Saudi Arabian Oil System

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Case Analysis: Saudi Arabia: Modern Reform, Enduring Stability (A) (HBS Case 9-709-042)

Question #1: How has the global oil system impacted the development of Saudi Arabia?|

Saudi Arabia has taken major strides towards economic reform in the past few decades, and this is largely caused by its increase in revenues from oil. Saudi Arabia is the largest producer of crude oil in the world. It contains a quarter of the world’s known oil reserves, and its state-run company, Aramco, is the highest valued company in the world at $781 billion. Saudi Arabia received 90% of its $230 billion export revenue from petroleum products. It requires that oil prices remain between $49 and $55 per barrel to keep the country operating. Therefore, the global oil system has impacted the development of Saudi Arabia by its regulations of oil prices. There are three main factors that I will discuss that have influenced the global oil system and consequently the development of Saudi Arabia. First is the emergence and growth in importance of OPEC countries, followed by an increase in production from non-OPEC countries. Second is the commoditization of oil and its effect on oil prices. Lastly is the power and importance of state-run oil companies, notably Saudi Arabia’s Aramco.

One of the factors that control the price of oil is the artificial amount of oil supply that is managed by OPEC nations. The OPEC cartel is an intergovernmental organization of 12 oil-producing countries, which possess up to 75% of the world’s proven oil reserves. Saudi Arabia joined the cartel in order to maintain economic stability so they can support their own development projects. It was created in the 1970’s, which is the same time Saudi Arabia was able to develop a more sound economic system. Throughout OPEC’s history, member countries have attempted to control the supply of oil in order to maintain a higher market price for oil. Saudi Arabia, as the largest influencer of the cartel, has been a strong advocate for supply reduction. Unfortunately, some member countries have been oversupplying their oil at a lower cost in order to increase their own market shares. Saudi Arabia was losing 20 billion dollars a year because countries weren’t fulfilling their contracts. OPEC countries have lost some control because the high prices of oil triggered non-OPEC countries to invest in domestic oil production. In 2000, non-OPEC countries supplied 60% of the world’s oil demand. Saudi Arabia recently reacted by seeking higher market share, which indicates sacrificing high oil prices because of the increase in supply.

Another determining factor of oil prices is the financial markets, which analyze supply and demand as well as investor expectations. In the past few decades, oil has largely become commoditized and is therefore more volatile in pricing. Although countries and the OPEC cartel can attempt to control the amount of supply on the market, organizations such as the International Energy Association have developed more transparent and accurate reserve level data. Oil prices are also heavily impacted by the economic growth of major oil importers. For this reason, oil prices fell during the recession since this was a strong indicator that demand would decrease by major Oil Importers. It is for this reason that Saudi Arabia has realized the importance of developing its private sector and loosening its dependency on oil. Losing price control makes it too difficult to estimate growth and therefore budget for development projects. Saudi Arabia has made efforts to open up its private sector, and reduce its barriers of trade in response to oil commoditization.

The final major element of the oil industry, which has impacted the development of Saudi Arabia, is the importance of state run companies. Not only has Aramco contributed to the majority of the country’s GDP through its tax revenues, it has also employed over 54,000 people in 2010. However, because Aramco is...
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