Economy of Saudi Arabian - Essay Example

Economy of Saudi Arabia Introduction Saudi Arabia is always linked with oil as it is estimated that the country accounts for 25% of the world's total supply of petroleum. The abundance of oil in Saudi Arabia made it largely an oil-driven economy. It can be noted that the performance of the country is heavily affected by the production and export of its oil and oil products. It is estimated that oil export revenue accounts for 90-95% of the country's total earnings, 70-80% of the total state earnings, and 40% of Saudi Arabia's Gross Domestic Product (GDP). The country's robust economy therefore, is indicative of the strong performance of Saudi Arabia's oil industry specialize in the production and shipment of oil (Saudi Arabia 1-2). It is acknowledged that the oil industry is a major contributor in the GDP of Saudi Arabia. However, one should not lose sight that other sectors also have significant roles in shaping the economy of Saudi Arabia. These other sectors, though currently not as significant as the oil industry have a considerable bearing in the performance of Saudi Arabia. Also, the Hubbert Peak Theory, which foretells the downslide in Saudi Arabian oil production, warns of the possible collapse of the oil industry's which will considerably reduce or even eliminate the significance oil to the country. This paper will look at the economy of Saudi Arabia as a whole. The first part will talk about the country's GDP and its composition. Next, it will tackle the contributing sectors individually mostly concentrating on the oil industry. An assessment of the Hubbert Peak Theory and its opponent will also be done. Saudi Arabia's Gross Domestic Product In general, Saudi Arabia has a robust economy supported by its strong oil industry. Saudi Arabia's economy began to flourish during after 1973, when the price of oil in the world market skyrocketed. This phenomenon made the country one of the fastest-growing economy in the world as it enjoyed a substantial surplus in its overall trade transactions with its partners, rapid growth in imports, and the generation of substantial government revenue that supports the country's development efforts (Background Note 27-28). During 2004, the country recorded a total GDP of $310.2 billion dollars which translates to a per capita GDP of $11,742. It should be noted that in terms of GDP, the country is in a decline. The aggregated GDP average growth during the period of 1975-2000 was -2.2% as opposed to the -4.4 recorded during 1980-2000 (Saudi or Saudi Arabian Economy 5). In spite of the overall decline in the economy, Saudi Arabia is showing signs of slow recovery from the oil price collapse in 1998. Real GDP growth rate during 2004 was seen at 5.2% while experts forecast that Saudi Arabia will expand at an annual rate of 5.7 and 4.8% for the years 2005 and 2006, respectively (Saudi Arabia 2). The oil industry largely contribute to the total GDP of Saudi Arabia. As stated above, oil export revenue accounts for 90-95% of the country's export earnings, 70-80% of the total state revenue and 40% of the total GDP. The largest chunk of the country's GDP is shared by the industry sector which makes up 58.8%, followed by the services sector at 36.5%. The remaining 4.7% is accounted for by Saudi Arabia's agricultural sector (Saudi Arabia 2). The Oil Industry Saudi Arabia controls the largest petroleum reserves in the world which is 26% of the proved total, ranks the largest exporter of petroleum and undeniably plays a significant role in the Organization of Petroleum Exporting Countries (OPEC). According to the Oil Gas Journal, Saudi Arabia possesses 261.9 billion barrels of proven oil reserves in the world including those, which are in the Saudi-Kuwaiti Divided. The country has 80 oil and gas fields though more than half of the total reserves is concentrated in only eight fields which includes Ghawar and Safaniya. Ghawar is considered the largest oil field with an estimated remaining reserves of 70 billion barrels while Safaniya is the largest offshore oilfield, with reserves half that of Ghawar (Saudi Arabia 10). The country's oil industry is highly regulated by the government as the state corporation Aramco controls 98% of the total oil reserves and monopolizes Saudi's upstream oil development. In addition Saudi Basic Industries Corporation, another large state corporation is the 11th largest petrochemical producer also dominates oil production (Saudi Arabia 6). Oil Production The discovery of oil in Saudi Arabia by US geologists dates back to the 1930s. However, large-scale oil production in the country began only after the World War II (Background Note 27). Saudi Arabia's abundant oil reserves undoubtedly make it the largest oil producer and oil exporter in the world. Figure 1 shows the country's oil production and consumption since 1980. It can be seen that production of oil is generally volatile with an upward inclination. There has been a deep plunged in production during the mid-1980s yet recovery is imminent as oil production continue to mount in the early 1990s. Presently, there is an upward trend in consumption, yet the bulk of production is shipped to major oil destination abroad. Figure 1. Saudi Arabia's Oil Production and Consumption (Million Barrels per Day, 1980-2006)1 Source: EIA The Hubbert Peak Theory During the late 1950s, the prominent geophysicists M. King Hubbert has utilized the combined principles of geology, mathematics, and physics to come up with a predictive model which is used to forecast oil production decline curves. This model is now known as the Hubbert Peak Theory (Puplava 9-10). Hubbert theorized that oil production would follow a logistic curve. This curve is bell shaped implying an initial period of increasing production followed by a steep decline after the peak point is reached. This is somewhat logical as after the discovery of oil reserve, initial production is relatively low indicating the lack of needed facilities in place to exploit the reserve (Hubbert Peak Theory 8-9). As time goes by, proper technologies are established to aid production and total output mount. The peaking of production, however is still questioned by scientists. The Hubbert curve is refuted by other experts as this, they say is not a viable explanation of the events happening in the oil industry. Hubbert estimates that the total oil reserves adds up to 1.8 trillion barrels. This was further augmented to 2.0 to 2.1 trillion barrels as new reserves are being discovered. Data shows that oil production has been started since the early 1850s. According to the aforementioned data, the peak in oil production will occur between 2004-2008. Annually, the global consumption of oil depletes 6% of the total oil reserves while global demand is growing at an annual rate of 6%. This implies that world is required 8% of the depleted reserves annually to support the growing demand and make up for the consumed portions (Puplava 10-11). An economist Charles Maxwell however, strongly supports Hubbert's Peak Theory of oil production. The theory is used to support the decline in oil production in the United States starting 1970s. After becoming the world's largest producer of oil, the country's oil production reached it maximum and started to decline. It can be noted that since 1970s, the United States had become more dependent on oil imports for its consumption (Maxwell 17). Saudi Arabia and Hubbert Peak Theory Saudi Arabia can also experience the possibility of oil depletion. Currently, production of oil in Saudi Arabia is believed by theorists to have reached its maximum. For one, after the destruction of oilrigs due to the Huriccane Katrina, it had openly admitted that it cannot in any way possibly increase production to readily make up for the loss of Gulf Mexico oil rigs (Hubbert Peak Theory 7). This phenomena is thought to signal the beginning of an oil production decline where the world is not capable of increasing or even sustaining current levels of production. This down trend will not only occur in Saudi Arabia, but will be experienced by the world oil industry. As discussed above, Saudi Arabia is mainly an oil-based economy as its oil industry makes up a significant portion of the country's revenue. The effect of oil depletion in the world will have a significant effect on the prices of oil produced by Saudi Arabia, largely affecting the revenues generated by the country and its economy as a whole. The world is irrefutably becoming more and more dependent on oil as almost all the processes are mechanized. The technological advancements are facilitating the influx of high technology equipments, which requires the higher utilization of oil. Mechanization led to the steady increase in oil demand in order to run new machineries and equipment. As demand for oil increases and supply of oil declines, Saudi Arabia and other large oil producing countries benefit from the mount in world oil prices. In fact, Saudi Arabia was expecting a budget deficit in 2004 arising from the extremely conservative oil price assumption set by the Ministry of Finance. However, the sharp rise in oil prices due to scarce supply pushed up the country's revenue leaving Saudi Arabia with a $21.6 billion budget surplus was used to finance the country's spending on debt servicing, research and development, security expenditures, and subsidies (Saudi Arabia 3). This highlights how the oil industry operates to save Saudi Arabia's economy. The Price of Oil Basic economics that tells us that demand mounts as the price of a commodity fall. This law is reflected in the downward-sloping demand curve. In contrast, upward-sloping supply curve is indicative of producer's willingness to supply more at higher prices. We also know that in a free market economy, the price of a commodity is determined by the operation of several market forces in the industry that influence the supply and demand. Currently, the world oil market is determined by the short-term supply and demand perceptions (Powershif-Oil, Money, and War 25). It is apparent that the world oil market is strongly influenced by large-oil producing economies like OPEC where Saudi Arabia plays an active role in. In fact, these producers monopolize oil production and prices are strongly affected by their production capacities. The price of oil is expected to mount should oil production start to decline. As demand for fuel rises and oil production declines, the oil-producing countries which have a strong foothold in the world oil market will considerably strengthen the OPEC monopoly. This will enable these countries to charge higher prices as oil users are heavily reliant on these small pool of suppliers. However, the world is undoubtedly looking into ways of bidding down the high demand for fuel. Recognizing the high expenses associated with rising oil prices, economies are looking at alternative for fuel. Natural gas, for example is becoming a viable substitute for oil though the high cost of obtaining it becomes a hindrance in productive and efficient production. It should be noted that the cost of obtaining oil is the same as the cost of obtaining natural gas. There is also a huge problem in transporting natural gas from the pipelines in Russia, Turkmenistan, Algeria, and Iran to Europe. Meanwhile, the natural gas in the United States is already in decline (Maxwell 12). Coal is also an alternative though the much-needed technology to cleanly burn oil is not yet available in the international market (Maxwell 13). Lack of substitutes for oil further implies high bargaining power in the hands of oil producers like Saudi Arabia. Realizing that oil is a non-renewable resource and a scarce commodity which can be depleted in the long run, the country's oil industry can take advantage of this by strengthening its alliance with its current trading partners and enhancing its pricing strategy to account for the scarcity in supply. Other GDP Contributors It is stated above that the oil industry makes up 40% of the GDP of the entire Saudi Arabian economy. The remaining 60% is then a contribution of other sectors which are significant in the revenue generation. Agriculture, Forestry, and Fishing The country's agricultural sector generates employment for 6% of Saudi Arabia's workforce. It is estimated that the sector shored in 5.1% of the economy's GDP in 2002. Agricultural production is limited by the abundance of water. Water supply also determines the crop that can be grown in a particular season. Significant crops include wheat, dates, potatoes, tomatoes, watermelon, and sorghum. Saudi Arabia is self sufficient in the production of dairy products (Country Profile 25). The country's forest is but a small portion of the country's land area making it unable to establish and sustain a forestry industry. On the other hand, the fishery sector produces an annual catch of nearly 50,000 tons. Industry and Manufacturing During 2002, the manufacturing sector provided employment to 8.1 percent of the Saudi labor force and shared 10.2 percent of GDP. Experts forecast an expansion in the industrial production of 7.7 percent for 2004. Most manufacturing jobs are linked in some manner to the minerals sector as petroleum refining continues to be the most significant activity. In addition, manufacture of cement, fertilizer, and steel contribute significantly to the country's revenue (Country Profile 26). Services The services sector is currently one of the most significant sector in the Saudi Arabian economy. This sector accounts for 44.1% of the country's GDP in 2002, employing 73% of the country's total working population. According to sampling which was used to ascertain the composition of the services industries, 16% are represented by the retail subsector, 12% in education, 10% in domestic services, and 9% in construction (Country Profile 27). Banking and Finance The banking industry of Saudi Arabia is heavily regulated by the government. The banking industry is comprised of 10 banks, three of which are owned by the state. Consistent with the laws of Islam, these banks forbid the payment of interests. The remaining seven are jointly owned by foreigners and citizens. In addition to commercial banks, four specialized credit institutions are designed to meet private and corporate financing needs. The country's largest stock market Tadawul has a market capitalization of $157 billion (Country Profile 27). Tourism The World Tourism Organization estimates that around 7.5 million tourists visited Saudi Arabia in 2002. Aggressive efforts by the government are pushed to boost the performance of the tourism industry. Hajj or pilgrimage is the major driver of the country's tourism sector (Country Profile 27). Conclusion The economy of Saudi Arabia, in the long run can possibly experience a decline if it became solely dependent in its oil industry and is not able to develop enhance its other contributing sectors. Recognizing the upcoming decline in the country's overall oil production, Saudi Arabia should focus in boosting the efficiency and productivity of its agricultural and services sectors and capitalize on its other competitive advantages to harness its full potential. Saudi Arabia, aside from being an oil-based economy should diversify to discover and tap potentials, which is different from its present structure. This should be undertaken to generate adequate revenue to support the growth of the economy. Works Cited "Background Note." US Department of State. August 2005. Department of State. 28 Nov. 2005. "Hubbert Peak Theory." Wikipedia-The Free Encyclopedia. 27 Nov. 2005. Media Wiki. 28 Nov.2005. < http://en.wikipedia.org/wiki/Hubbert_peak > Maxwell, Charles. "The Raging Storm." Energy Bulletin. 15 Nov. 2004. The Energy Bulletin. 28 Nov. 2005. < http://www.energybulletin.net/3161.html> Puplava, James. "Powershift-Oil, Money and War." Financial Shift Online. 22 February 2002. Financial Sense. 28 Nov. 2005. < http://www.financialsense.com/series3/intro.htm> "Saudi Arabia." Nationmaster.com. 2005. Nationmaster.com. 28 Nov. 2005. < http://www.nationmaster.com/index.php> "Saudi Arabia Country Analysis Brief." Energy Information Administration. 2005. Department of Energy. 28 Nov. 2005. Read More