Domestic Oil Subsidization Impact on the Saudi Economy

Domestic Oil Subsidization Impact on the Saudi Economy

4/30/2012

King Saud University

Motaz Alturayef

Table of Contents

1. Introduction 2

2. Current Consumption Trend 2

Population Growth 2

Oil Consumption 3

Water 4

3. Effects of Low Energy Prices 5

Increased burden on Government 5

How Can we be and Oil Independent Country 8

4. Conclusion 10

1. Introduction

Saudi Arabia the largest oil producer in the work is facing economic challenges due to the increasing domestic consumption trends. The consumption trend is attributed to three factors: population, standard of living and efficiency of the economy. Saudi's oil extreme dependence on oil revenue, about 90% of total GDP, has a great negative long term economic effects.

I this paper we will look at the reasons behind this catastrophic trend. We shed some light of the impact of subsidizing oil for the local consumption. In this regard we look at the cultural impact, environmental impact. Then possible improvements for the Saudi economy will be discussed.

2. Current Consumption Trend

Population Growth

On the of the main factors contributing to the high domestic growth in the oil consumption is population growth. Population achieved 19% growth from 2000 to 2010. One thing to notice is that year over year growth is declining which is good for the future of Saudi Arabia and will help easy the pressure on the growing domestic oil consumption.

Figure.1

Oil Consumption

Due the subsidization the oil consumption in Saudi Arabia is increasing at an uncontrolled dangerous way. Saudi Arabia is consuming 2.3Mb/day which accounts for about 25% of total production. This is %50 higher than its consumption in year 2000. From the preceding numbers one can see that enrgey consumption is increasing as rate more than population. This is due the high consumption culture that has been built over the years because of the subsidy of the Electricity, water, and gas fuel. The below figure shows the Saudi Oil production, export and consumption.

Figure.2

The below graph (Figure.3) show the oil consumption per person per year, this is useful to assess how wore off relative to other countries. You can notice that Saudi consumption is hiting about 40 bbl/person/year and word average is about 5 bbl/person/year. The second highest in the graph is united states siting at about 22 bbl/person/year. However, the USA does not have an increasing trend like the case in Saudi. So it is clear that the domestic consumption can be reduced to almost half if its current state.

Figure.3 Source : http://2ndgreenrevolution.com

In 2009 Saudi Arabia peak consumption reach about 2.4mbbl/day and with current consumption growth of about 7% this number is expected to reach about 8mbbl/day. Currently local consumption is accounting for 25% of total production, which cost the government about 165 billion SR to subsidized. The oil subsidy is about 16% of the Saudi total GDP in 2011.

Water

Providing fresh water to Saudi's millions is a very high priority in their desert environment. To date, 27 desalination plants operate throughout the country, which provide 70% of the nation's potable water along with 28 thousand megawatts of electricity from Integrated Water and Power Plants (IWPP). Unfortunately, this currently requires burning approximately 1.5 million barrels per day of crude oil.

3. Effects of Low Energy Prices

Increased burden on Government

As discussed earlier about 16% of the government GDP is spent on subsidizing to be used for distilling water, electricity power plants, automobile fuel. As the population grows the government oil subsidy will increase sharply. Notice that, assuming current oil production, when local consumption reaches about 5m bbl/day Saudi Arabia will only have 5m bbl/day to export. At this level of local consumption Saudi Arabia will not be able to support subsidizing oil anymore and will start running on deficit. The below supply-demand graph show effect of subsidy on the quantity consumed and the ever growing government subsidy. The shaded area show how much the government is paying just to subsidize energy in Saudi Arabia. One Can notice that they are even paying above the equilibrium price. This is causing a deadweight loss that has negative overall social welfare.

And of course, the Saudi population is growing as illustrated before, which will increase the demand for energy. This increase in demand will force the government to increase their subsidy in order to keep the energy prices at their current level. This shown the below graph:

The increasing pressure poses huge challenge on the government of how to approach/avoid this upcoming crisis. The Saudi citizens think of the subsidized oil as a birth right. In addition to that, the current Arab Spring makes it even more difficult for them to make any price or policy changes to lower the pace of consumption.

The easy money that Saudi Arabia is earning from exporting oil lead the Saudi government to neglect investing in people and sustainable industrialized society. Every five years the Saudi government have a 5 years development plan, and in each plan one of its main goal is to diversify the Saudi exports. However, no signs of improvements are observed since non-oil exports account for less that 10%. In recent years with the high oil prices Saudi Arabia is running surplus and as result the government is increasing it expenditure on the infrastructure.

Before we discuss possible scenarios to build sustainable economy that is non-oil dependent and could compete in the global market with differentiated products and services, I would like to discuss the