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How will Saudis adapt to low oil prices?

Saudi Arabia will have to rely on its reserves and cut its projects and other aid to cope with falling oil prices, a tall task for a rentier state.
An employee fills a container with diesel at a gas station in Riyadh December 19, 2012. Saudi Arabia could as early as next year do something it has resisted for decades: raise what is currently the world's lowest price for natural gas, in order to reduce expensive subsidies and curb energy waste. A price hike would be an important economic shift for the country but a difficult one, as it would risk hurting the competitiveness of industries such as petrochemicals. To match Analysis SAUDI-GAS/PRICE REUTERS/F

As oil prices plummet, media reports give the impression that Saudi Arabia is comfortable with the situation. The International Monetary Fund (IMF) report released in October urged Gulf states, led by Saudi Arabia, to reform their economies, cut their spending and government support, create jobs in the private sector and address their domestic energy consumption. knowing that Saudi Arabia had stopped the exportation of 1 million barrels of oil during the past five years.

However, the IMF is simply ignoring the elephant in the room, exemplified by the Saudi social contract. Oil accounts for approximately 90% of the state's income, supporting the entire Saudi economy. In Saudi Arabia, the rentier state is the guarantor of political stability. Government projects constitute the backbone of the economy and ensure the income of the wealthy classes as well as well-paid jobs for low- and middle-income classes. On the other hand, the state is the ultimate arbiter of the distribution of wealth.

Low oil prices will have an impact on the Saudi economy, and the Saudis do not seem to have a way to adapt to the current situation. This is not the first time Saudi Arabia has faced low oil prices, and based on previous experiences in 1986, three policies will likely be adopted. The government will likely have to use its reserves, cut government projects and reduce public employment.

In March 1986, Saudi Arabia experienced the first oil-surplus crisis in its history as a modern state. The price of a barrel of oil reached $10, having deteriorated from $32 in November 1985. After reaching a historic high of $147 July 11, 2008, prices dropped again in January 2009 to $40. In both cases, oil lost more than 60% of its value in less than six months.

In late 1987, King Fahd bin Abdulaziz Al Saud believed that low oil prices would last and opted to reduce the rentier state services. In a budget statement, he explained that he would try to protect citizens and help them get state services despite the $10 billion budget deficit. However, gasoline, electricity, travel, visa and other government services fees gradually increased.

At the same time, government subsidies were canceled for some agricultural products and the wait-list for government housing loans increased, while the per capita income halved in a period of four years from $11,000 in 1983 to about $5,500 by 1987.

Almost a decade later in 1998, Saudi Arabia faced a new crisis of decreasing oil prices due to the Asian financial crisis, when oil prices dropped below $10 a barrel. As a result, Saudi Arabia was drowning in public debt, which exceeded 100% of its gross domestic product by the end of the 1990s. Saudi Arabia tried to reduce public spending by announcing a privatization strategy. Against the background of this crisis, then-Crown Prince Abdullah warned during a Cabinet meeting in 1998, “The time of abundance is over. … We should all get used to a lifestyle that is not totally dependent on the state.” Each time the price of oil falls, the Saudi public recalls King Abdullah's famous austerity policy of the 1990s.

During the 2009 crisis, the Saudi state reduced hiring for public jobs, from 9.5% of the total number of hires to 2.7%, while the annual raises for Aramco employees, for instance, decreased dramatically — by 35%. During the same year, government projects were 25% fewer than the following year, which had witnessed an upswing in oil prices. While the 2009 experience directly influenced projects and employment, it did not affect the rentier state services, as had happened in the 1980s.

The separation of Saudi public opinion from oil prices and revenues is one of the consequences of the Saudi social contract. Aramco, the only oil company in the country, ever since its inception 80 years ago has worked in isolation from the local community. I speak from personal experience, having worked for several years in a gas plant affiliated with the company. The plant produces 310,000 barrels of gas liquids per day, and none of the workers know who the ultimate consumers are or how much the value of the product is. Both the company's staff and the rest of Saudi society are unaware and uncertain about the oil policy.

Following the Arab Spring, to allay concerns that the unrest would spread to the kingdom, Saudi Arabia spent $250 billion annually to support the welfare state, with 15% of government expenditure going to the private sector through government projects. The major share of the spending is in salaries for 2 million employees working under the government umbrella, directly or indirectly. Programs for the support of the unemployed and the provision of housing for citizens have allocated hundreds of billions of dollars from the Saudi budgets of the last three years.

At the same time, and due to security concerns caused by the Arab Spring, government spending rose in the military and security sectors. The famous royal statement issued in March 2011 included the creation of 60,000 new security jobs. The Facilities Security Force, established to protect civil and industrial establishments in the country, is one of the fastest growing sectors in the Interior Ministry. According to the Stockholm International Peace Research Institute, Saudi Arabia's military spending jumped to fourth place after the United States, China and Russia, respectively, at $67 billion in 2013. Moreover, due to the Arab Spring, Saudi Arabia has expanded that spending through its political commitment to supporting Gulf unity, providing grants to Bahrain and Oman and supporting stability and development in the region through financial aid for the regimes in Egypt, Lebanon, Jordan, Morocco, Yemen, Pakistan and the Syrian opposition.

These large expenditures, sustained by oil prices above $100 a barrel, are no longer possible. Cuts will be needed, and unless managed properly to avoid exasperating local citizens in a region mired in conflict and multiple threats to Saudi national security, the price plunge could backfire on Saudi leaders.

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