Saudi Arabian Economics and the Energy Business: Oil and Gas

The recent history of the region is closely tied up with the invention of the combustion engine and the growth in the demand for oil.  The future direction of the oil price is likely to have a key impact on the future activities in the country.  Estimates over what will happen to the oil price vary enormously, and some are politically loaded.  Lowest estimates for the future price of oil might be in the long term are around 20 dollars a barrel.  Higher estimates go up to 60 dollars a barrel.  The current OPEC target range is 22-28 dollars a barrel.  The following graph shows some of the possible future paths, plus the history since 1970.

Oil exploration in Canada, Russia, South America and the Middle East, together with global politics are likely to impact on the price.  There are a number of research organisations currently trying to understand and predict the price of oil in the future.  No doubt, US military and political intervention in Iraq , and potentially in Syria and Iran will change the factors affecting the oil price.  It might lead to a disruption or expansion in oil supplies: at this point in time it is difficult to tell.

Oil has brought much wealth to the region, but it has also brought a lot of strife. Let us hope that peace will reign in the future.

In terms of reserves of world oil, it appears that Saudi Arabia has approximately 25% of the share, which is in excess of the current sales share.

In understanding the direction of the oil price, one needs to appreciate the factors driving the price.

DEMAND FACTORS
As a scare resource, the price reflects the high demand for the commodity. If alternative technology can drive cars and warm and cool our homes, then demand for oil will drop.

SUPPLY FACTORS - COST OF EXTRACTION
Although it is quite cheap to produce oil in Saudi Arabia, in many places oil extraction is a very expensive process. In addition, it needs to be considered that the quantity of available oil is to some extent dependent on the price of the commodity. At a high price, more money will be spent on oil extraction in areas where it is expensive to extract the oil.

SUPPLY FACTORS - QUANTITY OF SUPPLY
Political instability tends to drive the price of oil upwards.

ASSET INVESTMENT VALUE
"Hotelling's Rule" may be instructive here - a rule of thumb that says that a finite resource will increase in price by the same as the interest rate. If this were true, the oil price would have increased over time. Since the 1930s, the oil price has increased, although, since 1980 the price has not increased. This could be due to either an artificially high price in 1980, or an artificially deflated one now. Alternatively, it could be due to greater quantities of oil supplies found, or a reduction in demand.

COMPETITION FACTORS
Technological developments are decreasing the reliance on oil, however it remains a very useful substance - millions of years of processing went into creating the stuff, it is relatively simple to pull it out.

Dynamic effects of changes in the price of oil

Effects in the price of oil have a complex effect on the world economy. First of all it should be noted that much of the industry is relatively unaffected by direct effects.

Direct effects

Assuming a constant demand, the direct effect represents a change in the distribution of income from industrious non-oil economies to industrious oil economies. A typical example of a country that gets penalised heavily for oil price rises is Japan which has no natural oil. The USA is able to supply half of its own oil requirements and so is less affected by oil supplies. Saudi Arabia produces much more than it can use and therefore benefits enormously from rises in the oil price.

Indirect effects

Surpluses in the economies of oil producing nations get partially re-invested back into the economies of countries like Japan and the USA via the stock market. Hence when the oil price rises, although there is a wealth reduction in oil-user countries, additional wealth is made available through the boom to the capital markets and the lowering of the interest rate. So as more expenditure is required on energy costs, so less is required on interest repayments.

High Oil Price: The Big losers

Apart from oil-user countries, the biggest losers are those people who benefit from a high interest rate, low energy cost economy, which tends to be investors/people living on the fruits of their investments.

Expatriate Labour

The economy of Saudi Arabia still relies very heavily on expatriate labour. Historically, this has been due to two key factors, firstly the incredible wealth generated by the oil revenues, secondly because of the need to upskill very rapidly, an attempt has been made to buy in expertise from abroad to advance the productivity of industry to the maximum. The majority of expatriate labour comes from poorer countries like Pakistan, Bangladesh, Sri Lanka and India. On the highways you can see old yellow American school buses ferrying workers between sites. A Pakistani might be employed as a taxi driver. He will sign a contract for several years. At the end of 2 years he will have an extended holiday back to his home country. Wage rates in the Kingdom are so much higher than in the home countries that workers in Saudi and the other middle eastern states will put up with difficult work conditions.

Employment

The high birth rate has led to a surplus of Saudi workers in comparison to the job opportunities. This has led fairly recently to high unemployment. This is something the government is trying to deal with by amending the labour laws of the country. For example, it is becoming increasingly difficult and or expensive to use expatriate labour for certain types of jobs. Some job categories can no longer be used to justify importing labour. The other method in which influence is being exerted by the government is to apply a quota system: requiring organisations to employ a maximum percentage of foreign nationals.

Home Benefits

There are enormous benefits in being a Saudi, healthcare is free, education is free, although advanced education is limited in provision, and there are no taxes. It should be pointed out that petrol really is very cheap, about 1 riyal for a litre, which is 25 US cents of 16 British pence.