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Saudi Arabia’s new broom reaches its energy prices

The partial lifting of fuel subsidies included in the kingdom’s 2016 budget represents a change to the assumptions on which the economy is based, and could eventually prompt calls for greater public representation

The lines of cars outside gas stations in the hours after the announcement of the Saudi budget for 2016, the first since King Salman and his team of young princes came to power a year ago, was sign enough that something major was happening. To the surprise of all, the government had announced the first tranche in a range of measures that will see a gradual lifting over the coming five years of subsidies on energy sources and basic commodities like water and electricity.

The first to notice the change were the millions of Saudis and foreigners who rely on private transport for their daily needs. They learnt that gasoline prices had been increased by at least 50%. Thus the rush to the pumps while stocks covered by the previous price remained.

The changes represent a momentous shift, not only in the shape of the economy but also in the social contract between the government and the people. There has so far been an unspoken acceptance, throughout the GCC, that in return for minimal charges on basic commodities and services, the government would be left to take care of the affairs of state without interference from a public whose needs were generously taken care of.

So delicate was that balance that Saudi leaders have so far been unwilling to disturb it, despite numerous pointers to the fact that the system was unsustainable. Plans were in place to make changes in 2011, but were put on hold after the outbreak of popular uprisings in other parts of the Arab world. Raising basic prices in that climate, the late King Abdullah argued, might spark social unrest.

Today, with global oil prices continuing to fall, the squeeze on revenue has made the removal of at least some subsidies unavoidable. According to Jadwa Investment, a Saudi bank, energy subsidies cost the Saudi government around $61bn in 2015, or around 9.3% of its GDP, with diesel accounting for $23bn and gasoline $9.5bn. Both are targeted in the 2016 budget. Higher-grade gasoline has risen from $0.16 a litre to $0.24/l; lower grade from $0.12/l to $0.20/l. Diesel for transport is now $0.12 /l, up from $0.07/l.

But the cuts extend beyond transport and cover electricity generation and the profitable and thriving petrochemicals sector, which for years has enjoyed an edge on its international rivals because of exceptionally low natural gas feedstock prices. The price of gas feedstock finally rises from its decades-long level of $0.75 per million British thermal units (/m Btu) to $1.2/m Btu, while ethane rises from the same level to $1.75/m Btu.

For the petchems sector, the 133% hike in feedstock bills presents a big challenge. With product prices already linked to declining global crude oil prices, thereby already putting Saudi products under pressure, the feedstock rise will force the sector to look for ways of cutting costs. For example, Saudi Arabia’s National Industrialisation Company (Tasnee) predicts that the budget changes will dent its 2016 results by around $50.7m – a drop of around 17%. “This is quite a significant hit,” Tasnee’s chief executive Mutlaq al-Morished told reporters in mid-January. “We are getting the management together and we are putting plans on how to find the ways and means to absorb this cost and try to save as much as we can.”

An open economy

The gradual lifting of energy subsidies is part of the wholesale reform of government structures and its executive process that has been under way since King Salman’s accession. The mastermind, Deputy Crown Prince Mohammed bin Salman, who controls economic and energy strategy, has made it clear that he wants the kingdom’s economy to be more transparent and flexible to respond to changing global conditions. The announced plan for a limited sale of shares in Saudi Aramco should be seen in this context of opening up the economy.

So far the changes that the young and energetic Mohammed has brought in – cutting excessive state spending, slimming bureaucracy, and consolidating decision-making – have won broad public approval. The coming weeks and months will see how Saudis react to the reforms.

This is a critical moment. The economic reforms have not been matched by equivalent political changes. On the contrary, the recent mass execution of 47 people on terrorism charges sent out a clear message that dissent of any kind will not be tolerated.

The challenge for the Saudi authorities will be to convince the population that the budget changes are both essential and work in their best interests – without needing to offer political concessions in return. In other words, the Saudi leadership will have to discover how far it can press taxation without responding to calls for representation – or at least a relaxation of the current constraints on political expression.

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