The Fuse

Saudi Arabia Reins in Runaway Energy Subsidies

January 11, 2016

Guest Post by Matthew M. Reed | @matthewmreed

Matthew M. Reed is Vice President of Foreign Reports, Inc., a Washington, DC-based consulting firm focused on oil and politics in the Middle East.

The first year of King Salman’s reign will be remembered as one of extraordinary assertiveness at home and abroad. The most obvious example of this new trend was the intervention in Yemen—the repercussions of which will be felt for years to come. At home, also, it’s hardly business as usual for Saudi Arabia. On December 28, the Kingdom unveiled the first round of energy subsidy reforms, which hiked the prices of gasoline, electricity and other utilities.

The reforms are hugely important because Saudi Arabia’s stability hinges on the robustness and reliability of the welfare state, which citizens hold as their birthright.

The reforms are hugely important because Saudi Arabia’s stability hinges on the robustness and reliability of the welfare state, which citizens hold as their birthright. Saudi stability, of course, has international implications because the Kingdom is among the largest oil producers in the world. On any given day, Saudi barrels represent about one-tenth of world oil production and one-third of OPEC production. But, in light of painfully low oil prices and unsustainable consumption trends, Saudi leaders have decided now is the time to fine-tune lavish subsidy programs.

Fine-tuning is very different from “radical austerity,” which is how the Financial Times described the reforms. It’s true some energy prices in Saudi Arabia are rising on a double-digit percentage basis, but it’s also true that prices were extremely low to begin with and that the new system was carefully designed to protect the poor and middle class, which typically provide the critical mass for civil unrest. Wealthy Saudis—who consume the most by far—will pay more in general. Even then, prices do not necessarily reflect prevailing market rates in other parts of the world.

The ultimate goal is not to dismantle the welfare state but to make it more durable through incremental reform over years. The latest changes are not whiplash-inducing. Rather, the December 28 price hikes are expected to shave the country’s annual energy subsidy bill by about 12 percent in 2016 compared to 2015. Education and healthcare provisions will remain robust, while energy prices will remain low for most users.

The new prices for utilities are progressive. The biggest users will pay more to use more, including industry, government and individuals. This tiered system allows for most households to enjoy low rates. Going forward, Saudis will pay pennies per kWh so long as their monthly usage does not surpass 4,000 kWh. (In 2014 the average monthly usage rate for a residential customer in the U.S. was 911 kWh.) The new electricity and water prices won’t spawn anger once households compare their utility bills to that of their mobile phones. At least that’s the case for most energy consumers. By contrast, owners of huge estates will pay more this year to light, cool and water their properties. Some wealthy citizens—including royals, no doubt—must be unhappy with the price hikes.

At today’s higher rate Saudis are still filling up their tanks for about half of what Americans are paying.

Fuel prices are different. Everyone in Saudi Arabia gasses up their cars and trucks at the same stations, so everyone will pay the new, higher rate. However, that rate is still heavily subsidized, and remains low in an international context. The cost of a gallon of high grade gasoline in Saudi Arabia is now $0.90, when last year it cost $0.60. What’s more: The new rate is actually the old rate. Why are Saudis responding to the 50 percent price hike with shrugs? Because what they’re paying today is the same as what they paid from 1999 through 2007. Then and now there was no public outcry because prices are relatively cheap. At today’s higher rate Saudis are still filling up their tanks for about half of what Americans are paying.

Saudi Arabia’s deep pockets mean it can endure low oil prices for years, but that doesn’t mean it can afford to do nothing and simply wait for prices to rebound. Saudi leaders have made that clear. Recent comments by Deputy Crown Prince Mohammed bin Salman, who serves as Defense Minister and head of the Council of Economic and Development Affairs, are serious and encouraging.

In November, Prince Mohammed told the New York Times that dialing back subsidies and raising domestic prices was the only way to make alternatives like nuclear and solar competitive. Otherwise, the Saudis were doomed to burn oil for power generation rather than export it. On average, Saudi Arabia burns about 550,000 barrels of crude oil every day to meet electricity demand; that amount surges during hot summer months.

If Saudi leaders are convinced that price is the only way to moderate use, then they are on the right track—but they have a long way to go. “We want to reach free energy markets, but with subsidy programmes for those with low income, and not to have the subsidy in the form of lowering the energy prices, but through other programmes,” Prince Mohammed told the Economist this month. In other words, Riyadh is planning to phase out subsidies for all and instead provide relief directly to poorer citizens.

These price hikes are not a complete shock. In fact, the path to today’s reforms was paved in part by a long-running conversation inside Saudi Arabia and around the Gulf, where other states are weighing similar reforms. Since oil prices began sliding in mid-2014, belt-tightening has been a hot topic for local news outlets and social media users. Now that it’s happening the popular response has been anti-climactic.

Reform appears to be the new normal in Saudi Arabia. The next milestone will be National Transformation Plan, which is to be made public in the coming weeks.