The Enormous Political Risk of Saudi Arabia's Oil Reform

Riyadh’s radical economic plan could shake up society.

On June 7, Saudi Arabia laid out its National Transformation Plan to shift away from an oil-based economy. To do so, the plan’s architect, Deputy Crown Prince Mohammed bin Salman, intends to create the world’s largest sovereign wealth fund, to float an IPO of the world’s most valuable oil company and to cut welfare for some of the world’s most heavily subsidized people. Given all of the superlatives, it’s hard not to speculate about the plan’s ambition and viability. And many have. GE has already made an enormous bet, promising to invest at least $1.4 billion in the country.

But even if he can check off all the items on his wish list, the deputy crown prince may not guarantee a prosperous future for his kingdom. By cutting subsidies and ceding some control over its oil industry, Saudi Arabia might surrender an asset rivaling oil in value: political order in a region engulfed in conflict.

The primary cause of difficulty will be the belatedness of the post-oil push. Large economic transitions are most attainable when coffers are full and revenues are high. Saudi Arabia is setting out on a path for diversification under a chronic deficit and persistently low crude prices.

To realize a diversified economy, Saudi Arabia would need to create an unprecedented private sector with six million new jobs by 2030—more if women enter the workforce in larger numbers. The oil boom between 2003 and 2013 created only one-third as many. Saudi Arabia hopes to create 450,000 non-oil jobs before 2020. However, the country needs to create 226,000 jobs a year just to accommodate new entrants.

The prospect of a smooth transition has already passed by. In past years, the kingdom could have invested its massive foreign exchange reserves into the same schemes it now hopes to realize. Instead, Saudi Arabia is using that money to plug deficits nearing $100 billion a year.

Compare that to reserves of $593 billion in February declining by $10 billion a month. Graver still, domestic fuel consumption threatens to squeeze Saudi Arabia’s only significant revenue stream: oil.

The Saudi populace relies almost entirely on domestic diesel and associated natural gas for power. Demand is growing so fast it will shave two million barrels a day from exports by 2020 at current rates. Ironically, Saudi Arabia needs these exports to finance the post-oil future.

The country has long benefited from commanding international oil markets and deriving vast revenues from its oil wealth. Now that boon is a burden.

Without a glide path, Saudi Arabia must find the investment—$4 trillion, by McKinsey’s estimate—to push Saudi Arabia toward a new economic future. Doing so could destabilize the kingdom, the world’s biggest oil exporter and a U.S. ally.

The tough timetable has already prompted several unprecedented decisions, most notably the move to float an IPO of Saudi Aramco. Even if only 5 percent of the company were sold as per current plans, it would be the largest offering in history, estimated at $100 billion.

Deputy Crown Prince Mohammed bin Salman framed the IPO in “the interest of more transparency, and to counter corruption.” Certainly, going public with even part of the company would nudge the kingdom’s finances toward transparency. This may be the problem.

Saudi Arabia, far more so than many of the region’s monarchies and autocracies, maintains an expansive, intricate patronage network of royal family members. While impossible to calculate the exact sum of “family allowances” sustaining the network, it was estimated at $37 billion in 1996 with revenues from one million barrels of oil going entirely to “five or six princes.” This figure has likely grown since.

Family stipends offer political stability in a country without direct hereditary succession and where opposing factions within the family loom large. Going public with their stipends endangers the long-standing bargain of cash for compliance.

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