend on oil as a major source of energy during production (Pettinger, 2015).  While low prices benefit the users, oil producers have to contend with real income losses. Large oil-producing countries such as Saudi Arabia have an economy that is largely dependent on the revenue from oil and this means that oil price fluctuation affects the economy. Such countries are largely net exporters of oil and with reducing export revenues come to the dampening of GDP growth (Monetary Policy Report, 2015). The larger dependence by exporting countries on the prices of oil as compared to importing countries means that there are significant negative effects on the economy of such oil exporting countries.

The continued drop in oil prices means the Saudi Arabian economy is expected to decline due to the overreliance on oil export. Cunningham (2016) notes that Saudi Arabia’s fiscal deficit for 2015 was at 98 billion dollars with expectations of an 87 billion dollar deficit in 2016. For the country to rekindle its economy and maintain a positive growth, it has to undertake measures that will stimulate the economy in the short and long term. Failing to cushion the economy from the oil price decline will result in a continued substantial economic decline.

Current and future impacts of low oil prices in Saudi Arabia

Saudi Arabia’s economy is highly dependent on oil export as its main boon and this means that the drop in oil prices has significant negative outcomes for this country’s economy. The country features some of the elite and wealthy individuals, and the wealth in this country is largely as a result of government subsidies and the fact that there are no personal income taxes for the country’s nationals. Such subsidies and facilitation to economic progression are due to the fact that the country is a large oil exporter. The Saudi Kingdom’s budget is reliant on oil for about 80 percent and this translates to about 45 percent of the Gross Domestic Product (GDP) (Bremmer, 2016). The drop in oil prices means that the country will have to contend with austerity measures that it is not used to.

According to the projections by the IMF, Saudi Arabia could go bankrupt in about five years if it fails to change its economic policy and cut support to its allies (Walker et al., 2015). The economic effect of the declining oil prices will not only be felt in Saudi Arabia, but will extend to its foreign allies that it has been supporting with the oil resources. Saudi Arabia has been using wealth from oil to support its allies and countries that have benefited from these measures are such as Egypt, Lebanon, Bahrain, Jordan, and Palestine. With the social and economic instability that Egypt has faced in the recent past, there has been a shortage of foreign currency that has also been exacerbated by declining resources from Saudi Arabia. Bilateral relations between the two countries are being strained by the decline in available resources and this could affect the trade and economic ties between the countries. With such strenuous relationships between the two countries, the Saudi economy is likely to be further hurt by the indirect impact of the oil price decline. As of 2009, trade between the two countries hit 2 billion in the first six months and has been growing ever since (Business Today, 2009). The numbers are likely to drop and hurt both the Egyptian and Saudi Arabian economy.

To deal with the economic effects of low oil prices, the Kingdom announced budget cuts for 2016 as a way of addressing the 15 percent deficit it incurred on its GDP in 2015 (The Guardian, 2015). The cuts are directed towards ensuring that the country still has resources to support its huge economy. Public spending cuts are increasing in 2016, where the cuts have been directed towards subsidies and infrastructure (Bouyamourn, 2016). As much as the drop in oil prices is leading to deficit and cuts in spending, the Saudi government is not all out desperate as it already has a cushion against deficits. The Saudi government has over 600 billion dollars in cash reserves that can be used to finance its fiscal deficits for several years, but there has been a large depletion of the reserve following the drop. As of 2014, the cash reserves were at 746 billion dollars and this means that over 100 billion has already been used within a period of just over 18 months (Cunningham, 2016). Should the country fail to take any measures to deal with the declining state of its economy, the economic growth that it has been accustomed to will be in the past. Without a rebound in oil prices, the deficits will increase and the economy will continue declining.

The country has not been reluctant in applying changes that will oversee a progression of the economy and emergence from its current economic turmoil. According to the Atlantic Council, the Saudi kingdom is reforming its economy in positive ways such that it is now relying more on taxes than revenues from the oil industry (Cunningham, 2016). The country has also been successful in trying to diversify its economy with new industrial facilities directed towards cement, aluminum, fertilizers, chemicals, and other industrial products.  Also, King Abdullah opened up a new city in 2010 that centers on research and development in other energy sources besides oil (Bryant, 2015). As such, the country has been committed towards economic diversification, but any failure to implement practical principles will mean that the country cannot cushion itself against any future economic downturns.

Future projections on different scenarios

  1. Further decline

A continued decline in oil prices implies that the Saudi kingdom will have to contend with continued spending cuts as initiated by the government. The government is still grappling with the fact that it will have to initiate an economic shift and policy that focuses on balancing payments and its fiscal position. The current situation with regards to the government’s stance cannot be balanced in the near future and is likely to take up to five years (Samba, 2016).  A continued decline in oil prices will only imply that it will take longer for the government to maintain stability and the country will have to contend with a continued economic decline.

Figure 1: GDP growth for 2015 and 2016 Q1

Even with the continued government investment in the diversification of the economy and the encouragement of the private sector to take a lead in job creation, the outcomes from these initiatives will not be instant and this means that the economy will still be susceptible to the fluctuation of oil prices. The figure above indicates a declining GDP growth and this will only get worse with a continued decline in oil prices without substantive corrective measures. Another important implication is that the government will focus on taxation as a means of generating revenue and move from its ‘rentier’ status. As such, declining oil prices imply that the economy will continue declining as public spending that the government is cutting will continue to be an economic activity determinant.

Stabilizes at $50 for five years

Current oil prices are fluctuating just below $50 and this is a considerable low from the 2008 oil peak of $145. By having the oil prices at a stable $50, this will put a strain on some oil producing countries as their national budgets will have to grapple with reduce oil revenues (Hartmann and Sam, 2016). Although Saudi Arabia is already experiencing deficits, its cash reserves can be enough to cover these deficits for the five years as it also looks towards the diversification of its economy. As the figure below depicts, the reserves could run for as long as ten years if the country maintains its current economic policy. The availability of the cash reserves does not cushion the country’s economy from any downturn, but the reserves place the country at a safer zone with regards to any adverse economic effects. The implication is that the government will continue cut spending and also focus on taxation to supplement its income. A stable price of $50 may not have any significant adverse economic effects on Saudi Arabia but the country will have to grapple with low economic outcomes.

Figure 2: a depiction of the effects of $50 price stabilization

Price increase to $100

A price increase to $100 will be a 100 percent increase from the current oil prices and only about 30-40 percent less of the peak oil prices from 2008. Such an increase following the decline means that Saudi Arabia will be able to restore its economy to where it was before the decline in a period of about two or three years. The government will regain its revenue stream from the oil export industry and this will stimulate further growth in the economy as there will be reduced cuts. On the other hand, Saudi Arabia is exploring an economic policy on diversifying its economy and this means that the country’s economy will not be dependent on oil alone. With a diversified economy and a booming oil industry, the country’s economy may experience its largest growth in a period of 10 years.

Alternative energy sources

As previously mentioned, King Abdullah opened up the King Abdullah City for Atomic and Renewable Energy in 2010 where the focus is on research towards alternative energy sources. The city announced that it would start generating 41 gigawatts of solar energy by 2032 and this will be a substantial rise from the current 0.003 gigawatts of solar energy (Bryant, 2015). Solar energy presents an alternative energy source for the Saudi kingdom and the fact that the country has started a move towards this goal implies that it is attainable in the recent future. Solar energy is not only a viable energy source for future developments it negates the negative effects of climate change brought about by an overreliance on oil. As a renewable source of energy, it is viable in the quest towards environmental sustainability and the need for sustainable developments.

Another alternative energy source is wind energy that is equally sustainable and viable as an energy source for future developments. The Saudi Arabia wind map indicates that the kingdom lies within two vast regions along the Red Sea coast and the Arabian Gulf.

Figure 3: Wind map of Saudi Arabia

From the map above, high wind speed is present in different regions and this offers the potential of building wind farms in regions such as Alwajh, Dhahran, Jouf, and Turaif (Pazheri et al., 2012). The harvesting of wind energy and connecting it to the power network through the grid system will offer the country an alternative renewable energy source for its developmental activities. Unlike the crude oil, wind energy has no adverse effects on the environment.

Conclusion

The low oil prices around the globe have negatively affected the Saudi Arabian economy as the prices have led to deficits as well as spending cuts by the government. Although the kingdom has a substantial cash reserve, the continued decline in oil prices has an immediate and long-term negative impact on the economy. With the kingdom having an 80 percent reliance on oil revenue for its domestic budget, the situation has called for an immediate reconstruction of the economic policy and a focus on diversification of the economy. The cash reserves will help cover the deficits should the price stabilize at a low of $50, but the reserves cannot hold for long and hence the need for alternative actions. Some of these alternative actions can include an investment in renewable energy sources such as from the wind and the sun as a way to reduce energy and economic dependence on oil and as a move towards environmental sustainability.

 

References

Bouyamourn, A. (2016). Lower oil prices hit UAE and Saudi Arabia economies, latest PMI         survey shows. The National. Retrieved on November 16, 2016, from http://www.             thenational.ae/business/economy/lower-oil-prices-hit-uae-and-saudi-arabia-economies-      latest-pmi-survey-shows

Bremmer, I. (2016) Saudi Arabia will be the big loser from the plunge in oil prices. Time,             January 21, 2016.

Bryant, S. (2015). How cheap oil will hurt the Saudi Arabian economy. Retrieved on November 16, 2016 from http://www.investopedia.com/articles/investing/091515/how-cheap-oil-          will-hurt-saudi-arabian-economy.asp

Business Today. (2009). Egypt-Saudi trade touch $2 billion mark in the first half of the year.       Retrieved on November 16, 2016 from http://www.businesstoday-eg.com/banking-         finance/middle-east/egypt-saudi-trade-touch-2-billion-mark-in-the-first-half-of-the-    year.html

Cunningham, N. (2016). Low oil prices forcing Saudi Arabia to modernize economy. Retrieved    on November 16, 2016 from http://oilprice.com/Energy/Energy-General/Low-Oil-Prices-       Forcing-Saudi-Arabia-To-Modernize-Economy.html

Hartmann, B., and Sam, S. (2016). What low oil prices really mean. Harvard Business Review,    March 2016.

IMF. (2015). Global implications of lower oil prices. Retrieved on November 16, 2016, from             http://www.imf.org/external/pubs/ft/sdn/2015/sdn1515.pdf

Monetary Policy Report. (2015). Effects of the falling oil price on the global economy. Retrieved             on November 16, 2016 from http://www.riksbank.se/Documents/Rapporter/PPR/2015             150212/rap_ppr_ruta2_150212_eng.pdf

Pazheri, R., Malik, N., Al-Arainy, A., Safoora, K., et al. (2012). Use of Renewable Energy           Sources in Saudi Arabia through Smart Grid. Journal of Energy and Power Engineering,       6 (1), 1065-1070.

Pettinger, P. (2015). Impact of falling oil prices. Retrieved on November 16, 2016, from             http://www.economicshelp.org/blog/11738/oil/impact-of-falling-oil-prices/

Samba. (2016). Saudi Arabia. Riyadh: Samba Financial Group.

The Guardian. (2015). Recession, retrenchment, revolution? Impact of low crude prices on oil      powers. The Guardian, December 30, 2015.

 

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The Effects of Lower Oil Prices on the Economy of Saudi Arabia

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