Saudi Economy 2.0 versus OPEC 2.0

SAUDI Arabia this week unveiled its ambitious plan to use its sovereign wealth fund, the Public Investment Fund (PIF), to move the economy away from oil. The plan is the start of what the government coined as the Saudi Economy 2.0. Themes such as digitalization, urban development, investments in smart technology and clean energy are what Saudi Arabia will focus on under the new plan and these new areas are where the PIF will invest after it gets the proceeds from the sale of Saudi Aramco shares that will happen very likely in the second half of next year.

However, as Saudi Arabia tries to move away from oil, many of its fellow OPEC members are still clinging to the petrodollars.

This is not to say that Saudi Arabia or any other oil-producing nation will totally abandon oil, but the game now is how to make oil one of many sources of income and not the only source, as was the case for many years.

OPEC’s addiction to oil is a problem that will endure for some time. Saudi Arabia is trying to break away from this addiction, as Crown Prince Mohammed bin Salman said in April 2016.

The addiction of OPEC can be easily seen in the level of high break-even oil prices needed to balance the fiscal budgets in the member countries of the organization.

Nigeria, the largest oil producer in Western Africa, needs oil prices at $139 per barrel for it to balance its fiscal budget in 2017, according to estimates by Fitch Ratings.

Brent oil prices are fluctuating between $55 and $58 even with the current efforts made by OPEC and non-OPEC producers.

Angola, another OPEC member, needs oil at $82 to break even. Iraq would need $62 while Saudi Arabia needs a price of $74 a barrel to balance its fiscal budget this year, said Fitch. Only Kuwait and Qatar can break even with oil prices below $60. Even non-OPEC producers who are part of the agreement need higher oil prices to avoid seeing deficits this year.

Russia needs $72, Oman needs $75, Kazakhstan $71, and Azerbaijan needs $66 to break even, according to Fitch.

Oil prices may not stay higher for long though. Citibank expects oil prices to remain between $40 and $60 over the coming decade.

This means that balancing fiscal budgets may become a difficult goal to achieve even if producers maintain their production cuts for an extended period.

Keeping oil prices at above $60 for a longer period could be a “self-defeating” policy for OPEC and its allies. Surely, other producers in the world will start to have more funds to invest in bringing more crude to the market and with prices at $60, the profitability of many producers will improve.

The main risk to prices might come from high-cost producers who can flood the market over the coming two years with the right prices even as demand will keep increasing by healthy rates of 1.2 to 1.4 million barrels a day.

Some can argue that oil at $60 won’t help to bring back the investments to the oil industry at the same rate as three to four years ago when oil prices averaged around $100. And even with $60 a barrel, some argued that only shale oil producers can bring production online fast enough to meet an increase in prices and demand while other conventional producers may need years to respond to prices and demand.

OPEC and its allies enjoy a low cost of development for their crude compared to others elsewhere as they produce conventional crude. Yet the problem is that to develop a conventional oil field might take two to three years at least between discovering a find, drilling, exploring, connecting the wells, and building facilities to process the crude.

Therefore, by the time conventional producers take a decision to invest and the time their crude hits the market, many things can happen. So the market can go up or down.

Due to uncertainty over demand for crude oil, many big producers might be worried about committing themselves to projects that can take three to five years to be completed and this would result in higher oil prices in the future.

This might sound like good news for OPEC and other oil producers, but it is better to plan for the worst and expect the best.

For this reason, moving away from oil and gearing up for the future is important. Initiatives like Saudi Economy 2.0 and Saudi Vision 2030 are steps in the right direction. However, moving away too much from oil is another problem. Consumers must help producers by showing interest in oil to make them feel secure about their investments.

And producers must diversify away from oil but at the same time keep the flow of investments going.

The need for OPEC to diversify income might not be pressing over the next three years, but OPEC needs to keep in mind that “by failing to prepare, we are preparing to fail,” as Benjamin Franklin once said.

Wael Mahdi is an energy reporter specializing on OPEC and a co-author of “OPEC in a Shale Oil World: Where to Next?” He can be reached on Twitter @waelmahdi

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