21 01 2016

Will the Absolute Monarchy of the House of Saud survive?

The Middle East has many bizarre regimes. A theocracy in democratic disguise governing Iran, an elected coup general as President of Egypt plus Sultans and Emirs of all shades. And then the most bizarre of all: the Absolute Monarchy of the House of Saud in Saudi Arabia. A medieval absolute Kingdom armed to the teeth with sophisticated weaponry and until recently awash with cash. Our most important ally in the region, who we support unconditionally, also when it chops off the head of its opponents, cuts off the hands of thieves and beheads women accused of sorcery. It is an absolute Kingdom and an absolute anachronism. How durable is it?

As the oil price plunges, doubt is suddenly arising regarding the durability of the Kingdom. But first a reminder: even if the oil may drop to 20 dollars for a barrel, this is not a price that can prevail in the longer term. Presently, there is too much oil on the market and nowhere to store it, so the price can in the short run fall to whatever level – even to ten or five dollars. But not for long. The price of oil will in the medium term be equal to the cost of production of the highest cost producer still on the market. And we know who they are: US shale oil, Canadian tar sands, deep water oil and oil in the Arctic. These producers are all losing money now. This is a phase called “shake-out”, where the weakest or the most inefficient will be forced to leave the market. It may take some time. But it will eventually happen, and the price will rise again. And the longer it stays low, the more it will rise.

From a production view-point, Saudi Arabia has the strongest hand. Their production cost is probably less than 10 dollars. So, as I have mentioned earlier, there is from this point of view absolutely nothing irrational about the Saudi Arabian strategy in the present price-war. All the talk about this strategy “backfiring” is wishful thinking from the US shale-oil industry. They have the weakest hand. They have no chance of surviving with a price below 60 USD.

What may backfire, however, is the strategy of the Saudi-Arabian absolute rulers to violently clamp down on all opposition at home, chopping of heads when deemed convenient, and at the same time stage wars abroad. They don't have the same cash they used to have to buy off friends and foes and to pay for their wars.

The point of departure for the Saudi economy is quite strong. The Kingdom has no external debt worth mentioning and it has big international reserves (around 630 billion dollars). But the rulers may be underestimating the problems they have at hand, and the time it will take for their strategy to play out. It made headlines when IMF a couple of months ago drily stated the rather obvious fact that with the present budget deficit (at around 20% of GDP) the Kingdom will run out of cash in five years. Now five years is a long time, and I can't see how the US shale-oil industry should be able to survive a 5-year price-war. If, as predicted, half of the shale-oil producers will go bankrupt in 2016 unless the oil price recovers, there may be a shortage of oil in end 2016, even with more Iranian oil on the market.

However, even if the Kingdom wins the price-war, prices will not go up again to the level that prevailed before it started, and in the longer term the future of oil is not rosy, as it will be squeezed by the falling prices of renewable energy (and perhaps also political action to reduce CO2 emissions). So it has to prepare for a future that is not exclusively based on oil.

The country is full of contradictions. According to the IMF, 56 % of the workforce is made up by foreign workers, and for low-skilled jobs it is 85%. At the same time unemployment is high (over 11.5%) and rising. The rulers want the foreign workers out, but the nationals don't want to take over the low-skilled works. So most of them are working for the Government in an inflated bureaucracy. The country has its name from the ruling family, the House of Saud, consisting of around 15,000 princes and other descendants from the founder, Muhammed Bin Saud, all of whom it has to keep happy with a ridiculously lavish lifestyle.

It is a rich country with a GDP per capita as Southern Europe. But it is also a high-cost country. Stupidly, or perhaps out of fear of the reaction in the population, they have refused to devalue the currency. The currency is pegged to the US dollar and its value is therefore rising, making it impossible to diversify the economy (there is a very nice graphic here). It is running an enormous budget deficit, but at the same time it is increasing the spending on the military and the internal security (as percentage of GDP, its military spending is the highest in the world: 10.4% in 2014).

What the population thinks and how it will react as some of its privileges are taken away, is everybody's guess. Any opposition is immediately jailed, so it is difficult to know. There have been rumours about disagreements within the 15,000 strong ruling family, but it is difficult to imagine it falling apart over the division of the shrinking spoils, as the risk of losing everything – even the head, literally – must be a strong argument to stick together. So, who knows.

There has been some speculations too regarding the US shifting horse in the region. It doesn't need the Saudi oil any more, so a strong strategic argument for holding hands with the Monarchs has disappeared. But Saudi Arabia is now the world's biggest arms importer, and the US is its biggest provider. So my guess is they will go on holding hands for some more time.

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Thorbjorn Waagstein

Thorbjørn Waagstein, Economist, PhD, since 1999 working as international Development Consultant in Latin America, Africa and Asia.

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