Here’s How Cheap Oil Is Pushing Saudi Arabia to Reform

Saudi Crown Prince Mohammed bin Salman’s tour of the U.S. seems perfectly tailored to put a new face on the world’s deeply conservative oil-rich kingdom. After meeting with President Donald Trump, the 32-year-old reformer is expected to make stops in Silicon Valley to meet tech executives and Hollywood to talk to the entertainment industry while also touting his country’s softening of some conservative policies that subjugate women.

The sharp turn for Saudi Arabia is the result of more than just Salman’s enlightenment. A slew of pressures in the energy industry including a sustained period of low oil prices, increased competition from the U.S. as a result of fracking and a long-term shift away from fossil fuels to combat climate change have shifted the dynamic and left the country facing pressure to reshape itself.

“Everybody knows that the writing is on the wall,” says Jean-François Seznec, senior fellow at the Atlantic Council who studies the oil industry in the Persian Gulf region. “There will always be a need for crude oil, but crude oil cannot carry the country alone.”

That represents a sharp change. In the past century, leaders of the country turned the kingdom itself into the region’s richest country by exploiting vast oil reserves that fed the world’s addiction to the fossil fuel. The government then used the seemingly endless stream of revenue from selling oil to keep the people happy with public spending.

The most urgent concern is the low price of oil, or at least that was the biggest threat when bin Salman took over the day-to-day job of running the country last year. Oil traded at around $46 per barrel at the time. Today, the price has risen significantly to around $64, but that still falls short of what independent analysts believe is the country’s $70 per barrel breakeven point, according to an IMF report. That shortfall makes a difference over a sustained period of time with the country facing a $52 billion budget deficit in 2018 and oil currently making up more than 60% of the country’s budget.

Oil prices may rebound, and the country has led other OPEC nations in cutting production in hopes of pushing up prices. But as prices rise the country will face unprecedented competition from oil producers in the U.S. New technology — namely fracking and horizontal drilling — has opened parts of the country to oil development that have long thought to be uneconomic. A forecast from the International Energy Agency released earlier this month suggests that U.S. oil production will meet 80% of new global demand for the fuel source in the next three years.

In the longer term, Saudi Arabia faces the prospect of what the energy experts have termed the “energy transition.” Renewables, battery storage and energy efficiency will play a more prominent role in the global energy mix both because countries want to address climate change and because those resources can increasingly compete with the costs of fossil fuels. Most significantly for oil producers, hundreds of millions of electric vehicles will roll out of factories in the coming decades cutting demand for oil to power vehicles. About a fifth of global oil demand goes to passenger vehicles and the transportation sector broadly uses more than 50% of global oil demand.

“When you put it all together, it really meant that now is a time when economic reform, which has always been pressing, is more of a national emergency,” says Amy Jaffe, director of the program on energy security and climate change at the Council on Foreign Relations.

That reform has taken several forms. One of the country’s most significant changes is the promised initial public offering for Saudi Aramco, the country’s state-owned oil company. The company is valued in the trillions of dollars and the offering could generate $100 billion for the cash-starved kingdom. That money will then allow the country to diversify so it is no longer as dependent on the fluctuations of the oil industry.

The country’s sweeping social changes — allowing women to drive and reducing the authority of religious police, to name two major ones — can also be linked to the struggles in the oil industry. It’s easier to operate a repressive government if the people rely on the government’s support and do not pay taxes. But when the largesse dries up — as it has in recent years — people get restless without reform.

“The reality of lower oil prices has made it more urgent for oil exporters to move away from a focus on redistributing oil receipts through public sector spending and energy subsidies,” wrote International Monetary Fund analysts in a report last fall.

It’s a concept Tom Friedman described as “the first law of petropolitics” in a 2006 article in Foreign Policy. Friedman found a correlation between oil prices and political freedom. Lower prices mean governments grant a higher degree of freedom while higher prices mean further repression. “One can actually correlate rises and falls in the price of oil with rises and falls in the pace of freedom,” he wrote. “The connection is very real.”

That does not mean Saudi Arabia has given up on its vast oil resources entirely. Amin Nasser, the CEO of Saudi Aramco, told industry executives gathered at the CERAWeek conference in Houston that “the market fundamentals remain healthy” for oil even if the future looks different than today. Nasser says his company will increasingly focus on petrochemicals to build products from oil pipelines to skyscrapers.

But Nasser’s public confidence belies the seriousness of the issue. “If they’re talking about it,” says Jaffe, “they’re worried about it.”