Political Risk Assessment of Saudi Arabia - Essay Example

Introduction

The successful operations of a business depend on the political, economic, and social environment under which transactions occur. While some of these success factors are externalities, they are integral to ensuring profitability and sustainability of the business. In foreign investment, it is important to consider both the internal and external factors that potentially affect the venture before establishing it. Therefore, an assessment of the political factors influencing investments in the petroleum industry of Saudi Arabia is indispensable in ensuring a competitive foreign investment. Saudi Arabia is one of the six nations forming the Gulf States whose economies largely depend on the oil industry. Despite the milestone developments in the petroleum and oil industry in the country, regional unrest, terror attacks, and military operations are formidable threats to foreign investment. This paper provides a succinct assessment of the political risk factors in the context of investing in the Saudi Aramco petroleum business.

Important facts about Saudi Arabia relevant for making foreign investment decisions

Saudi Arabia is a country whose economy heavily depends on the hydrocarbon sector. It derives approximately 40% of its Gross Domestic Product (GDP), 85% of exports and 90% of fiscal revenue from the hydrocarbon sector. The country’s GDP growth for 2015 was approximated at 3.5%, but it slowed to 2.7% in 2016. The reduction in GDP growth accruing from the petroleum and oil sector is attributed to the government adjustment of its spending in response to the lower oil prices in the international market (Alawaji, 2012 p.78). The 50% drop in oil prices between July 2014 and April 2015 has adversely affected Saudi Arabia economy. This decline in oil prices changed the economic outlook of Saudi Arabia as an oil exporter (Mazaheri, 2016, p. 126). Therefore, the country is faced with massive oil revenue losses hence resorted to using accumulated financial buffers and alternative sources of finance to leverage some of the impacts of slower economic growth amidst heightened terrorist threats and political instability (Riedel & Welsh, 2016 p.57). The volatility, social unrest, and terrorism in many parts of the Arab Gulf region pose uncertainty on the business ventures. Due to this uncertainty and instability, investor confidence has to be won before making any form of foreign venture in the country (Simmons, 2013, p. 69).

The Saudi Arabia clamor to control the world politics through its oil industry has resulted in a shift of production to new markets such as Russia and the United States of America. In the past, Saudi Arabia greatly influenced the policy of maintaining crude oil output at approximately thirty-one million barrels per day that became a centerpiece in the operations of OPEC (Al-Rasheed, 2013, p.132). This approach has forced economies such as USA and Russia, which are producers of higher-cost hydrocarbons to cut their production. Nonetheless, the producers of the higher-cost hydrocarbons have proved more resilient in the industry due to stronger economic and financial policies instituted by their regimes (Quandt, 1981, p. 95). The resilience of the US and Russian oil drillers has resulted in the stagnation of oil prices thus putting pressure on the Saudi Arabia finances. If the low prices and increased Saudi spending persist, the scenario is that they will be forced to reduce their spending on other programs that are equally critical for the establishment of a foreign petroleum investment (Smith, 2014, p.117). For instance, reduced monetary allocations to infrastructure would hinder the mobility of commodities thus increasing costs of transportation.

Political risks of investing in the Saudi Arabia oil and petroleum industry

Foreign investment in Saudi Arabia oil industry is predisposed to the effects of government or bureaucratic inefficiencies, societal tensions, inadequate legal system and international tensions (Shaffer, 2009, p.79). These factors are likely to adversely affect investment environment thus leading to business failure. Political risks facing investments in Saudi Arabia companies include the instability of the government and society, strained international diplomatic relationships, the non-reliability of the legal system and the poor business infrastructure (Guzanski, 2015, p.97). In addition, the government’s bureaucracy involving foreign investments and less efficient economic policies are likely to inhibit the democratic establishment of a fledgling enterprise within the country. The Saudi legal system has a weak transparency, which hampers free trade. The enforcement of judicial decisions and proceedings on business operations such as insolvencies take too long to complete with the outcomes being uncertain (Thompson, 2014, p. 97). Notably, the bureaucracy in Saudi Arabia coupled with corruption and lack of transparency in the judicial system plagues foreign investment. In fact, the inadequate transparency among the Saudi authorities and ministries limits foreign investors’ access to financial information. This situation creates problems of credit assessments that are critical in ensuring business competitiveness and success.

The Monarchical and unstable governance system of Saudi Arabia occasioned by incidences of war in the neighboring states and unpredictable legal regimes are a threat to investment. The foreign investment in the petroleum industry requires the host country to have a political system that guarantees long-term leases and has a history of political stability (Reed, 2016. P. 112). Issues such as sudden nationalization or shift in political environment are prevalent in Saudi Arabia thus causing unprecedented changes in the business regulatory structures (Cohen, 2014, p.123). It is projected that Saudi Arabia will continue positioning itself in the ongoing power struggle in the Gulf region and extend its expansionary economic policies. These factors inevitably make the country vulnerable to diplomatic wrangles with serious ramifications on the operationalization of foreign enterprises (Parra, 2004, p. 113). Notably, the complicated nature of the Saudi Arabia legal system is hard for a foreign investor to navigate (Kechichian, 2013, p.103). The clergy controls the Saudi judicial system with no standardization of legal precedents and court rulings. This nature of legal arrangement implies minimal safeguards for a foreign investor. The risks associated with weak statutory provisions on foreign investments are incredibly high.

The relationship between Saudi Arabia and some of its neighbors including Iran is characterized by tension and mistrust (Mabon, 2013, p.94). There is a persistent mistrust between the Shiite Iranian and the Sunni Saudi governments. This threat is a significant factor that limits the free operation of the foreign petroleum investment (Great Britain, 2012, p.117). In addition, the Saudi Arabia labor force is composed of foreigners thus denying the locals employment opportunities. The emergence of extremist terror groups such as the Islamic State is partly attributable to the low employment rates of locals. This situation increases the susceptibility of foreign investments to territorial aggression (Egovis 2012 & Kő, 2012 p. 87). Nonetheless, an investment procedure that favors local employments can leverage adverse relationship with the unemployed individuals in the country.

Traditionally, Saudi Arabia influenced the global oil prices as the largest oil producer in the world. However, since 2014 the economy realized its inability to increase its oil prices persistently. In 2016, the Saudi economy had to raise the price of oil up to USD100 per barrel, which is unrealistic. The government has resorted to the diversification of the economy and adoption of expansionary spending policies (Cherif and Fuad, 2014, p.14). These changes are targeted at creating jobs and supporting the growth of non-oil-related sectors of the economy. In essence, the Saudi economy is only stable in the short term due to enormous resources, but there is a projection of policies favoring diversification of its economy. Such a shift from the mainstream oil economy has inevitable consequences on the oil industry (World Economic Forum and European Bank for Reconstruction and Development WEF/EBRD, 2013 p. 85).

Sources: HIS (Data from US EIA, OPEC, Russian government)

Conclusion

The political environment and dynamics of Saudi Arabia are described as stable in the short run but with potential triggers of instability. The complicated relationship between the economic, social and political environment implies that a change in any of them causes a subsequent shift in the other two. This projection of an unstable political situation indicates that Saudi Arabia is characteristically unsupportive of the profitable business environment. Any foreign investment thrives on guaranteed social political and economic factors. At worst, the business and political environment of the host country should be predictable. These prerequisites for the efficient operation of a foreign investment imply that the business deal between the company and the UK Petroleum firm must be based on a thorough evaluation of Saudi’s future political arena. Nonetheless, the assessment of the internal and external political factors in Saudi points to it as a market suitable for short term investments. The unreliable nature of the country’s legal system and its central role in the activities of the Gulf States predisposes it to political instability. Moreover, the stabilization of other economies in the production of hydrocarbon products portends a disruption of the strength of Saudi Arabia as a major determinant of world oil prices.

Some of the internal political influences in Saudi Arabia include the critical and challenging reforms in the country, power crisis between the leading Sunni and the minority Shiites, persistent abuse of human rights by the ruling monarch, and succession politics of the monarch family. The external factors threatening trade in Saudi Arabia include its strained relations with Iran and unsettling US-Saudi. In principle, businesses only thrive in peaceful and supportive environments. Nonetheless, the assessment of both internal and external political factors in Saudi Arabia does not guarantee long-term business operations. The unfavorable trends of geopolitics characterized by the overindulgence of world superpower states; especially the United States in the Gulf oil based economies is a threat to regional peace and international trade within the country.