Even Saudi Arabia Is Giving Up On Oil - It's Over

Written by Jason Simpkins
Posted February 19, 2016

Saudi Arabia is waving the white flag... or maybe more appropriately the black flag.

The world's top oil producer is giving up on oil.

Of course it may be too late. Considerable damage has already been done.

Saudi Arabia and other major petro-states, like Russia and Venezuela, badly overplayed their hands.

All of these countries blundered during oil's delirious price rise. They overspent on social programs, energy subsidies, and war machines. And they've been slow to adapt to new technologies.

Now, they're paying the price.

Just take a look at what's happening in these three paragons of the petroleum industry...

In Russia, inflation is in double-digits, as the ruble careens to one record-low after another. Its economy is set to contract through 2017. Money is fleeing the country at a rate not seen since the fall of the Berlin Wall. And the central bank is burning through reserves like an arsonist.

Venezuela's economy contracted 10% last year, and is set to shrink another 8% this year. Its inflation rate is a mind-boggling 720%. The population is in a state of crisis, suffering widespread food shortages, with no international aid forthcoming.

As for Saudia Arabia, its economic model is failing, too. Oil, the Kingdom's lifeblood for so long, has finally betrayed it. Its budget has been strained to the max, provoking unheard-of austerity measures and credit ratings downgrades.

Like Venezuela, the Kingdom squandered oil revenues on populist programs that returned no value other than borrowed social stability. And like Russia, it prioritized its military, with the third-largest defense budget in the world.

As much as these countries want to dismiss this as a temporary market downturn, it's not. As the Saudi Prince himself said, oil will never return to $100 per barrel. And yet that's exactly what these countries need to save their economies.

Oil at $50, $60, or even $80 per barrel simply won't do the trick.

We're witnessing a watershed moment here: The fall of the petro-state.

Venezuela is doomed to failure, and Russia isn't far behind.

The only one that has a chance to emerge from this chaos is Saudi Arabia.

That's because Saudi Arabia is the only country of the three that's acknowledged its sickness — and more importantly, is working to correct it.

Saudi Arabia is turning fully away from oil and focusing on a new source of energy — one that the Saudi oil minister says “will be even more economic than fossil fuels."

Saudi Arabia wants to dominate the market for this new fuel, the same way it dominated the oil market.

It's investing heavily, and changing the very fabric of its society.

That, and that alone, could save it.

A few decades from now, Saudi Arabia may be the only petro-state left, but it won't be a petro-state any longer.

It'll be something different...

Darkness in the Desert Kingdom

What makes this all so remarkable is that oil is quite literally Saudi Arabia's lifeblood.

Oil revenue accounts for 92% of Saudi Arabia's budget.

It pays for free healthcare and free schooling. It subsidizes water, electricity, and gas. It's poured into a fund that provides interest-free loans to help families buy homes and start businesses.

There is no income tax in Saudi Arabia. Oil pays for everything.

It also fuels everything.

Some 25% of the oil Saudi Arabia produces is kept at home and burned for electricity. (This is a costly, dirty, and inefficient process most the world has abandoned, mind you.)

The Saudi Electricity Company buys oil for about $4 a barrel, roughly the cost of production, and it sells electricity to the people for as little as $0.01 per kilowatt-hour. Gasoline costs just $0.50 a gallon. (The average American pays about $0.12 per kwh and $1.71 per gallon of gas right now.)

The World Bank estimates that Saudi Arabia spends more than 10% of its GDP on these subsidies.

Still, above all of this, the No. 1 thing oil provides for Saudi Arabia is jobs.

Remember, this is a totalitarian state we're talking about. It's helmed by one of the world's last remaining royal families. But that ruling family will only be tolerated if it can provide subsidies and jobs for its people.

Without those things, the Saudi government has a huge legitimacy problem. And those two components of prosperity are being threatened by low oil prices.

The recently-released 2016 budget was one of the sternest the Kingdom has ever seen.

Riyadh has reduced fuel subsidies, raised electricity taxes, and bumped up water costs.

This has helped reduce its fiscal breakeven from over $100 in 2015 to an estimated $77.60 in 2016 — a reduction of $22.80.

However, going by what we've seen in Europe, every $1 of austerity costs about $1.50 of GDP when it's not offset with interest rate cuts or a weaker currency. And Saudi Arabia's currency is doing quite well for that of a petro-state. The Saudi riyal rose 15% against a basket of currencies last year, compared to a 25% drop for the Russian ruble.

So, Saudi Arabia's tax hikes and spending cuts, which equate to about 4% of GDP, could actually add up to a 6% GDP contraction and 3% higher unemployment.

That's devastating, considering, nearly 30% of those aged 15-24 years old were unemployed in 2014 — a figure that's held steady since 2007. Saudi Arabia needs to create at least 3 million new jobs by 2020 to combat the problem.

The situation is potentially explosive in a country where 70% of the population is under the age of 30.

The fear that the Arab Spring would spread is a big reason why subsidies and social spending were raised to such a high level to begin with. If this situation carries on, Saudi Arabia could easily go the way of Egypt, Libya, Syria, Yemen, and Tunisia.

That's why the Kingdom is taking drastic action, abandoning oil for a new form of energy.

A New Lease On Life

Here's how you know Saudi Arabia is giving up on oil for good.

First, it willfully oversupplied the market, imploding prices. This hurts Saudi Arabia's competitors, but as I've outlined, the state is suffering too. It's something like a scorched earth policy.

Second, Saudi Arabia has acknowledged that it's considering taking Saudi Aramco public. This is big news.

Saudi Aramco says it has more than 260 billion barrels of proven oil reserves and the equivalent of 50 billion barrels of natural gas reserves. That's more than 12-times the largest publicly traded oil company, Exxon Mobil.

If it were to list, Saudi Aramco could be valued in the trillions, topping Apple as the biggest company in the world.

This would bring a huge boon of cash to Saudi Arabia, but it would also loosen Saudi Arabia's grip on its chief revenue stream.

The only way that trade-off makes sense is if you plan to open up a new revenue stream.

And Saudi Arabia is.

The Kingdom has already announced it's making a staggering $109 billion investment in this new energy source that the country's oil minister says will be “even more economic than fossil fuels."

It plans to get at least one-fifth of its electricity from this source by 2032, with 41 gigawatts of capacity.

(Note: It's not nuclear, though Saudi Arabia has signed a memorandum of understanding with South Korea to build the Kingdom’s first two nuclear reactors, and possibly more.)

This new source of power could absolve Saudi Arabia of its reliance on oil, providing affordable electricity and much-needed jobs.

Of course, it has competition from a familiar foe — Texas.

That's right. First, fracking broke the Saudi stranglehold on oil, and now Texas is at the forefront of this new energy boom. And the Desert Kingdom is desperate to change that.

Saudi Arabia has turned its oil taps full-tilt, flooding the market and imploding oil prices to try and re-establish market dominance. Now, it's pouring hundreds of billions of dollars into a fight for the energy source of the future.

Whether or not its successful will ultimately determine its fate as a nation.

One thing is for sure, though: The days of the petro-state are numbered.

Fight on,

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Jason Simpkins

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Jason Simpkins is an Editor of Wealth Daily and Investment Director of Secret Stock Files, a financial advisory focused on security companies and defense contractors. For more on Jason, check out his editor's page. 

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