Saudi Arabia – a G20 country which sets the record for having the biggest oil reserves in the world – is increasingly being defined as one of the hottest emerging markets of the moment. What’s behind the Kingdom’s recent popularity are the numerous reforms (both social and economic) that the Saudis aim at introducing in the next decade. Their main objective is to diversify their oil-dependent economy and make it more ‘foreign investor friendly’.
Whilst entering the OPEC’s leading country might rightfully be appealing to you, reader, Saudi Arabia remains a conservative totalitarian kingdom, which lacks transparency and, when needed, gets rid of political opponents or human rights activists. Reforms must, in this case, be contextualised.
Brief overview of its politics
Although claimed to be complex, Saudi Arabia political life is quite straightforward. The Kingdom of Saudi Arabia (for simplicity, “KSA”) is an absolute monarchy ruled by the Al Saud family. There is almost no participation in political life, mainly because there are no elections of national bodies. Some formal political apparatuses do exist, but the decisions that matter are always taken within the royal family and senior princes. Political parties are also outlawed. The country doesn’t have a legally binding written constitution, as the main law remains Islamic law (called Shari’a). In the end, the king embodies legislative, executive and judiciary functions. There is little to no space for political opposition, and the kingdom remains very conservative.
Oil: n1 economic driving force
Saudi Arabia’s economy is the largest in the gulf region, and also the only one in the region to be part of the G20 group.
It is oil that drives the economy and brings richness in the kingdom. This is because of its impressive (and also worldwide largest) oil reserves: they account for 19.1% of total global reserves (!). Petroleum accounts for approximately 87% of budget revenues, 42% of the country’s GDP, and 90% of export earnings revenue. This makes Saudi Arabia the most influential country of the OPEC.
Parenthesis on OPEC: Organization of the Petroleum Exporting Countries, founded by Saudi Arabia, Iraq, Iran, Kuwait and Venezuela. It added with time, UAE, Libya, Nigeria and Qatar. Members of OPEC make up a cartel, which has the purpose of coordinating the politics relating to production and export of oil. It is quite a powerful organization as these countries (which control over 40% of the world’s oil supply and 80% of oil reserves) can decide how much oil to export in the market, and therefore greatly influence its price.
It was indeed the discovery of oil that changed the economic situation of KSA. In 1933, when oil in the country still wasn’t discovered, Saudi Arabia granted the ‘Standard Oil Company of California’ a concession in its territory. This meant, in substance, that the American company had permission to search for oil in the Saudi territory. The same year the oil company founded the ‘Arabian American Oil Company’, (Aramco in short). They found the first oilfield in 1938.
During the 1970s and 80s control of Aramco gradually passed to the Saudi Arabian government, which eventually took over it and renamed it ‘Saudi Aramco’ in 1988. The company has today the second-largest crude oil reserves globally and is regarded as the most profitable company in the world (it was recently valued by Bloomberg $2 trillion).
Nowadays still, all Saudi oil production is controlled by state-owned Saudi Aramco (this is different in Russia or in the US for instance, where numerous companies produce and sell oil and act in their own self-interest).
Saudi Arabia’s share of oil production (almost 20%) confers the kingdom an impressive economic power, and therefore makes KSA a very influential player in the financial markets.
This is because of how oil prices work. Oil prices change daily because they are controlled by traders who bid on oil futures contracts. To make this very simple, oil future contracts are agreements to buy or sell oil at a specific date in the future for an agreed price. When deciding the price, traders, amongst other factors, look at oil demand and supply. Saudi Arabia, by withholding three or four million barrels a day of oil from the market, is in the position to drastically influence supply and therefore prices. This is what happened in 1973, when the OPEC countries stopped exporting oil to the US. In just four months, prices quadrupled. Because oil is such a high-demand economic supply, fluctuations in its price definitely have an impact on the global economy more generally.
The problem with oil
While petroleum exports definitely represent a big revenue for the country, many see Saudi Arabia’s dependence on it as problematic.
Problem number one is that the Saudi economy is left vulnerable to shifts in the price of oil, lowered demand, or to the disruption of demand caused by regional conflicts and the Organization of Petroleum Exporting Countries (OPEC) shifting oil production quotas. Saudi Arabia’s economy had grown very steadily due to high oil prices and output, which resulted in fiscal surpluses and very low levels of sovereign debt. However, after prices reached a peak in 2014, they have been on a roller coaster ride. They have experienced a 20% drop just last November. For an economy which almost solely relies on oil, continuous fluctuations are far from positive.
Furthermore, some also point at a longer-term problem. Oil, as most nice things, will not last forever. At the current rate of production, and without the discovery of other oilfields, petroleum in the country will last for 87 years. And even if more oilfields become available as it is currently argued, diversification of its economy calls as an urgent matter.
“Saudi Vision 2030”: time for a change?
To go back to my initial point, Saudis are in the process of making their economy more successful by diversifying and reforming it. Here are some reasons why Saudi Arabia could become an interesting option for investment.
Saudi Arabia’s potential game changer is Crown Prince Mohammad bin Salman (nicknamed MBS), the de facto ruler of the country (his father the king is in fact suffering from Alzheimer’s and his 33-year-old son is now fully in charge since 2015). He was the one to initiate, in 2016, the ‘Saudi Vision 2030’ project. As you may have guessed, this consists of a number of economic reforms aimed at eliminating Saudi Arabia’s ‘addiction to oil and gas’, as well as completely transforming the country’s economy to make it more foreign investment friendly. It also plans to go ahead with some social reforms to boost the Saudi population’s employment and cultural development (women included).
The plan is considered a bit broad and too corpulent to be implemented in just ten years from now. It however places pivotal importance on economic reforms and initiatives.
I. Economic reforms
The diversification plan includes reducing the role of the public sector as driving force of the economy whilst empowering the private sector, which they want to become the new vehicle for economic growth (the so-called ‘privatisation’ plan). It also plans to grow private and foreign investment in key industries such as petrochemicals, biotechnology, automobile assembly, sectors that weren’t open to foreign investment before.
MBS has repeatedly argued that foreign investment is of crucial importance for reform in the country. In fact, when the prince decided that his plan of reforms was going to take place, foreign direct investment in Saudi Arabia was less than 1%. This is very low compared to other emerging markets. He has been on several world tours promoting business opportunities Saudi Arabia can offer the world, mentioning technology and entertainment as new opportunities.
The recent reforms to the Saudi stock market (the Tadawul) have led indexing firms to include Saudi Arabia into the mainstream of emerging markets universe. These reforms include measures to open it to foreign investors, such as new clearing and settlement processes, and rules that allow short selling and securities lending. FTSE Russell announced that the Saudi Stock Exchange will be part of the emerging markets index next March. Investors particularly like stability as well as political reforms, and MBS has been quite successful at spreading hope for a renewed economy and – at least on paper – a progressive country.
Once it is included, the Saudi bourse will be the largest bourse in the Middle East, accounting for around 2.7% of the index. This will definitely increase the possibility of foreign investment in the country, as it would be now possible for institutional investors as well as funds (pension, hedge funds etc.) to buy Tadawul’s stocks. Many investors are also drawn to invest in emerging markets as their growth potential is usually higher and continually evolving.
Some foreign friendly reforms have also been introduced when it comes to establishing a business in the country. At the moment, foreigners are required to both work in a joint venture with a Saudi firm and to obtain a licence from the State. However, since Vision 2030 was implemented, firms or businesses whose work is seen to help in any way the primary objectives of Saudi 2030 plan (diversification of KSA’s economy, development of KSA’s human resources, reinforcement of economic development etc.) are granted special privileges and incentives to work in the territory.
As Saudis foresee ‘Vision 2030’ to be quite expensive, the plan calls for the creation of a big sovereign wealth fund to be funded by an IPO of 5% of Saudi Aramco. It was this decision that caught particular worldwide attention. It was going to be the biggest IPO in history (it was supposed to raise $100 billion with just that 5%, meaning that the entire company is worth $2 trillion or more). Many of the biggest financial centres were battling to have in in their own stock market. The IPO was however delayed multiple times, and its date still remains clouded with uncertainty.
II. Shari’a and business
Reforms are also revisiting the legal landscape too, particularly touching the laws concerning the business world. Again, this is aimed at rendering the country more accessible and transparent to foreigners.
Saudi Arabia’s legal system is based on the Shari’a (Islamic law derived from the Qu’ran and traditions of the Islamic prophet Muhammad). The business world is therefore also regulated by the Shari’a. In short, this legislation consists of a number of Islamic principles which stress the idea of fairness, with little to no space for legal precedent. This has always been a great concern for foreign investors, as many (if not all) foreign firms come from a common law system where legal precedent is fundamental. Moreover, jurisdiction is also said to be unpredictable, as judges interpret the Shari’a according to medieval texts on Islamic jurisprudence.
Some reforms have been introduced in the field, even though they don’t change the religious basis of the system. These include a new bankruptcy law, which will see a commission speeding up the processes and making it smoother. Other reforms also aim at making Saudi courts closer to the legal system abroad. Whilst in the past Saudi judges rarely enforced judgements of foreign courts, last year courts received application to enforce 163 applications to enforce foreign judgements. Finally, with the goal of eliminating the unpredictability of some court hearings, authorities have started to enforce a law that gives judges less room to use their discretion.
III. Saudi population
Finally, MBS has put focus on the Saudi population too. The first key decision is the will to increase the employment of Saudi nationals in private sectors (known as Saudization). KSA has in fact a very young population, with over half of it being under the age of 35. This young population is the target of education reforms. Our Crown Prince wants to see Saudi universities develop into the top ones worldwide, so that young clever Saudis are not forced to abandon the country to study abroad.
Some social reforms are also on the way, especially targeted at women, who were finally allowed to drive last June. MBS has also reopened cinemas, allowed mixed audiences at concerts and in sports stadiums.
MBS’s media coverage has been, until recently, quite positive. Other heads of state have welcomed his plan of reform and economic diversification. For instance, China’s chief Xi Jinping particularly supported the Saudi plan, and during the G20 in Buenos Aires he discussed a partnership between the two countries and harmonizing the Vision 2030 with China’s BRI initiative.
On paper, Saudi Arabia has all the cards to do good and presents many opportunities for a successful foreign investment.
All that glitters is not gold
Despite the positive media coverage and the reformer appearance, many events suggest that crown prince MBS is not so much a reformer after all, and that the numerous reforms are just a nice façade to cover Saudi’s fragile economy and tyrannical politics.
The first aspect that may raise many concerns to the eye of the western investor lies in Saudi Arabian politics. One may argue that the space for political opposition, and for free speech more generally, is not much.
After having announced the greatest reforming plan KSA has ever experienced, MBS has also ordered what is probably the biggest ‘purge’ of the kingdom. As he felt that his country was flooded with corruption, he has ordered November last year the arrest and confinement of some of the richest men in the country said to be corrupt. They were interrogated in an hotel in the capital and, some sources say, abused or tortured before being released or incarcerated. MBS may or may not have done this in the name of corruption, but it is a thing that through this purge he has been able to get rid of high functionaries that didn’t please him and appoint 26 new judges which he probably liked more. Many are suggesting that this has been very useful to strengthen its power.
More recently, the positive public image that MBS was able to build began to seriously crack after the assassination of the journalist Jamal Khashoggi. After being close to the Saudi royal family for years, the Washington Post columnist had recently fell out of favour and went on a self-imposed exile in the US. He was particularly critical of the newly elected Crown Prince, who he did not see as a reformer at all. He has been brutally killed last October in the Saudi consulate in Istanbul, whilst getting some documents to get remarried.
Whilst initially denying any knowledge or connection with Khashoggi’s fate, a month later the Saudi public prosecutor claimed that the journalist was given a lethal injection inside the consulate. Eleven people have so far been charged over the journalist death. The possibility of a connection between the reformer crown prince and the murder shed a lot of negative light on the Kingdom.
And this is not an isolated matter. There were many cases, in the past few years, which saw the arrest of human rights activists or political opponents.
Investors were prompt to dump Saudi Arabia stocks, as they were not willing to enter a country involved in what became an international crisis. The stock market is however a pillar in the Crown Prince’s plan to revamp his country’s economy, and he is probably not willing to see some foreign-relation predicaments ruin his economy. An article from the Wall Street Journal published an insight claiming how MBS had been ready to counter the sell-offs his country was experiencing, all to keep a polished image of his stock markets. They observed how the Saudi stock exchange normally discloses the stock bought by the government. Yet, recent purchases were concealed by public view after the recent crises. It was argued that this is because the Saudi government was routing its money through asset managers at Saudi financial institutions, rather than buying stock directly. These institutions don’t need to reveal their clients. Hence, to an external eye the Saudi stock exchange might look as healthy as ever, whilst in reality, it is only the government that pushes it forward.
Finally, there is also the element of transparency, and the question of whether Saudi Arabia is as prominent as it claims.
Saudi Aramco’s IPO can be taken as an example. Described as the richest IPO financial markets had ever seen, it still hasn’t taken place and has been delayed multiple times. This is raising some doubts if it will take place at all, especially because MBS had placed it at the forefront of his ‘Vision 2030’.
Firstly, there are some concerns on whether the forecast of raising $100 billion from publicly listing just 5% of the company is actually credible. This means that the entire business is worth at around $2 trillion. Many investors argue that it is an overambitious plan.
There is also the question of whether Saudis may have changed their mind. Listing Saudi Aramco on an international stock exchange (London, New York and Hong Kong were willing to have it) means that Riyadh needs to be as transparent as ever (an IPO in fact requires the company to show all his balances and cash flows). The Saudi State and Saudi Aramco’s balances are quite intertwined, so listing the oil company might mean that the state needs to be transparent about its balances too.
In substance, Saudi Arabia reforms are all there and might be working too. However, to make the country truly appealing to the foreign investor, KSA should start from a reform of its political life. More reassured investors would follow.
Camilla is a member of TCLA’s writing team. She is a third year social and political studies student at UCL. She is currently on her year abroad in Germany.