By Xander Snyder

Saudi Arabia is in a race against time to implement massive reforms that it hopes will minimize its economy’s dependence on oil and, in doing so, insulate it from social unrest once oil prices inevitably fall. And the government must do this without surrendering its control of the country. It’s a tall order for Crown Prince Mohammed bin Salman, the heir apparent to the kingdom who, by all accounts, appears to have consolidated enough power to at least try to pull it off.

There’s plenty of reasons to doubt that he will actually succeed, but that’s a problem for a later day. Right now, Brent crude is at about $75 per barrel, slightly above what the International Monetary Fund lists as Saudi Arabia’s breakeven point, giving the government some more revenue and thus a little more breathing room to change its ways.

Time and Money

It’s hard to say how long that will last, though. Prices have been rising, thanks to a combination of OPEC cuts, production agreements between Saudi Arabia and Russia, decreased U.S. inventories, and fears that a U.S. withdrawal from the Iran nuclear deal will take Iranian supply offline. And they have gone up despite increased U.S. shale production – which counterintuitively makes sense, considering shale producers will up production as soon as oil prices exceed their own breakeven points, which tend to range between $35 and $70 per barrel.

Increasing production, however, takes time and money. The cost to finish uncompleted wells must be accounted for, as must the cost of transportation to market. Pipelines are a good option in this regard, but some pipelines are nearly at maximum capacity. (The delays have prompted producers to offer discounts of as much as $9 per barrel, according to some reports.) Another option is to transport by truck, something that requires more time and money. Other cyclical factors, including the demand for components such as the sand used to fracture a well, likewise drive costs up and forestall oil coming to market.

The delays mean that oil prices will stay high until shale producers can overcome their short-term barriers to production. As it happens, they are beginning to do just that. The number of active rigs in the U.S. has been increasing steadily since the middle of 2016. (As of April 2018 that number is 1,013.) Production has predictably surged. In May, the Energy Information Administration estimates that U.S. oil production will increase to 7 million barrels per day, a 15 percent increase compared to last May.

So while $75 per barrel of oil may allay some of Saudi Arabia’s immediate financial concerns, the long-term trend remains: More U.S. production will drive prices down. Saudi Arabia knows this and so must move quickly to take advantage of the current high prices. How quickly it acts depends on how much money it actually needs to fund its ambitious reforms.

Believable Rumors

And how much money it will earn remains to be seen. The International Monetary Fund puts Saudi Arabia’s breakeven price at $73 per barrel, in theory netting Riyadh a nice budget surplus at current prices. There are, however, some issues with the IMF’s breakeven figure. For starters, the formula it uses to calculate this figure isn’t publicly available. Second, according to a paper published by the Council on Foreign Relations, IMF estimates vary by as much as 20 percent, even in the same year. Either way, as shale production responds to the market, oil prices are likely to decline, putting greater strain on the Saudi budget.

It’s no wonder, then, that the Saudi government is desperately trying to diversify its sources of non-oil revenue. And it has been somewhat successful, so long as you don’t look too closely. Non-oil revenues as a percent of the government’s total budget have increased from 8 percent in 2012 to almost 37 percent in 2017, an annualized growth rate of about 20 percent.

Still, in this same period, oil revenue has decreased so much that the total budget has declined by almost 45 percent, from about $330 billion to $185 billion (using the current riyal/USD exchange rate). In other words, the non-oil share of revenue appears to have increased so much primarily because its total budget has shrunk nearly by half. If Saudi Arabia was earning as much in non-oil revenues in 2012 as it is today, then non-oil would account for a much smaller share of the budget, about 18 percent.

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The Saudi government expects spending to outpace revenue in 2018, estimating a deficit of more than $50 billion, or roughly 7 percent of gross domestic product. Aside from raising taxes – something it has steadily done despite the political risks – there are only three ways it can account for this shortfall: dip into its reserves, seek foreign investment or confiscate assets from the elite. As of February 2018, Saudi Arabia had approximately $487 billion in reserves, a 5 percent decline from last February and a 33 percent decline from its peak in 2014. If the kingdom were to maintain deficit spending at the same rate as is anticipated in 2018, it would have about 10 years of runway. Of course, if oil revenue declines without a commensurate decrease in its reform expenditures, the deficit will grow, and its cushion will shrink.

Unsurprisingly, Saudi Arabia prefers to raise foreign investment. The most publicized measure in that regard is the initial public offering of Saudi Aramco. This offering, however, continues to be delayed, and while the Saudi energy minister may be citing “litigation and liability” complexities, the real reason is most likely the inability of Saudi Arabia’s bankers to reach the $2 trillion valuation that Mohammed bin Salman has sought. At that valuation, the anticipated sale of 5 percent of the company would raise $100 billion for Saudi Arabia, while somewhat more conservative market valuation estimates, ranging from about $500 billion to $1 trillion, would raise only between $25 billion and $50 billion.

Riyadh has also turned to the debt markets, issuing $17.5 billion in its first dollar-denominated debt offering in 2016, and another $11 billion this month. Though Moody’s A1 rating may give some assurance to investors, the reality is that Saudi Arabia remains bogged down in a proxy war in Yemen and preoccupied by Iran, its regional rival that is well positioned to gain more power. Any new developments in the broader Middle Eastern conflict that threatens to lure Saudi Arabia in either financially or otherwise – say, a war between Iran and Israel – is sure to make foreign investors wary and limit Saudi Arabia’s access to external capital.

Saudi Arabia has also confiscated assets from its elite. The arrest of 400 oligarchs last year netted $106 billion in confiscated wealth, according to the Saudi attorney general. This no doubt helps to plug the gap for now, but there are limits to how much the government can seize without facing a more concerted resistance.

All told, Saudi Arabia isn’t on the brink of collapse, but nor are the rumors of a palace coup from last weekend all that surprising. They attest to the difficulty of the government’s position. It needs to radically transform its political-economy in a relatively short time, all while it contends with regional security threats. The need to move quickly, then, is paramount, since a divided, weak homefront will preoccupy the regime’s focus and prevent it from confronting its external threats effectively.

A lot must go right for Saudi Arabia to achieve its far-reaching reform goals, and in the annals of history, countries are rarely so lucky.

Xander Snyder
Xander Snyder is an analyst at Geopolitical Futures. He has a diverse theoretical and practical background in economics, finance and entrepreneurship. As an investment banker, Mr. Snyder worked in corporate debt origination and later in a consumer-retail industry group at Guggenheim Securities, participating in transactions ranging from mergers and acquisitions, equity and debt capital raises, spin-offs and split-offs to principal investing and fairness opinions. He has worked on more than $4 billion worth of transactions. He subsequently co-founded and served as CFO for Persistent Efficiency, an energy efficiency company that used cutting-edge technology to create a new type of electricity sensor for circuit breakers and related data services. In his role, he was responsible for raising more than $1.5 million in seed capital and presented to some 70 venture capital and angel investors in the process. He also signed four Fortune 500 companies as customers, managed all aspects of company accounting, budgeting and cash flow, investor relations, and supply chain and inventory management. In addition to setting corporate strategy, he helped grow the company from two people to a 12-person team. As an independent financial consultant, Mr. Snyder wrote an economics publication for a financial firm that went out to more than 10,000 individuals and assisted in deal sourcing for a real estate private equity fund. He is an active real estate investor and an occasional angel investor. Mr. Snyder received his bachelor’s degree, summa cum laude, in economics and classical music composition from Cornell University.