Saudi Arabia’s energy reforms could save billions

If Saudi Arabia’s energy subsidy reforms can overcome populist opposition, the radical economic changes may save billions and offset the oil price drop

Riyadh, Saudi Arabia. The emirate's proposed energy reforms could save billions of dollars, but face strong opposition from the public 

On December 28, 2015, Saudi Arabia introduced energy subsidy reforms that were expected to save $7bn a year. Released by the Finance Ministry, the reforms, along with spending cuts aimed at raising tax revenues, marked the biggest reorganisation of the country’s economic policy for over a decade. However, Saudi Arabia’s cradle-to-grave welfare state has bred a society that is reliant on subsidies, and so, while the reforms may be necessary to stabilise the economy, they face the challenge of public opposition.

Last year the world’s top oil exporter posted a record budget deficit of $98bn – 15 percent of GDP – while the total cost of energy subsidies was estimated at $61bn. Due to a $123bn fall in oil revenues, income for the year dropped to $162bn, the lowest since the global financial crisis. Over the last decade, oil accounted for an average of 90 percent of total revenues, yet looking at last year alone, this figure dropped to 73 percent.

Public backlash

The IMF has estimated that energy subsidies have cost Saudi Arabia $107bn, an extortionate amount that is massively in need of a reduction. In the state’s budget report, energy subsidy reforms were central to reducing the pressure on the country’s economy.

According to Jadwa Investment, direct savings from the price hike on diesel are estimated at $2.75bn. Gasoline price rises are expected to save an additional $2.5bn. The rest will come from price hikes on natural gas, fuel oil and propane.

It is clear that these reforms are essential for nurturing the Saudi Arabian economy: the former Saudi petroleum ministry senior advisor, Dr Mohammed, told the BBC that they are “necessary, and not a luxury”. However, with the cradle-to-grave welfare state mind-set ingrained in the country’s economic policy, a negative popular reaction is expected to hinder the reforms. Such drastic alterations have the potential to provoke a social backlash, especially if the rulers ignore the people’s most basic requirements.

At the risk of agitating the population, King Salman nonetheless announced the first subsidy price rise in the budget, and so the price of cheap petrol increased by 40 percent overnight. It was also announced that there were more changes to come, with plans to decrease other subsidies, reduce the growth of public sector salaries and limit the country’s dependence on oil in the pipeline.

There are already people opposing the energy subsidy reforms: Saudi Arabia’s oil minister, Ali al-Naimi, disagrees with the subsidy lifts. “You only go back and take away assistance if you are in dire need. And, fortunately, Saudi Arabia is not today in such dire need”, he told a forum in Riyadh.

The reforms may have a substantial impact on the population’s wellbeing, and will therefore likely prove unpopular, but the state has set in place other measures so that residents are not left in financial jeopardy. According to the Financial Times, a senior official said that the government plans to extend welfare payments, such as unemployment benefits, so that the country’s poor and middle-classes are not as largely affected by the subsidy cut. He also said that businesses affected by the rise in expenses would be offered cheap loans in order to lessen the impact.

Leading the rest of the region

If the economic improvements outweigh the social repercussions of the energy subsidy reforms, it could potentially create a knock-on effect throughout the rest of the Gulf region. In a press release in November, Christine Lagarde recommended a course of action for the GCC on how to move beyond the oil drop, saying that “the main elements are common across countries: an expansion of non-oil tax revenues; raising energy prices which are still well below international norms; firm control of current spending, particularly on public sector wages; and a review of capital expenditures. Reforms to strengthen the fiscal frameworks would support these consolidation efforts.” The IMF stated that it expects the Arabian Gulf states to move faster on spending cuts rather than introducing taxes in the face of massive budget deficits.

Kuwait has shown its intentions to proceed with subsidy cuts. But as the state also has a large population that is dependent on government support and subsidies, the reforms face the same social obstacles as those in Saudi Arabia.

With oil accounting for more than 90 percent of Kuwaiti revenues, the Kuwaiti leader, Sheikh Sabah al-Ahmad Al-Sabah, called for “urgent measures”, one of which was to adopt economic reforms. Last September he said, “The decline in global oil prices has caused state revenues to drop by around 60 percent while spending remained without any reduction, leading to a huge deficit”. He added, “I also call on every citizen to realise the importance and usefulness of these reforms.”

However, these reforms are easier said than done: Kuwait already attempted to lift energy subsidies last year, on both kerosene and aviation, and both came up against a public backlash. Strikes occurred, and the government began making exemptions for particular groups. As such, further spending cuts to electricity, water and petrol subsidies could create further agitation among the Kuwaiti population.

There is no doubt that to alleviate the pressure of the oil drop, spending on energy subsidies needs to be significantly reduced, yet implementing these reforms without consequence for the population at large is unlikely. The process needs to be handled carefully. The UAE this year managed to lift subsidies on petrol with no public backlash, if Saudi Arabia can do the same, then the rest of the Gulf region may follow.