While this set of reasoning should be enough to dissuade any Middle Eastern power from taking such steps, the real risk is not in a political embargo of the sort experienced by the world in 1973. Despite the fact that global oil policy has long been animated by the specter of another such embargo, Middle Eastern producers learned from the largely failed effort of 1973 that such moves did not easily translate into political influence; the Arab producers of OPEC were not only unable to drive Israel from the occupied territories, but the world plunged into a period of stagnation that was bad for producers and consumers alike.
The greater risk to the global economy in a continuous, very low price scenario is that global production becomes ever more concentrated in the most volatile region of the world: the Middle East. In this circumstance, any number of wars, terrorist attacks, or collapsed states could send the global economy reeling. Until and unless tight oil production becomes truly a global phenomenon and significantly dilutes the influence of the Middle East on global markets, this scenario remains an all too real global risk.
An Invitation to Reform
In 2006, seized with enthusiasm for a blossoming idea over lunch, journalist Tom Friedman grabbed a napkin and drew two lines on a graph, one a sharp mountain shape and the other the mirror image of it. The lines intersected on the far left and far right, forming a diamond. On the vertical axis was notionally the price of oil, with some index of political freedom on the horizontal. Later dubbing his theory “The First Law of Petropolitics,” Friedman proposed an inverse relationship between political freedom and the price of oil. Pointing out that Bahrain is both the first Arab Gulf state to be running out of oil and the first to hold a free and fair election where women could run for office as well as vote, Friedman deduced, “I don’t think that’s an accident.” Although Friedman came under a barrage of criticism for his methodology, history could well favor his theory. The problem is, if it does, neither Friedman nor many of us may be alive to give him credit. As the years since the first hopeful protests dislodged authoritarian rulers in North Africa demonstrated, the road to greater political liberalization will be long and fraught with potholes.
Figure 11.2: Tom Friedman’s First Law of Petropolitics
Source: Thomas L. Friedman, “The First Law of Petropolitics,” Foreign Policy 154, no. 3 (2006), 29.
Whether Friedman was conscious of this or not, the first part of his logic lies in the comprehensively researched and debated idea known as the “resource curse”: countries whose economies are heavily reliant on natural resources tend to grow more slowly and to be less democratic than those whose economies are not. Despite some recent improvements, Nigeria was long held up as the poster child of the resource curse. Even though it was the thirteenth largest oil producer in the world in 2012, more than half of its population lived below the poverty line. But the phenomenon of the resource curse is not only about corruption. Resource wealth is also believed to shape the nature of the political system, lending itself to governments that are less responsive to their people (particularly given that they often do not pay taxes) and have invested heavily in repressive institutions. Friedman’s theory builds on this idea by positing that when faced with lower revenues, the ruling classes of resource-rich countries cannot maintain the systems that have kept them in power.
Given the political upheaval already experienced by the Arab republics—Tunisia, Egypt, Libya, Iraq, and Syria—the obvious place on which to test the validity of this theory is the single part of the region that has thus far escaped the roil of popular uprisings: the Gulf monarchies of Saudi Arabia and, to a lesser extent, the United Arab Emirates, Qatar, Kuwait, Oman, and Bahrain. Will the kings, emirs, and sultans of the Middle East be able to keep their thrones in the face of the new energy abundance? Or, will the new energy abundance combine with other factors to deliver a new wave of Arab revolutions to the Gulf?
The challenge to existing regimes is greater than it might first appear. In the past, the Gulf states largely needed to manage a price cycle whose details were unclear, but whose broad contours were well known. In the early 1980s, they endured years of low oil prices, and were forced to exhaust their reserves, to resort to debt, and—in the case of Saudi Arabia in 1986—to repeatedly delay the passage of new budgets. But the familiar cadence of rising and falling prices helped these monarchies preserve their power. Lean periods were tough, but they were inevitably followed by fat ones. The new energy abundance, however, is changing this customary cycle. Gulf producers must now think beyond weathering a few months or years of a low oil price. If lower prices are the new normal, these governments must wrestle with the much more difficult challenge of adapting to lower revenues over the long haul.
Moreover, two revolutions are tougher to survive than one. The challenge of managing the effects of the new energy boom have been greatly compounded by the complex political, security, and demographic problems facing the region and the ways in which many regimes initially chose to deal with them.
From their palaces across the desert kingdom, the Saudi royal family watched the events occurring in Egypt, Tunisia, and Libya with alarm. In response, the Saudi government increased its arrest of dissidents and cracked down on suspected instigators of political unrest. But its immediate hallmark reaction to the Arab revolutions in the region was notably softer. On February 23, 2011, less than two weeks after Egyptian president Hosni Mubarak was forced from power by a popular uprising, the Saudi regime announced new pay hikes, bonuses, new housing projects, and other spending for the population; the total price of these perks soon reached $130 billion.
Although this massive expenditure was ostensibly to celebrate King Abdullah’s return from the hospital, the lavish outlay had the desired effect. Many Saudis, long citing the disarray the Iraqis experienced in their quest for democracy, focused on enjoying their new wealth, rather than on organizing against the regime that provided it. Such handouts were not the first of their kind, nor the last. Shortly after acceding to the throne in early 2015, King Salman bin Abdulaziz Al Saud showered his citizens with grants, gifts, and bonuses in a giveaway that one economist anticipated will cost more than $32 billion, an amount equal to the annual budget of Nigeria or the amount the United States spends each year on medical research through the National Institutes of Health. Appreciative Saudis created a new Arabic Twitter feed, #two_salaries, to share how they were spending the two months’ extra salary the new king had sent their way. Some Saudi men declared the largesse would enable them to take a second, third, or fourth wife, while others paid off loans or planned holidays abroad.
Such financial benevolence is part of a broader arrangement that has underpinned the stability of the Gulf monarchies since their establishment. These regimes have sustained elaborate, if unwritten, agreements with their populations. The rulers provide economic prosperity, physical security, public services, and comfortable government jobs for their citizens, without the undue burden of taxes. In exchange, the people consent to be governed with little or no say in the system, relying instead on the goodwill and judgment of their rulers. Those objecting to this contract can expect harsh treatment. The particulars of these arrangements vary significantly from country to country to reflect different histories, institutions, and peoples; Kuwait has a vibrant parliament wielding actual power, while Saudi Arabia has no elected representative body with real authority. The general idea, however, is similar. The generosity and durability of these compacts was a major factor in explaining the ability of the monarchs to survive, relatively unscathed, the Arab political revolutions that unseated their republican counterparts.
Maintaining these ever-expensive social contracts in the face of declining revenues is the real challenge facing the Gulf monarchies. Young, growing populations and ever more generous benefits have strained budgets. The yawning gap between the “fiscal breakeven price”—which refers to the price of oil at which a country is able to fund its internal budgetary commitments—and the actual price of oil in l
ate 2014 was one indication of the dire straits in which royal families found themselves. In Saudi Arabia, the breakeven price nearly tripled in five years alone, shortly before the price of oil began to drop. At the end of 2014, soon after the oil price began to plunge, everyone from talk show hosts to IMF economists noted that breakeven prices for virtually all the Gulf monarchies (as well as the constitutional republics) exceeded the actual price of oil. Saudi Arabia, Bahrain, and Oman needed oil close to $100 to meet their fiscal needs. In late 2014, only Kuwait seemed on track to balance its budget.
These numbers conjured up memories of the low oil price of the 1980s and the collapse of the Soviet Union, or the days of $10 barrels of oil and the 1990s rise of Hugo Chávez in Venezuela. These historical examples might lead one to predict dark days for many Gulf producers.
Yet the Gulf countries proved resilient, at least in the short and medium term, for several reasons. First, the extreme wealth of these countries provided them with immediate shock absorbers. In 2014, Saudi Arabia, for example, had financial reserves equivalent to its entire 2013 GDP—or the total amount estimated at the time by the United Nations needed to rebuild war-torn Syria, Iraq, and Gaza. Put differently, Saudi Arabia had enough money in its reserves to fund three years of spending at 2014 levels without drawing on any other source or accruing any further revenues. The reserves of the emirates of Abu Dhabi and Dubai were even more impressive, totaling nearly a trillion dollars, or roughly twice the annual U.S. defense budget or four times what it would cost to buy all American professional sports teams. For a small country with more expatriates than citizens, Kuwait’s financial reserves amounted to approximately $150,000 per person or nearly half a million per citizen. Even the few nations that did confront immediate fiscal dangers—such as Bahrain and Oman—still had the option to raise debt.
In the twelve months after the oil price began to falter in 2014, all of these countries cut their budgets. Big capital projects were targeted first, allowing countries to reduce their breakeven point without touching spending on social contracts. In the three months between October 2014 and January 2015, Saudi Arabia—like many other Middle Eastern countries—revisited its budget and effectively slashed its breakeven price from $102 to $87 by the estimates of the IMF. Bahrain, Kuwait, Oman, and to some extent the UAE, did much the same thing.
Such measures, however, did not seem adequate to allow all of the Gulf states to maintain their social contracts over the long run. Bringing down fiscal breakeven prices from $107 to $87 is easy to do when fat can be cut. But getting down from $87 to a more realistic $70 or even $60 will prove much harder in the face of growing demands and the continued political imperative to defend—and even sweeten—the social contract.
Saudi Arabia: A Giant Learns New Tricks
Of all the Gulf monarchies, Saudi Arabia will find this adjustment the most difficult. Behind Saudi Arabia’s staggering reserves lurk warning signs about the fiscal future of the kingdom. While Saudi financial reserves are abundant, they have been drained rapidly by the combination of high spending in 2014 and early 2015 and low oil prices. From 2014 to the end of 2016, Saudi financial reserves decreased by more than a quarter, or $200 billion. In addition, Saudi Arabia needs to be cognizant of its growing population. At more than thirty million people, the number of inhabitants in the desert kingdom far outweighs the tiny populations of Kuwait, Qatar, and Bahrain, and still dwarfs that of the UAE, which has fewer than ten million people.
Moreover, unlike other Gulf countries, Saudi Arabia faces significant demographic pressures. Birth rates in the kingdom have begun to decline, but in the thirty years before 2010, the population grew by three times the global average, or by 180 percent. As a result, a surge of young people born in previous decades is now testing the ability of the Saudi state to provide health care, education, and jobs. Such demographic growth would be viewed favorably in many societies seeking growth, from Japan to Italy. But in Saudi Arabia, where almost three-quarters of those employed work for the public sector and where no taxes are levied on income, this demographic explosion portends more burden than boom. More than a quarter of a million young people enter the work force in Saudi Arabia every year. In 2012, a report by Alkhabeer Capital, an asset management and investment bank firm based in Jeddah, claimed that 27 percent of Saudi youth and 78 percent of university graduates were unemployed. Providing health care and education for Saudis each year already takes up a whopping 44 percent of the government’s budget.
Low oil prices are not the only worry. The kingdom’s finances are also under pressure from the growing domestic energy demand that is eating away at the volume of oil Saudi Arabia can export. In 2015, gasoline was just 45 cents a gallon. It has been heavily subsidized, as have other forms of energy. In 2013, electricity prices were roughly one-fourth the average paid in OECD countries. As a result, domestic demand for energy soared; demand for electricity—more than half of which is generated inefficiently from burning fuel oil or diesel—was growing at 7.5 percent a year in 2014. In 2009, overall Saudi energy demand required the domestic use of 3.4 million barrels of oil-equivalent a day. Extrapolating that year’s demand growth rates forward, in 2010 Khalid al-Falih, the then-CEO of Saudi Aramco, warned that by 2028 Saudi Arabia might need to divert nearly a third of current crude oil production away from exports to satisfy domestic demand. This would place a major squeeze on government revenues at a time when the Saudi social contract was getting more and more expensive to sustain.
Finally, the kingdom’s finances are even further strained by the responsibilities of being a regional leader. Given the growing insecurity in the region, Saudi Arabia would be wise to anticipate continued—even larger—handouts to friendly regional governments in order to stabilize them. Aid to Bahrain, Egypt, Jordan, Oman, Yemen, Palestine, Morocco, Sudan, and Djibouti reportedly cost the Saudi government nearly $23 billion from 2011 to 2014. Moreover, during a visit of Saudi King Salman to Egypt in late 2016, the kingdom agreed to supply Egypt with 700,000 tons of refined petroleum products each month for five years on favorable terms, a deal also valued at $23 billion. Expensive, but a Saudi investment in regional stability.
Amidst such staggering simultaneous economic and political challenges, some positive developments have emerged. Rather than simply hoping for a revival in oil prices to spare them tough choices, many governments in the Gulf have embarked on programs of economic reform. As mentioned, they initially focused on cutting the less politically sensitive capital projects. But eventually they were forced to revise some of the privileges their citizens have long enjoyed. Kuwait, Saudi Arabia, and the UAE scaled back generous fuel subsidies in place for generations. Some Gulf states have begun requiring their inhabitants to pay for water, in a major departure from past practices. The countries of the Gulf Cooperation Council are deliberating whether to impose a region-wide value-added tax and a corporation tax.
Of all the Gulf states, Saudi Arabia launched the most ambitious reform efforts, partially out of necessity and partially due to the emergence of a new, young crown prince, Mohammed bin Salman—or MbS as he is called for short by many. The favorite son of the elderly and possibly ailing king, MbS has emerged as the most powerful prince his age since President Roosevelt’s counterpart and the kingdom’s founder, King Abdulaziz Al Saud, Ibn Saud, according to longtime expert on Saudi Arabia Karen House.
Since his father inherited the throne in January 2015, MbS has assumed the positions of crown prince, deputy prime minister, minister of defense, chairman of the council for economic and development affairs, and the head of Saudi Aramco. In short, he holds the reins for the defense, economic well-being, and oil policy of the kingdom. At thirty-one years of age, MbS has been viewed by many in the royal family as too young and too brash to be in charge of the kingdom, particularly at such a precarious time. But his energy and his willingness to work hard and hold people accountable have been welcomed by others, especially Saudis tired of a ruling class that seemed to do little, yet rea
p so much of the country’s wealth.
MbS has anchored his own personal ambitions to become king to the development and execution of Saudi Vision 2030, a national plan to move the kingdom away from its dependence on oil to a modern, diversified economy. While the document is filled with quirky, seemingly peripheral goals—such as getting Saudis to exercise more—at its core is a bold economic transformation. It invokes familiar prescriptions, such as increasing foreign investment, better utilizing female Saudi labor, privatizing much business done by the government, and incentivizing Saudis to spend their disposable income in the kingdom, rather than in neighboring Dubai or Bahrain. But the plan also extends to the controversial, including an initial public offering of part of Saudi Aramco, the country’s massive oil company. The proceeds will provide added capital to a revamped Public Investment Fund, which is envisioned to eventually contain $2 trillion and generate a nonoil source of income for the kingdom similar to the sovereign wealth funds of other Gulf countries. When he was still deputy crown prince, the young prince declared that by 2020 Saudi Arabia will no longer be dependent on oil.
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