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Saudi Arabia - shifting sands

The end of Saudi Arabia's market-share strategy and efforts to restructure its economy – while keeping subjects happy – make 2017 a pivotal year for the kingdom

Those first mouthfuls of the new Saudi diet were a shock to the system. First came a partial lifting of subsidies on oil, electricity and water, followed by a freeze on the salaries and fringe benefits of civil servants, who constitute around 70% of the workforce. Saudis are bracing themselves for more unsavoury fare in the months ahead; in 2017, the changes underway in the kingdom will start to hit home.

The National Transformation Programme (NTP), the first part of an implementation schedule for the broader Vision 2030, will dominate most aspects of Saudi economic life in 2017, including oil. Already the face of the oil and gas sector has changed, with the post of petroleum minister scrapped, a symbolic indicator of oil's eventual demotion from its position of unchallenged pre-eminence. Oil and gas now come under the umbrella of Khalid al-Falih in his role as Minister of Energy, Industry and Mineral Resources.

The months ahead will see further consolidation of the rejigged energy sector, with key strategy decisions taken by deputy crown prince Mohammed bin Salman in his capacity as head of both Aramco's Supreme Council and the kingdom's Council for Economic and Development Affairs, as well as architect and chief promoter of Vision 2030. Falih will remain Saudi Arabia's energy ambassador, leading the kingdom's delegation at Opec meetings and other international fora. But his focus at home will be on cost-cutting and restructuring to streamline the sectors under his supervision and help them meet NTP targets.

One of the eye-catching headlines of Vision 2030 is the plan to privatise up to 5% of Aramco. Further details on how the IPO, planned for early 2018, is to be arranged will become clear in 2017. Aramco's chief executive says the shares on offer will not be confined to the downstream, marketing and distribution wings of the company, but will also encompass upstream operations - an announcement that will whet the appetites of would-be investors. As the IPO approaches, Aramco will need to disclose its reserves data - something that is long overdue, the deputy crown prince said as he unveiled Vision 2030. The IPO could raise up to $100bn and the proceeds will be deposited in the newly reconstituted Public Investment Fund (PIF).

Once returns from PIF investments begin to come in, the shift away from oil will have started - but that's some time away. In the meantime, Saudi Arabia still depends totally on oil and so needs to find the best way of maximising revenue from it.

Oil traders in 2017 will have to get used to a more proactive effort by the world's biggest exporter to control the oil market. The policy shift the kingdom signalled this summer - made public in Algiers in September - will dominate the global oil market next year.

The change in tack is real. The strategy adopted in November 2014 - to allow an organic rebalancing of global supply and demand, by killing off what ex-oil minister Ali al-Naimi called "inefficient" rival producers - is no more. The argument two years ago was that Opec and Saudi Arabia would recapture lost market share as higher-cost oil supply was shut in. Oil prices would then stabilise at levels that were acceptable to Riyadh, but low enough to keep rivals at bay.

Price stability was achieved, but at an unacceptably low level, even for Saudi Arabia, where production costs may be low but public spending commitments are high. The outcome of the Algiers meeting implicitly acknowledged that the Naimi strategy had failed. So a major theme in 2017 - both for the kingdom and the world's oil industry - will be Riyadh's efforts to revive Opec, find common ground with fellow producers, and restore the oil price to the kingdom's unpublished target of $60 a barrel.

It will be a tricky task. North American producers also stand to gain. So as the rigs fan out across Texas and North Dakota again, and tight oil output starts to recover in 2017, the kingdom will have no choice but to pursue an apparently contradictory strategy: restraining its own output, if necessary, while holding onto market share.

It still has sheer oil-output clout to wield, if necessary. Saudi production in mid-2016 reached 10.7m barrels a day. So if Iran, Iraq or other producers wreck the kingdom's plan to reduce Opec output, don't discount Aramco reopening the taps again in 2017. In the spirit of Vision 2030, with an eye on the post-oil era and the rapid expansion of both shale oil and renewables, some in the Saudi leadership still think the best idea might simply be to pump flat out while prices are reasonably robust. Just in case, in 2017, Aramco will keep the number of active rigs in the kingdom at similarly high levels to 2016. Aside from oil, the state company will also continue to target gas deposits in 2017; chief executive Amin Nasser says his firm will spend around $300bn on gas-focused drilling over the next 10 years.

So investment in upstream oil and gas ventures will continue next year, even while the talk is all about oil-supply constraint. Likewise, some restructuring of Aramco will get underway to make, in Falih's words, the firm "a top-tier, globally integrated energy and chemicals company". The expansion, from a low base, of renewable energy will be a less-noticed objective, while Aramco also tries at last to exploit what it thinks are big reserves of shale gas. Part of Aramco's new approach, which will become clearer in 2017, involves deeper involvement in petrochemicals to add value to the kingdom's vast oil reserves. Aramco is working with Sabic, the state petrochemicals giant, on a feasibility study for a crude-to-chemicals complex. Expect progress in 2017.

Elsewhere in the economy, a big focus in 2017 will be on cutting costs. Meeting the NTP goal of saving $5bn in public wages by 2020 will probably mean further pay cuts and public-sector hiring freezes in the coming months. There may also be more adjustments to subsidies, which are expected to generate savings of $53bn over the same period. None of this will be popular.

Saudi Arabia will also probably turn to international debt markets again next year, adding to the $36bn raised in 2016. One of the reasons for the sharp fall in foreign-exchange reserves - at $0.55 trillion in 3Q 2016, down from a 2014 peak of $0.746 trillion - is the cost of financing the war in Yemen. Finding a way out of that conflict, which is damaging the kingdom's international reputation and lightening its purse, will be an important political and diplomatic aim during 2017.

Deputy crown prince Mohammed, in his role as defence minister, will ultimately be judged by Saudis as much for securing an honourable exit from Yemen as for achieving the aims of Vision 2030. Saudis are making financial sacrifices in the cause of the Vision, with privileges long-regarded as birthrights being taken away. How long the population will happily stand by while billions of dollars are poured into an unwinnable war will become a more pressing question in 2017. If the conflict in Yemen continues through the year without major gains, senior figures within the ruling family will wonder whether the young deputy crown prince's future is as promising as it looked when his father acceded to the throne in early 2015.

This article is part of Outlook 2017, our annual book looking at energy market trends for the year ahead. To purchase a copy, click here

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