Economic Research Forum (ERF)

The energy sector reforms of Saudi Arabia’s Vision 2030

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Energy constitutes a major building block of Saudi Arabia’s economic reform agenda described in the government’s Vision 2030. This column outlines the key considerations, including the future role of the oil industry, energy efficiency programmes, domestic energy prices and diversification of energy sources.

In a nutshell

Reform of Saudi Arabia’s energy sector faces many challenges related to implementation and communication.

Winning the support of both the public sector and the private sector, as well as managing expectations in a time of change, are vital for the success of the reforms.

Transforming the economy from the notion of cheap and abundant energy to a more productive and competitive one will remain a challenge to policy-makers and stakeholders.

Saudi Arabia’s economic reform agenda enunciated in the government’s Vision 2030 rests on the premise that the decades-long development model – based on cheap energy, low wages for expatriate workforce, over-dependence on government expenditure for growth and employment as well as skewed incentive systems – are not sustainable given the world’s energy transformation.

A change in the mindsets of the government, the private sector and the citizenry was therefore needed to pursue a new development model that uses the Kingdom’s potential, lessens dependence on the state and addresses the mounting challenges.

Energy constitutes a major building block of the economic reform programme in two key dimensions. The first dimension incorporates the critical role of the oil and gas sector in the economy through the fiscal, entrepreneurial and technological channels.

But it also takes account of the overall energy sector and its interactions with the rest of the economy. There is an acknowledgment that diversification of the sources of fiscal revenues of the state and of GDP does not necessarily reduce the importance of stable oil revenues. Nor does it reduce the role of the oil industry in the economic transformation programme.

The different world oil market outlooks mostly project increasing the contribution of non-conventional sources, especially shale oil, in global supply on the one hand, and a slow growth in world oil demand, the extreme extent of which is the ‘peak oil demand’ notion, on the other. But as of now, it seems that the consensus is of continued but slower oil demand growth through till 2040.

In this context, one should recall the ‘peak oil production’ hypothesis that dominated the oil business and policy-making for more than half a century, and which might have influenced the production and investment decisions of some oil-producing countries at certain times.

While technology and economics on the supply side, exemplified in increasing recovery rates, resource base and prices, ultimately reduced the appeal of, and adherents to peak oil supply; technology and economics on the demand side, exemplified in disruptive technologies and declining costs of batteries for electric vehicles as well the changes in mobility and the Paris-21 climate change commitments, seem to be working to enhance the appeal of the ‘peak oil demand’ hypothesis.

One thing needs to be emphasised in this renewed peak oil debate: had producers rushed to factor peak oil supply conclusions into their policy framework that a barrel of oil in the ground was worth more than a produced barrel, oil supply security and market stability would have been compromised.

Similarly, rushing to factor in the conclusion of ‘peak oil demand’ notion that a barrel of oil produced now is worth more than the one in the ground could lead to accelerated depletion and might have as dire consequences for investments, excess capacity and market stability.

Fortunately, this notion of peak oil demand has not been as publicly debated in the oil-producing countries of the Middle East. The reason is that economic and revenue diversification objectives have been on the development agendas since oil was discovered, irrespective of peak oil demand or supply.

The public is more interested in what we make of oil today: transforming a depleting asset into more productive assets above ground if peak supply is to occur; or preparing the economy for an anticipated decline in its future value if the perceived peak oil demand occurs earlier.

While many uncertainties of the timing, process and implications of peak demand remain, policy-makers should incorporate into their decision parameters a scenario of prolonged slowdown in demand due to technology, climate change commitments as well as efficiency measures in all sectors and economies. Both hasty decision-making as well as complacency might affect investment, market stability and economic sustainability.

The second energy dimension of the reform programme relates to the domestic energy demand pattern, its fuel composition and local energy price levels. Saudi Arabia’s domestic primary energy and power consumption doubled over the ten years to 2014, averaging an annual growth of 6% and 7% respectively, with energy intensity at 2.5 barrels of oil equivalent per $1,000 GDP increasing by 1.5% annually compared with the global rate of decline of 1% annually.

Robust economic growth and artificially low fuel prices and electricity tariffs lead to inefficient energy use and an unsustainable growth of energy-intensive sectors. This state of affairs affected oil, gas and power investment outlays, oil export potentials as well as efficiency and equity considerations.

The Kingdom had to move swiftly on two fronts: enacting aggressive energy efficiency programme; and adjusting domestic energy prices. The energy efficiency programme encompassed all sectors: industrial, residential and transport.

In the residential sector, the programme updated the building code and mandated standards specifications for thermal insulation materials, computers, air conditioners, appliances, lighting, etc. In the transport sector, it developed a fuel economy label for light duty vehicles, introduced energy efficiency standards for tyres and regulated energy efficiency of heavy duty vehicles. In the industrial sector, it set up energy intensity targets for existing and new plants.

But the two rounds of oil and gas price adjustments in 2016 and 2018 are by far the most ambitious undertaking. Natural gas prices for utilities increased by 67% and for industry by 133%; gasoline and diesel prices for the transport sector by 240% and 80% respectively; and liquid fuels for the utilities by 60%.

These increases in gas and liquid prices necessitated an overhaul of the power sector to improve its fuel efficiency and enhance the privatisation process of the sector. They also necessitated major adjustment in electricity tariffs to the residential sector by around 260%.

To ensure equity, a ‘citizen account’ was set up to compensate the most vulnerable as a result of the second round of price adjustment, supplemented later by a one-year wage increase. A private sector stimulus package was also set up to support adversely impacted industries.

The efficiency programme, price adjustments, fuel switching and economic slowdown all contributed to a slower demand growth for some energy products and a decline for others. The ultimate aim of the reform is to align prices of oil, refined products and natural gas to market reference prices.

The third dimension of energy reforms relates to strengthening forward and backward linkages of the energy industry, an example of which is the plan of state-owned oil company Saudi Aramco to double the local content to 70% by 2021. Similar targets were set for the power and petrochemical industries. A dedicated national agency was set up to identify and promote the local content in all sectors.

The fourth dimension is the diversification of energy use which until recently has been dominated by oil. Saudi Aramco’s plans to double natural gas processing capacity and to raise its contribution to the energy mix from 50% to 70% by 2030 aims at diversifying the fuel mix of power generation.

Related to this is the nation’s renewables development strategy, which has been evolving rapidly. With the premise that investment in renewables and in oil and gas are not contradictory but complimentary, an objective to add 9.5GW generation capacity from renewables by 2023 and an initial 2.8GW nuclear power plants have been set.

The energy sector’s reform like the overall transformation programmes of Vision 2030 faces many challenges related to implementation and communication. Winning the support of both the public sector and the private sector, as well as managing expectations in a time of change, are vital for the success of the reforms.

Transforming the economy from the notion of cheap and abundant energy to a more productive and competitive one will remain a challenge to policy-makers and stakeholders.

 

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