What is Arabic for Thatcherism?
The plunge in the price of oil, from $110 a barrel in 2014 to less than $35 today, was partly because Saudi Arabia seems determined to protect its share of the oil market. Nevertheless, low prices are a time-bomb for a country dominated by oil and a government that relies on it for up to 90% of its revenues. The budget deficit swelled last year to a staggering 15% of GDP. Although the country has $650 billion of foreign reserves, they have already fallen by $100 billion.
When oil prices fell in the 1990s, the Saudis simply borrowed heavily. They were saved when China’s boom sent commodity prices soaring again in the 2000s. This time no one, including the Saudi rulers, expects a return to triple-digit oil prices. Instead, they acknowledge that the economy must change. Speaking to The Economist this week (seeBriefing), Prince Muhammad laid out a blueprint for reform that amounts to a radical redesign of the Saudi state.
The first step is fiscal consolidation. The goal is to eliminate the budget deficit in the next five years, even if the oil price stays low. Though there is much flab to cut, that is still a perilous undertaking which means dismantling the system according to which petro-cash, not taxes, pay for free education and health care as well as highly subsidised electricity, water and housing. More than money is at stake: this largesse has disguised how far the economy is chronically unproductive and dependent on foreign labour. It has been too easy for Saudis to avoid working, or to snooze away in government offices.
The new leadership has made a start. Spending cuts in the last months of 2015 stopped the deficit from soaring to more than 20% of GDP. The 2016 budget includes steep rises in the prices of petrol, electricity and water (though they remain heavily subsidised). The prince pledges to move to market prices by the end of the five-year period. He is also committed to new taxes, including a value-added tax of 5%, sin taxes on sugary drinks and cigarettes, and levies on vacant land.
Recalibrating taxes and subsidies is only the first step. Roughly 70% of the 29m-plus Saudis are under 30. At the same time, two-thirds of Saudi workers are employed by the government. With the workforce projected to double by 2030, the country will prosper only if the sleepy statist economy is turned on its head, diversifying from oil, boosting private business and introducing market-driven efficiencies.
Talking late into the night with the news left on throughout, Prince Muhammad discusses his country’s interventionist foreign policy and its uncompromising response to terrorism and sedition. Asked whether the kingdom’s actions were stoking regional tensions, he said that things were already so bad they could scarcely get any worse. “We try as hard as we can not to escalate anything further,” he says; and he certainly does not expect war. But for his entourage, Saudi Arabia has no choice but to stop Iran from trying to carve out a new Persian empire.
If his defence of Saudi foreign policy was unrepentant, even more striking was his ambition to remake the entire Saudi state by harnessing the power of markets. No economic reform is taboo, say his officials: not the shedding of do-nothing public-sector workers, not the abolition of subsidies that Saudis have come to see as their birthright, not the privatisation of basic services such as education and health care. And not even the sale of shares in the crown jewel: Saudi Aramco, the secretive national oil and gas producer that is the world’s biggest company.
Iran, the Shia power that has long alarmed Sunni Arabs, has spread its influence across the region, particularly through the militias it grooms—in Lebanon, Iraq, Syria and most recently in Yemen, Saudi Arabia’s underbelly. The Arab world is confronted not just by a Shia Crescent, “but by a Shia full moon”, says one confidant of the prince. As well as Shia militants, Saudi Arabia also faces resurgent Sunni jihadists: a revived al-Qaeda in Yemen to the south, and Islamic State (IS) in Iraq and Syria to the north. Both seek to lure young Saudis raised on the same textbooks and homilies that the jihadists use.
Pillars of the House of Saud
The Al Sauds have survived by making three compacts: with the Wahhabis to burnish their Islamic credentials as the custodians of the holy places of Mecca and Medina; with the population by providing munificence in exchange for acquiescence to absolutist rule; and with America to defend Saudi Arabia in exchange for stability in oil markets.
But all three of these covenants are fraying. America is semi-detached from the Middle East. The plummeting price of oil, which provides almost all of the government’s revenues, means the old economic model can no longer sustain the swelling and unproductive population. And the alliance with obscurantists brings threats, because they provide intellectual sustenance to jihadists, and form an obstacle even to modest social reforms that must be part of any attempt to wean the country off oil and create a more productive economy.
Not surprisingly, Saudi Arabia’s many critics have dusted off their obituaries of the House of Saud. But for Prince Muhammad the lesson of the Arab spring, and of history, is that regimes that lack deep roots are doomed to be swept away; by implication the Al Sauds are here to stay.
Yet he knows that change must come, and fast. He has injected new energy into government, and is taking huge gambles. What he lacks in experience and foreign travel, he compensates for with confidence, focus and a battery of consultants’ reports. He reels off numbers and policies with ease, pausing only to take a call from John Kerry, America’s secretary of state. He speaks in the first person, as if he were already king even though he is only second in line. Over five hours King Salman is mentioned once; his cousin, the crown prince, Muhammad bin Nayef, does not figure at all, though he is in charge of internal security and may be biding his time.Prince Muhammad’s most dramatic moves may be at home. He seems determined to use the collapse in the price of oil, from $115 a barrel in 2014 to below $35, to enact radical economic reforms. This begins with fiscal retrenchment. Even after initial budget cuts last year, Saudi Arabia recorded a whopping budget deficit of 15% of GDP. Its pile of foreign reserves has fallen by $100 billion, to $650 billion. Even with its minimal debt of 5% of GDP, Saudi Arabia’s public finances are unsustainable for more than a few years (see chart).
SAUDI ARABIA is thinking about listing shares in Saudi Aramco, the state-owned company that is the world’s biggest oil producer and almost certainly the world’s most valuable company. Muhammad bin Salman, the kingdom’s deputy crown prince and power behind the throne of his father, King Salman, has told The Economist that a decision will be taken in the next few months. “Personally I’m enthusiastic about this step,” he said. “I believe it is in the interest of the Saudi market, and it is in the interest of Aramco.”
Here’s how that list has performed since we pulled it on Jan. 5:
|Company||Ticker||Industry||Total return - Jan. 5, 2015 through Dec. 18, 2015||Total return - 2014|
|Freeport-McMoRan Inc,||FCX, -9.08%||Precious Metals||-71%||-36%|
|Nabors Industries Ltd.||B, -3.60%NBR, -6.68%||Contract Drilling||-33%||-23%|
|QEP Resources Inc.||QEP, -4.40%||Oil and Gas Production||-37%||-34%|
|Range Resources Corp.||RRC, +0.29%||Oil and Gas Production||-59%||-36%|
|EQT Corp.||EQT, +4.72%||Oil and Gas Production||-33%||-16%|
|Noble Energy Inc.||NBL, -2.52%||Oil and Gas Production||-26%||-30%|
|Wynn Resorts Ltd.||WYNN,-9.41%||Casinos/ Gaming||-55%||-21%|
|Newfield Exploration Co.||NFX, -2.10%||Oil and Gas Production||27%||10%|
|Williams Cos. Inc.||WMB,-10.00%||Oil and Gas Pipelines||-47%||21%|
|Quanta Services Inc.||PWR, -2.67%||Engineering and Construction||-28%||-10%|
|Security Name||Last||Days to Cover|
|Athabasca Oil Corporation||1.05||30.12|
|Copper Mountain Mining Corporation||0.29||21.97|
|Crew Energy Inc.||2.92||20.47|
|CARBO Ceramics Inc.||15.87||17.26|
|Energy XXI Ltd||1.02||15.23|
|Cliffs Natural Resources Inc.||1.83||14.64|
|Delphi Energy Corp.||0.58||14.08|
|Coeur Mining, Inc.||2.38||10.64|
|Fortress Paper Ltd. Class A||3.35||10.52|
|Comstock Resources, Inc.||1.51||9.87|
|Cloud Peak Energy Inc.||1.98||9.82|
|Chesapeake Energy Corporation||4.68||9.46|
|Peabody Energy Corporation||7.34||8.84|
|AK Steel Holding Corporation||2.52||8.06|
|Alacer Gold Corp.||1.9||7.91|
|Goodrich Petroleum Corporation||0.26||7.8|
|C&J Energy Services Ltd.||4.09||7.7|
|Canadian Oil Sands Limited||5.3||7.5|
|Detour Gold Corporation||10.89||7.27|
|CVR Energy, Inc.||37.73||6.74|
|Denbury Resources Inc.||1.71||6.53|
|Birchcliff Energy Ltd.||2.68||6.18|
|First Quantum Minerals Ltd.||3.38||5.59|
|Gerdau S.A. Sponsored ADR Pfd||1||5.16|
|Bill Barrett Corporation||3.69||5.01|
But equities, the vehicle most investors use to bet on energy prices, may not be as close. Consider, for example, the widely held Energy Select SPDR exchange-traded fund. Down 43% from its June 2014 peak, it fetched a similar price as recently as October 2011 and is some 50% above its recession low. In other words, a steep loss, but hardly panic territory.
Analysts at Deutsche Bank estimate that North American exploration-and-production stocks now factor in a long-term oil price of under $65 a barrel. That is low relative to the $110 hit 18 months ago, but that was in a world of seemingly insatiable emerging-market demand. Today, that is in doubt, particularly when it comes to China.
Energy stocks probably present an attractive buying opportunity since the average Brent crude price of the past decade was a little above $80 a barrel. But those with the willingness, and ability, to hang on to realize a profit must be aware that we are a long way from there—and perhaps even a good distance from the bottom.