“A New Price Era in a Time of Climate Action: Towards a Resilient and Responsive Saudi Economy”

By Noura T Al Saud & Mashael AL-Shalan

January 24th, 2016

The relentless pace of major consequential world events in recent years molded some of us into ardent pessimists. The world seemingly feels more vulnerable today than it has ever been; as we struggle to sustain a delicate balance between maintaining security and fostering economic growth. Less imminent and tangible of a threat, the issue of climate action has long been simmering behind the headlines. A convoluted manifestation of the “tragedy of the commons”, the issue of climate change carries a set of characteristics that have rendered it a unique and difficult issue to resolve. So it should come as no surprise that even the most skeptical amongst us cannot help but view the recent adoption of the Paris Agreement on climate change by all 196 nations as a beacon of global cooperation and coordination.

Failure of past experiences in climate negotiations − notably that of Kyoto and Copenhagen − led to the realization that a different approach was necessary. The aim in Paris thus became to adopt a voluntary agreement that grants each sovereign country the flexibility in proposing its own commitments depending on its socio-economic circumstance and global positioning. As such, it set out to establish a “global action plan” to “forestall and avert dangerous climate change” based on intended nationally determined contributions (INDCs). These incremental pledges are strengthened and reviewed every five years, after the agreement goes into force in 2020, to ensure legitimacy, inclusion and protection. Yet while the agreement undeniably sends a strong signal to markets and financial institutions about the determination of the international community as a whole to address the problem, the INDCs combined fail to achieve the emissions reductions needed to stave off “dangerous climate change”. Meanwhile, the long-term goal of the agreement is to “achieve a balance between anthropogenic emissions by sources and removals by sinks of greenhouse gases in the second half of this century”. This means that we have essentially only succeeded in writing the ‘first draft’ of what is needed to address this complex collective action problem.

Climate science warns about the net-negative effects the unabated, human induced emissions have on the planet. However, these consequences are geographically dispersed, globally varied and have consequences that intensify over longer time scales, falsely masking the urgency of addressing the problem. Tackling the problem also requires global cooperation and coordinated actions: no country can unilaterally reduce or stabilize greenhouse gas concentrations, just as no group of countries is willing to act unless all or most other major emitters ensure cooperation. More importantly, responding to climate change requires large financial undertakings and a substantial overhaul of existing energy systems, infrastructures and development norms. This requires both technical and financial expertise to ensure stable growth, economic prosperity and poverty eradication, especially in developing countries. The incentives to act differ, and this matters greatly.

The Kingdom of Saudi Arabia − often viewed as the recalcitrant player in the climate negotiations − has spearheaded a sincere effort in recent years to engage with international partners in an attempt to reach an agreement. However, as national circumstances and priorities differ, Saudi Arabia faces its own unique set of challenges as it seeks to decouple economic growth from oil revenues. So while the Kingdom views its contribution to the global climate challenge necessary, it cannot neglect its development priorities, especially at a time of economic uncertainty and rising security threats. In fact, the Kingdom views emissions reduction as mainly a product of economic diversification and development, and is thus a prerequisite for its continued contributions.

In the past few weeks, echoes of a Saudi economic shakeup began reverberating around the globe following the recent budget announcement and structural economic reforms. While this may initially seem as a move in haste to alleviate a dire fiscal situation, it is rather a shift from an inert system towards a more flexible structure able to cope with the dynamic events. Indeed, the low oil price environment has been a disruptive force, but a driving one nonetheless. It has mobilized swift action towards restructuring a long time resource dependent system, crippled by a capricious appetite for a hitherto prized commodity. While this marks a cardinal move towards a healthier more robust economy, such actions could also be seen as a first step in delivering on the Kingdom’s emissions reduction contributions through mitigation co-benefits.

Built on the riches of oil, the Kingdom of Saudi Arabia has long sought prosperity through the sales of this treasured resource. Over the past four decades, this resource wealth enabled the government to transform the country from a traditionally nomadic society − reliant on subsistent agriculture and Islamic tourism − into a modern country with a solid financial system through rapid economic and social transformations all while maintaining its Islamic identity. This growth was achieved at a rate faithfully concomitant with the value of crude oil.

Undoubtedly the Kingdom’s main engine for growth, oil has long been considered an unreliable commodity by the government. Despite nine development plans aimed at diversifying the economy since the 1970s, oil remains the main engine for growth. Today, oil revenue makes up over 80% of total export revenue, and 90% of government revenue, with the oil sector accounting for over 40% of the country’s GDP. Historical economic trends of Saudi Arabia make evident the strong correlation between oil prices, government spending and economic growth. The priorities of each development period is thus manifested in those trends, which display declines and sluggish growth in per capita GDP at times of high public debt, increased foreign investments and military spending. Over the past decade, high oil prices allowed the Kingdom to invest in international foreign assets while achieving decent economic growth. Complicating matters further, data from the Saudi Arabian Monetary Agency shows that growth in the private sector is highly correlated with government spending − itself contingent on oil prices − indicating a highly reliant private sector. Historically, the most seemingly significant changes in GDP that were indicative of a more diversified economy, were achieved when oil prices were in decline − right before the fourth development plan of 1985 -1990 − and the share of the non-oil sector rose as a consequence to 73% of GDP. Purportedly one of the most successful diversification attempts, the trend was reversed in the fifth development plan. The unsustainable trend of the fourth development plan was mostly due to a continued dependence on the public sector despite private sector growth.  While proving more resilient than the oil sector, per capita GDP remained relatively low as oil exports (despite declines from previous periods) remained high relative to total exports (88%), yielding lower revenue in a time of lower oil prices and or lower output levels. The private sector’s contribution to GDP, despite an increase of 11.5%, also remained on the lower end (just below 50%). Additionally, the increased share of private and non-oil sector contribution was due to the successful completion of the previous development plans which laid the necessary infrastructure for the private sector at the time to enhance its role in the economy. Nevertheless, population growth, recovering oil prices, and continued dependence on government support limited contributions from the private sector.

Given the dip in the price of oil, the fiscal episodes of 2014 and 2015, when the country experienced its first budget deficit since 2009 of SR 54 billion ($14.4 billion) and SR 367 billion in 2014 and 2015 respectively, come as no surprise. The security situation in the region has further added strain to this already stressed budget, where additional funds were mobilized and spent on government sector employees, beneficiaries of social security and retirees (77%) as well as on military and security projects (17%). The downward spiraling price of oil has already taken its toll on the Kingdom’s fiscal standing, especially in light of regional security threats. Fortunately the Kingdom’s strong financial system and the large reserves it accumulated over the years of high oil prices has kept its economy afloat and stable. In a welfare society that relies almost entirely on government support, the risks of unchecked spending and limited economic diversification are high, even during times of high oil prices. At a time of market uncertainty, the incentive to act has never been more compelling.

Efforts to develop the country’s INDC to submit to the UNFCCC began just months before the first drop in oil prices of this decade. In it, the Kingdom noted its pursued efforts to reduce domestic greenhouse gas emissions − which include reduction in methane emissions, a gas twenty times more potent than carbon dioxide but with a drastically shorter atmospheric residency period − through economic diversification and adaptation efforts. Nevertheless, as the Kingdom strives to achieve its sustainable development objectives, attainable contributions to global emissions mitigation remain limited.

A strong, stable and prosperous internal environment is the country’s foremost concern. The Kingdom is heedfully tackling its precarious situation through generous yet responsible and efficient allocation of resources as it addresses wasteful and inefficient spending and resource consumption patterns − focusing on gradual fiscal and economic reform, without relying on external financial support. As it seeks to do so, the Kingdom aims to shift away from a revenue-based economy that critically relies on a single commodity − threatened or not − to one that relies on a balanced mix of economic tools. The economic diversification package that the government introduced earlier this month, which included a slight reduction of energy subsidies, marked the first step of this reform, which will be enhanced over the coming years. If this trend is sustained and enhanced well into the future, subsidy reforms alone would have the capacity to contribute largely to emissions reduction and will unlock the benefits of enhanced efficiency measures currently underway in the Kingdom. This is especially true in the transport sector where unless otherwise, benefits from fuel economy standards could be largely outweighed by low fuel prices in the coming decade. In addition to enhancing efficiency measures globally in the transport, building and industry sector, the IEA report on climate change specifically identifies reducing methane emissions and fossil fuel subsidies in the MENA region as the most important emissions saving measures in the region. Therefore, these undertakings must not be transient. The challenge for the Saudi government is to maintain these policies when the price of crude rises again and not be persuaded towards a profligate return to opulence. For these efforts and policies to be successful, they must be cyclically enhanced and strengthened.

National government policies following the COP21 (Paris Conference) decisions and agreement will dictate the rate of emissions reductions and growth of low carbon fuels. It will not however put an end to fossil fuel demand, at least in the medium-term. Global efforts to curb global GHG emissions will continue and will achieve substantial outcomes as the share of alternative sources grow up to par with oil, gas and coal. But as this happens in tandem with continued growth in energy demand − propelled by developing economies in the east − energy systems globally would still yield an increase of 16% in energy related CO2 emissions by 2040. The transport sector more evidently accounts for one fifth of the current total energy related CO2 emissions and accounts for nearly half of the projected increase in global energy-related CO2 emissions by 2030. While there have been marked improvements in fuel efficiency, demand is nevertheless destined to grow as the global vehicle fleet more than doubles by 2035 and prospects for a switch to alternative fuels remain weak. Even the most optimistic estimates that see the large deployment of EV (electric vehicles) and biofuels for transportation leave oil with 50% of total market share in the road transport by 2040.

Saudi Arabia is a committed partner on climate change. In fact, addressing it is imperative for the country’s well-being. Ultimately, it is not the threat of the greatly exaggerated imminent demise of the oil industry that brought Saudi Arabia to the table. Countries like Saudi Arabia, that have the comparative advantage of a lower per barrel production cost, will continue to be a dominant supplier of crude for those sectors that rely on it until the very last barrel demanded. It is rather the admission that the time of ultimate reliance on a single commodity must come to an end in order to overcome an impasse in development and move towards a system that perpetuates sustainable growth. As the non-oil sector begins to play a larger role in the Kingdom’s economy, the gradual reduction in demand for oil over this century will become even less of a threat as the economy evolves.

From a global emissions reduction perspective, the Kingdom understands very well the inevitable risks climate change has on the environment, both domestically and globally. Yet it is also mindful of the risks that climate action may have on international energy markets and realizes the potential threat that climate response measures could have on demand for its single, most prized commodity − oil.  As such, the Kingdom seeks to address global mitigation through adaptation efforts and technological advancement in sequestration technologies; conditional on international support for capacity building and technological transfer.

This leads to one conclusion: there are no quick fixes. Changes will be incremental and the deployment of back-stop technologies are crucial. If the aim is to put the globe on a trajectory of zero or even negative emissions by the end of this century and beyond, it is imperative that investments in carbon capture and storage technologies (CCS) intensify. CCS in its current state is trapped in its own ‘valley of death’, one from which it sorely needs to come out. The main issues with CCS are not technology related, but rather ones of scaling up economically and global deployment. The focus thus far with CCS development projects have been rather narrowly focused on “proof of concept” and “cost effectiveness” on a local stage, with all eyes being on the outcome of ongoing projects, specifically in Europe and North America. In order to reach the necessary scale, and achieve economic viability, costs constraints must be overcome by governments and the industry. Financial institutions must also be included in the dialogue to mobilize and drive investment in the advancement and deployment of these technologies. Effective global coordination mechanisms must be enhanced to allow states to learn from global experiences − at all stages of the process – to adapt and adopt them according to their respective national environments. The Global CCS Institute and the Carbon Sequestration Leadership Forum are but a few of the much needed entities necessary for enhanced dialogue and mobilizing technology transfers.

Saudi Arabia is poised to play a leading role in these efforts, through leveraging its position as a lead producer of petroleum and petroleum products by harnessing collaboration and technological transfers. The incentives for the countries joining could vary: whether it is to take responsibility for historical emissions, to ensure a future market for their commodities, to ensure future access to them or to even allow countries future flexibility with their Nationally Determined Contributions, in line with their domestic goals. Whether it is the supply or demand that brings groups to the table is of no concern, the focus should rather be on achieving realistic ways of getting on a trajectory that would keep us within a safe temperature range. The IPCC and the IEA both agree, there is no way we could get there without CCS.