- Saudi Arabia is preparing for a post-oil era
- The Kingdom is to establish a public investment fund with $2 trillion in assets
- Shares will be offered in an IPO early in 2017
- Severe cutbacks are being made to state expenditure
- There won't be a total exit from the energy sector
By Stephen Pope
Saudi Arabia's Deputy Crown Prince Mohammed bin Salman has said that the Kingdom of Saudi Arabia
(KSA) has considered how to face a future where it is no longer so heavily reliant on oil revenues.
In its latest economic report, the central bank, Saudi Arabian Monetary Authority (SAMA) stated:
“Along with geopolitical risks, the Saudi macroeconomic outlook is subject to a key external risk of a downward pressure on global oil prices resulting from a supply-demand gap, the prospect of an economic slowdown in major emerging market economies (EME’s), and the appreciation of the US dollar. It is important to note that EME’s account for a significant portion of the global oil demand. Thus a significant and protracted slowdown in major EME’s such as China could put downward pressure on global oil prices and hence jeopardize growth prospects of Saudi Arabia."
New dawn ... the Kingdom of Saudi Arabia is preparing for a future where it is
less dependant on oil revenues. Photo: iStock
Therefore, in an attempt to get ahead of any potential crisis, the Kingdom is in the process of preparing an investment fund that will transform the state-owned Aramco oil company into an industrial conglomerate. This new strategic vision has been driven by the fact that Aramco’s balance sheet, profit and loss account, etc, is based on declining oil revenues.
With oil prices having fallen by 66.5%
since June 2014 Aramco is under pressure and KSA is undergoing an extreme belt-tightening process. The subsidies on gasoline and electricity prices are being cut and wasteful spending being eradicated from state ministry budgets.
Shares in the fund would be publicly traded with an initial public offering scheduled for early 2017 and the aim is that the fund will become the world’s largest sovereign wealth investor with the ability to acquire stakes in companies on a global basis as well as investing in liquid debt instruments and alternatives.
The IPO of shares in Aramco would be one of the biggest in corporate history even as just 5% of the company will be offered; the IPO could raise $125 billion. The rest would go to the new fund; alongside the resources of Saudi Arabian Basic Industries Corporation whose net profits in 2014 were worth $6.2 billion. Even if the reserves of Aramco were valued at just $10/barrel it would be worth $2.5 trillion.
How big is your book?
For decades, the Saudis held most of their wealth at SAMA.
In a former stage of my career I was one of many investment bankers that made several visits to the SAMA offices in Riyadh to make presentations to the then chief adviser, Bill Black, before being granted a place on the approved counter-party dealing list.
After many calls for KSA to create a separate sovereign wealth fund it has taken the fall in oil process to make it happen.
The bar chart above illustrates just how large the new fund would be when compared to better-known asset managers. Given the planned size of the fund, could the Saudis have the scope to have global excessive leverage through financial assets?
In general, the answer is not in the near term and not in reality. The most liquid market that the fund can access in terms of financial assets is still found in US Treasuries and US equities. However, we have to place the role and influence of the fund in context.
A sovereign wealth fund is really nothing more than an organisational construct that is designed to achieve certain objectives. This fund in particular is planned for national diversification and development to nurture economic stability as global preferences impact the tradition cash flows of KSA. It is a resource-based fund designed to transform physical wealth into financial wealth.
Still, the Saudis know that it is not in their interests to ever seek to gain a level of financial leverage over the US on whom they rely for large-scale defence. That simple fact will be sure to make KSA acutely aware that dollar investments are not as potent as warheads.
The Saudi government is focused on promoting economic growth and wealth sustainability. It is looking at the last 22 months and can see the trend in oil prices and so is taking proactive action so that the generations spanning the next 50 to 100 years are not living in a monoline nation with one export that is slowly falling out of favour. Of all KSA’s exports, 85.2% flows from crude oil and refined petroleum products.
This shows that the Saudis acknowledge that the path of growth over the next 50 years has to be totally different from that of the past half century. It is a testament to their foresight that there is now a shift to a reorientation of capital flows and to harness that momentum for economic development into a degree of regional leading to global political power
This huge fund will not solve all Saudi Arabia’s problems overnight or even in the medium term.
Saudi Arabia recorded a government budget deficit equal to 2.30% of GDP in 2014 and as oil prices fell throughout last year the deficit soared to SAR 367 billion or roughly $98 billion, 15.0% in 2015.
In December, it was announced that KSA would cut expenditures and raise domestic fuel prices after years of spending its oil wealth to support the local economy with subsidies. On Monday, officials said the government had been pushed by the deficit level to cut planned spending by 14% in 2016 amid expectations that income from oil sales will remain under pressure.
A side effect of cutting subsidies is that inflation has risen. Consumer prices were up
by 4.2% year-on-year in February. Photo: iStock
Unemployment has stayed above 5.5% for three years now and among Saudis aged 30 or under it averaged 29.0% last year and so the policy of “Saudi Preferences” in the job market will continue with a strict green card programme being enforced for non-nationals that wish to become resident, even on an expat basis.
Shortly after unveiling the budget for 2016, Saudi Arabia increased domestic fuel prices in a move that suggests the government is willing to adopt some difficult measures as it deals with cheap oil. One side effect of cutting subsidies is that inflation has risen. Consumer prices increased by 4.2% year-on-year in February 2016, compared with 4.3% in the previous month. Upward pressure came from: transport (up 12.7%) housing and utilities (up 8.2%) and food (up 1.3%), boosted by a hike in gasoline prices in December.
Not goodbye to oil, but no longer just a producer
KSA is never going to turn its back on oil, after all, the Kingdom still has plentiful reserves. Instead it is planning to become a broader player in the oil market by becoming the world’s biggest refiner of oil. It also intends to diversify into other areas of the energy space by developing a significant presence in mining and petrochemicals.
In January, the Kingdom formally launched a new information, communication and technology fund worth $133 million in an attempt to pioneer new ventures. So given it is looking at new ideas, but has a long historical connection with energy it would be no surprise to see the Saudis looking for new energy industrial joint ventures.
A potential avenue that could be explored is that of Low Energy Nuclear Reactions or Lattice Enabled Nanoscale Reactions (LENR). This is a chemical/physical event where anomalous amounts of heat are generated when certain metals absorb hydrogen or deuterium and an external stimulus such as an electric current is directly applied.
A potential partner for KSA to partner with is Industrial Heat LLC that was incorporated in 2012 and is based in Raleigh, North Carolina. This firm has already been granted the license to sell and manufacture energy catalysers “E-Cats” in Saudi Arabia. Therefore, I do not think it unreasonable to envisage the Saudis looking for partners to help start laying the groundwork for commercialisation of LENR within the Kingdom and for export overseas.
Over the next 50 years the financial fortunes of the Kingdom are going change as dramatically as the skyline of Riyadh and Jeddah.
– Edited by Gayle Bryant