Saudi Arabia's position as one of the world's largest producers and exporters of oil has provided it with expansive wealth and a number of foreign policy tools. However, there are several signs that Riyadh will have to adjust its energy policies in the coming decades. Saudi Arabia has not announced a significant new oil discovery in more than two decades. Fluctuations in global oil prices, developments in alternative energies, threats to export routes such as the strategic Strait of Hormuz, and concerns about the kingdom's internal stability and the status of its petroleum reserves all pose challenges to the House of Saud and Saudi energy exports.
Riyadh's Oil Dependence
The kingdom is thought to sit on nearly one-fifth of the world's proven oil reserves. The discovery of oil only a few years after Saudi Arabia's founding in 1932 allowed the country to develop quickly. Oil provided the kingdom with massive revenues and gave the House of Saud the means to establish and maintain patronage networks that helped build tribal alliances. It also served as a powerful foreign policy tool and created the basis for Saudi Arabia's strategic relationship with the United States. However, Riyadh is entirely dependent on oil for its economic and foreign policy heft, despite an increase in government-backed diversification initiatives. That dependence is a crucial vulnerability that leaves Saudi Arabia facing an uncertain and potentially problematic future.
Saudi Arabia's dependence on oil permeates the entire economy. Oil receipts account for 90 percent of government revenues and directly account for 40 percent of gross domestic product; indirectly, they are responsible for the existence of the majority of the rest of the economy as well. Electricity, food, gasoline, housing and water are all subsidized — directly or indirectly — for the kingdom's 28 million residents. Efforts to reduce reliance on foreign workers and employ more Saudis, a campaign known locally as Saudization, has had limited success. From 2004 to 2010, the population of foreigners in the kingdom rose from 6.1 million to 8.4 million, a 38 percent increase. Foreigners dominate the private sector, including agriculture, construction and services. A $36 billion government spending spree launched after the 2011 Arab unrest has only added to the need for foreign workers by increasing the number of construction projects. Even the government's diversification plan has focused on energy, power generation, natural gas exploration and petrochemical products — all connected to and funded by the oil industry.
At the same time, there are some questions about the longevity of Saudi Arabia's oil reserves. Like much of the region, Saudi Arabia has not announced a significant oil discovery in more than two decades. Indeed, Saudi Arabia's estimated proven reserves stood at 260.9 billion barrels in 1991, 262.7 billion barrels in 2001 and 265.4 billion barrels at the end of 2011. Saudi estimates have remained almost constant, even though the kingdom has produced on average about 4 billion barrels per year for the last two decades. There is a reason the figures are so unclear: National oil reserves are a state secret and are highly politicized, since they are used to determine things like OPEC production quotas. Therefore, the figures are intended less to reflect reality than to serve a variety of political and economic purposes.
It is possible that Saudi Arabia is simply biding its time when it comes to oil exploration. State-owned Saudi Arabian Oil Co. has pegged total oil in place — which includes oil that is not considered recoverable with current technology — at 722 billion barrels, and has said it wants to raise this figure to 900 billion barrels by 2020. However, a former Saudi Aramco geologist and head of exploration has questioned these reserve figures, saying they may be inflated by as much as 40 percent. The geologist also warned of a production plateau that would be followed by a steady output decline. Adding new and sizable proven reserves will be key to the kingdom's ability to maintain its position in the long term. Due to a confluence of regional and international factors, Saudi Arabia has long dominated the globe as the largest swing producer of oil. It is the only country that maintains a significant amount of production offline that it could tap within a few months' time. Indeed, Saudi Arabia produced 8.9 million barrels per day (bpd) of crude oil in 2010 and 9.5 million bpd in 2011, even though its stated production capacity is 12 million bpd. (It is, however, unclear if 12 million bpd is a realistic medium- to long-term production level.)
Saudi Arabia has not needed to do massive exploration or use enhanced recovery techniques due to the size of its reserves and its ease of lifting. In fact, lifting costs at the main Saudi fields average $3-$5 per barrel, less than a tenth of cost levels commonly seen in the rest of the world. Additionally, Saudi Arabia has many large fields that are untapped. For instance, the Manifa offshore field, which is estimated by some to be the fifth-largest oil field in the world, has been minimally exploited since its discovery in 1957. However, development is under way to bring the Manifa field online in the next few years, with daily production expected to be 900,000 bpd. The newer fields are much more expensive to produce from, which reduces the amount of money earned from each barrel sold. Nevertheless, Saudi oil will remain profitable and will continue to bring large amounts of money into the economy and government coffers.
One problem that Saudi Arabia will face in coming years is rising global oil production. Some of this is already visible in the United States, where crude oil production is at its highest level since 1998, with even greater increases expected. Nations such as Canada, Brazil and Angola, among others, are expected to raise their oil production levels in the future. All of this will chip away at the importance of Saudi Arabia's spare production capacity and will reduce its share of the global market.Meanwhile, the kingdom's two nearby energy rivals, Iran and Iraq, continue to lag behind, though both have the potential to greatly increase production over the long term. The development of their energy industries has been arrested by years of conflict, sanctions and underinvestment. Iraq, however, has seen its proven reserves climb from 100 billion barrels in 1991 to 143.1 billion barrels in 2011, and in July 2012, Iraqi oil production surpassed 3 million bpd. Baghdad hopes to reach from 8 million to 10 million bpd by 2017. Although this timeline is unrealistic given the problems the Iraqi energy industry faces and the country's substantial political problems, Iraq's increasing production will eventually be a concern for Saudi Arabia.
Riyadh's other rival, Iran, has also suffered setbacks due to sanctions, underinvestment and aging infrastructure. But with estimated proven reserves of 151.2 billion barrels, Iran has the ability to significantly increase its production, assuming it can work out the political obstacles that currently limit the foreign investment needed to revitalize its energy industry. Should there be a political shift in Tehran that would allow for significant investment and technology transfers from foreign energy majors, Saudi Arabia's centrality in the world oil market would decrease further.
In the short to medium term, the curbs on Iranian and Iraqi energy capabilities benefit Riyadh. In fact, Saudi Arabia will remain a critical player in the global oil market even if its influence is reduced. Over the longer term, however, there is a problem. As Saudi production remains stable or declines, Iran and Iraq have an opportunity to close the gap. Saudi Arabia's geopolitical position in the region could wane and, more important, so could its ability to depend on its main security guarantor, the United States. Washington has long viewed the stability of the House of Saud as a question of U.S. national interest and has used a variety of tactics to contain any threat from Iran and keep oil flowing from the Gulf via the Strait of Hormuz.
Significant changes in global demand, including technology that would allow natural gas to be converted to transport fuel, could also pose serious problems for Saudi Arabia. Such changes could cause the United States and other importers to attach less strategic importance to Saudi oil, cutting into Riyadh's revenues. While Saudi Arabia will remain important to the United States under any scenario — the steady flow of 9 million to 10 million bpd of oil is critical to the global economy — its role as the only source of extra capacity will be less significant as global production increases.
Rising domestic demand will also add to the pressure on Riyadh. Saudi Arabia uses more oil per capita than any other country with a population of more than 28 million people. It uses 40 percent more oil per person than the United States, and more than three times as much as Germany or France. Its population is expected to grow by as much as 10 million people by 2030. If Riyadh does not restrain domestic consumption in some way, population growth will remove nearly one million bpd from Saudi exports, costing Saudi Arabia tens of billions of dollars per year in lost revenue and cutting away at the country's swing production capabilities.
A Temporary Buffer
The kingdom has weathered previous collapses in oil prices and has massive foreign holdings, estimated to be worth $533 billion in June 2012. The government's debt level is very low, limiting foreign influence through that avenue, and the combination of currency reserves and low debt gives the government flexibility in dealing with any drop in cash flow.
Saudi Arabia's extensive foreign reserves could help mitigate a decline in the kingdom's oil revenues, but they do not address long-term issues. Riyadh faces greater challenges from a growing population, rising electricity demand and an unmitigated dependence on desalinated water — not to mention the impending leadership changes and rising criticism of the religious establishment mentioned earlier in this series. Oil revenues hold the kingdom together and finance patronage networks, infrastructure projects, social spending and subsidies. Any substantive decline in oil revenues would radiate throughout the economy and would force serious and painful reforms upon the ruling House of Saud, potentially undermining the kingdom's stability.
Oil and cash reserves will be there in the short to medium term. Indeed, Saudi Arabia should be able to continue pumping oil at current levels for decades to come. But between rising global oil production, a rapidly increasing population and a very expensive subsidy regime, Riyadh will have to make substantial reforms if it wishes to slow the decline of both its profit and its influence while it attempts to maintain internal stability.