Mira AlShankitiMay 5, 2011

Did Saudi Arabia’s discovery of oil

pave the country’s road towards

development… or towards a

mirage?

I. Introduction

The discovery of Oil in Saudi Arabia was assumed to eventually lead to the country’s

advancement by aiding in economic development and a change in the society culture.

Nevertheless, although revenues do stream from oil exports, Saudi Arabia’s “black gem”

couldn’t overturn the external shocks associated and lead the country toward development.

II. Economy of Saudi Arabia prior to the oil discovery

Saudi Arabia suffers from harsh weather conditions associated with its geography being mainly

a dessert. This prevented much settlement in the area. The Arab Peninsula’s wealth was

depended on trade and pilgrimage.

In 1750, Muhammad bin Saud and Muhammad Abd-Al-Wahhab joined forces to create a

political entity in the central of the Arabian Peninsula. For 150 years, several confrontations

occurred between the Saudi rulers with Egypt, the Ottoman Empire, and other Arabian tribes.

Before the 1930s, Saudi Arabia was consistent of multiple differentiated regions:

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- Western Province (Al-Hijaz): The western hemisphere was an agriculture province. Its wealth

depended on agriculture, trade, and provisions paid by pilgrims travelling to Mecca or Al-

Medina.

- Easter Province (Al-Sharqiyah): The eastern hemisphere’s wealth dependent on the

production of dates and crops.

In 1902, King Abdul Aziz Al-Saud, founded Saudi Arabia, unified the different regions under the

name of Kingdom of Saudi Arabia. Thus, the Al-Saud’s dynasty began.

The scarcity of water and the existence of few natural springs and wells formed the separated

habitation of people (as people congregate near a water source), and created a very tribal,

antagonistic environment where clusters of people controlled a different area of the land,

resulting in difficulty in travelling and foreign infiltration.

III. Direct short-term effects associated with the oil discovery

Prior to the discovery of oil in Saudi Arabia, the US was an oil exporter and was supplying its

allies in World War I. The policy that was adopted by the US at that time was to establish an oil

open market. The US, officially, was not seeking for an additional oil reserve, as reserves in Iraq

were monopolized by British, French, and Dutch oil companies. However, on March 15, 1938

SoCal (Standard Oil Company of California) discovered oil reserves in Saudi Arabia and started

the establishment of the company Aramco; consisting of three companies: Standard Oil,

Texaco and Mobil.

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ii. Economic effects

After the oil discovery, commercial production started during WWII. The wealth generated from

the oil enabled the country to supply the population with free health care and education

without collecting any taxes.

However, a decade after the discovery, the wealth generated from the oil production was not

reflected on the economic conditions of the country. Due to the corruption of the royal family,

the revenue generate was in the hand of the elite.

iii. Social effects

At the time of the oil discovery, Saudi Arabia was largely populated with nomadic tribes.

Foreign presence was seldom present. The existence of a foreign company in Saudi Arabian soil

was not highly acceptable. People resisted the foreign manifestation and protested immensely

calling for their expulsion.

In 1953, Saud bin Abd-AlAziz took control over Saudi Arabia. His luxurious way of living and his

enormous expenditure towards alimonies for tribes in order to gain their support forced the

Saudi Arabian currency, the Riyal, to devalue even though the revenue from oil production was

increasing.

The underdevelopment of the society, the invisible advancements in the economy, and the low

wages made the population realize the dual living standards that were existent. Protests started

and strikes were formed but, however, in 1956 an official decree was announced prohibiting

the formation of any strike or protests.

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iv. Legislative effects

Saudi Arabia is ruled by monarchy which is reigned by one family; Al-Sauds. Some studies show

that the discovery of oil in non-democratic countries would lead the country to face a slower

move towards democracy. It states that when a country discovers 100 billion barrels of oil, the

discovery pushes the country’s democracy score 15 points downwards. For further proof,

Bahrain, which is an adjacent country to Saudi Arabia and doesn’t have oil, possesses a

democracy score 15 points higher. Jordan, another adjacent country to Saudi Arabia and not

owning any oil reserves, possesses a democracy score which is 30 points higher. 1

When oil was discovered, foreign companies were the sole owners of Aramco. The concession

among the Saudi Government and Aramco was tilting towards Aramco’s benefit. The

application of such absurd rules by the Saudi government reflect the King’s quick need for

money or greediness, his low bargaining skills, and his and his advisors miscalculated

speculation of the oil future production.

The concession stipulates a loan of 50000 pounds to be given to the Saudi government, a four-

shilling gold per net ton of crude production as royalty fee, and an unrestricted supply of

specific products generated by Aramco. In addition, Aramco was excluded from Saudi taxes and

was granted exclusive rights for the production, exportation, and excavation of oil in the

eastern part of Saudi Arabia. Needless to say, the generous rules which Aramco landed upon

led to Saudi Arabia’s downfall at that time.

IV. The emergence of Saudi Arabia as a leading country within the Arab World

a. Relationship of Saudi Arabia with the Arab world

As a new emerging power, Saudi Arabia decided to keep its relationship close with the

surrounding Arab countries and maintain an authoritative stand within. In the Yum Kippur

1 https://www.res.org.uk/society/mediabriefings/pdfs/2011/03/tsui.pdf

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incident, Saudi Arabia didn’t join forces with Jordan, Syria, and Egypt, but, nevertheless,

decided to offer their assistance by providing annual subsidies to the mentioned countries.

However, with the US decision in supporting Israel, Saudi Arabia had to position itself with the

Arab countries and force its influential stance by forming an embargo on the US and

Netherlands.

Nowadays, Saudi Arabia is considered an influential country within the Arab region. Being the

wealthiest and the most recognized country within the Arab world, aided Saudi Arabia to act as

an ambassador for the Arab countries in front of the western hemisphere several times. Saudi

Arabia’s role in the Arab world has now being long established and will continue to reign for a

long time.

b. Relationship of Saudi Arabia with the US and the Western Hemisphere

In 1930s, the king of Saudi Arabia, Abd-AlAziz, needed further income in order to secure his

position in the kingship particularly after the plunge in revenues due to a plummet in the

number of pilgrims accounted for at those years and the widespread economic depression.

Once a US company showed interest in searching for oil in Saudi Arabia’s soil, a cooperative

relationship started to develop between Saudi Arabia and the US. Thus, a commercial

relationship was formed between the US and Saudi Arabia without the hassle of colonization

that other western countries used to adopt.

By 1944, the US granted Saudi Arabia the loans they

requested and official aid for future advancement after it

was guaranteed that the future production of oil reserve in

Saudi Arabia would cover the debt. Since then, the US

became a net importer of oil.

Since Aramco was owned fully by US oil companies, Aramco was acting as an ambassador for

the US in Saudi Arabian soil. This role adopted by Aramco was a main factor in shaping the

Saudi-American relationship.

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In order to found a successful plantation, Aramco was forced to build the country’s

infrastructure and facilities from scratch. The obstacles faced were more than a few; Saudi

Arabia had no infrastructure at that time, only few Saudi were familiar with machinery, and

materials were scarce.

Aramco took on training local Saudis in order to take over several existent jobs in the company

from educational programs to granting scholarships abroad. Nevertheless, the higher

management ranks were always occupied by foreigners (the separation was halted in 1970s

and 1980s).

The development aided by Aramco assisted in the boost of Saudi Arabia’s economy; more

specialized experts existed in various fields. In addition, Aramco assisted in searching for water

resources and enhancing the agricultural perspective of the country.

By 1950, an agreement was made between Aramco and the Saudi government stipulating the

sharing of profits of oil production by

half. This was considered as a

contribution from the US to Saudi Arabia

in order to facilitate its defense against

the threat of the Soviet Union.

Consequently, Saudi Arabia established

an agreement with the US for leasing the

Dhahran air base for a 5-year contract.

However, by 1980, Saudi Arabia

succeeded in owning 100% of Aramco.

In 1973, an oil embargo was formed by the OAPEC (Organization of Arab Petroleum Exporting

Countries) which Saudi Arabia was a member of. The reason behind the embargo was the

tendency of the US to favoritize Israel in any political matter involving the Israel-Palestine

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situation. US decision to re-supply Israel in the incidence of Yum Kippur witnessed a huge

outrage from the Arab world and ended up in establishing an embargo on the oil production.

The tension that was formulated among Saudi Arabia and the US at that time was being

criticized by other industrialized country whom their economies depending on the import of oil

from Saudi Arabia. Nonetheless, the anchor in which Saudi Arabia steered with forced the US to

lessen their leniency towards Israel and re-establish a good relation with Saudi Arabia.

V. Saudi Arabia & OPEC: Who is the controlling “swing producer” of oil prices?

OPEC (Organization of Petroleum Exporting Countries) is an intergovernmental organization

that supervises the oil production. It sets quotas for each country member for exporting and

stabilizes the oil prices. It consists of 12 countries whose main export is dependent on oil and

their economic stability is highly dependent on their oil exports.

Saudi Arabia is the second largest OPEC member. It possesses 20% of the world’s oil reserves.

Being the largest exporter of oil, Saudi Arabia has an integral influence over the future oil

prices. Although OPEC set quotas for each country’s oil export, Saudi Arabia tends to exceed

their quota in order to meet with the world growing demand for oil.

Having an integral authority over the oil prices gives Saudi Arabia the ultimate power in

becoming the oil swing producer. Saudi Arabia is considered to play a major part in balancing

the oil global market, and their future oil development projects is noted to have an integral role

in raising future oil prices. Five major projects– Khurais, Khursaniyah, Hawiyah, Shaybah and

Nuayyim,- are being developed and which account for 13 billion barrels of reserves are

forecasted to supply the global demand with a 3 million extra barrels by 2015.2

In the period of 1974-1985, Saudi Arabia had the title of Swing Producer within the OPEC. Saudi

Arabia’s large production eased its way towards earning the position. However, the oil embargo

2 http://energy.pressandjournal.co.uk/Article.aspx/947447?UserKey=

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that was formed by the OAPEC caused inflation in oil prices, as oil prices increased from

$3/barrel to $12/barrel. Nonetheless, the increase of oil prices aided towards the formation of

an economic growth in Saudi Arabia as its GDP increased by 1858%. However, the growth in

economy was not witnessed by the whole population as, it was suspected, it benefited the elite

family solely.

VI. The flooding of FDIs

By 1970s-1980s, Saudi Arabia was generating a lot of revenues from the production of oil; it

closed its economy from outside investors. It was believed that the revenues generated could

be the only source used for economic development at that time. Thus, Saudi Arabia became a

self-sufficient country which wanted to be considered as a net exporter. However, the growth

in population and the decrease in oil prices were making the Saudi Arabian government

strategy hard to abide with.

Currently, Saudi Arabia is considered to be a “Success Story” in its ability to attract a huge influx

of FDIs. The main inflows were coming from the US, Kuwait, UAE, France, and Japan. Most of

the FDI inflows concentrated on high-tech services, but, nevertheless, Saudi Arabia witnessed a

growth in FDIs in sectors related to real estate, banking, and insurance.

The foundation of the Saudi Arabian General Investment Authority (SAGIA), the establishment

of foreign investment laws, and the reformation of the judicial system taking into account

commercial laws have assisted in the increase of inflows of FDIs. The cartel created business

incentives that are highly attractive for foreign investors for the purpose of being one of the top

10 countries in the world for investment. Recent statistics showed that the discrepancy usually

present between the potential to attract FDIs and the present inflows is now closing in Saudi

Arabia. This proves the efficiency of the SAGIA and the effectiveness of its approach.

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In the “Doing Business” ranking which is established by the UNDP, Saudi Arabia jumped from

being the 67th in 2004 to the 13th in 2010.

VII. Saudi Arabia’s Exchange Rate

Since 1986, the Riyal was pegged to the IMF SDRs officially while in practice it was pegged to

the US dollar with a rate of 3.75 Riyal/$. In 2007, the Riyal appreciated due to the fact that

Saudi Arabia decided not to follow suit when the US decreased its interest rate as not to spur

further inflation. Nonetheless, the peg to the US dollar was re-applied in 2007.

The reason behind pegging the Riyal to a currency is to deter inflation from occurring. Floating

the Riyal freely would trigger the Dutch Disease; the currency would appreciate, the export

industry would plummet, and inflation would sour.

VIII. The Everlasting Debate: Religion & Economy

a. Sharia law: A reason for the unattained development?

Wahhabis is the sect which is followed by the rulers of Saudi Arabia. A Wahhabi is considered

one of the most fundamentalist sects in Islam. Foreign infiltration was lagged due to the

difficulty in its acceptance.

Since the foundation of the Kingdom, A group of people named “Uli Alamr wa AlNahi” was

formed. Their main objective was to preserve the Islamic laws within the country and advise the

rulers when a decision is to be made. Over the years, the power they exhibited strengthened.

This halted the development within the country.

During the 1970s and 1980s, foreign investment was prohibited. With the poverty that was

engulfing the Kingdom and the uproar of the population, fundamentalism started to emerge.

People started believing that stringent application of Islamic laws will lead to the salvation of

the economy. However, it worsened.

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Currently, King Abdullah II is adopting a modernized reform strategy. Releasing the society

suddenly from all the pillars that were constraining its development could lead to a counter-act.

For that purpose, King Abdullah II decided to modernize the society gradually to deter it from

any external cultural shock that may occur. He focused on education and infrastructure

development. He is developing an Economic City in order to develop the cities in Saudi Arabia.

He founded several new universities, some co-joined with foreign universities such as Harvard

in US and Cambridge in UK.

b. Financial innovations

Saudi Arabia is governed by the Sharia law. In order to preserve the Islam laws, an Islamic

financial banking system was invented. This system consists of:

1. Free- interest financing instruments

2. Cost and profit sharing development instruments

It’s conditioned that the financial instruments are used only

on Sharia-complied projects. As Saudi Arabia consists of

religious, nomadic tribes, the foundation of such a system

aided in the development of socioeconomic aspects and

provided the banking system with an attribute of being

ethical. The banking system was not only a financing mean in

which people could save and withdraw money from, they

development into becoming the core for Saudi’s economic development and played a huge role

is uplifting people’s morals and securing Islamic way of upbringing.

IX. Dutch disease: Could oil “poison” the economy?

Oil accounts for 90% of Saudi Arabia’s exports and 75% of the government revenues. The huge

dependency on oil export and the influx of FDIs in the kingdom to invest in the oil industry

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resulted in a loss in competitiveness for local products against imported foreign products as

imports became cheaper than locally-made products due to the appreciation of the currency.

In 1980, Saudi Arabia witnessed a slump in its GDP growth due to the decrease in oil exports.

The 180 oil glut was formed due to the plummet in the industrial sector all throughout the

world after the 1970’s oil crisis and the inclination of the western countries to develop

technologies which are environment friendly; thus les use of crude oil.

In 1997, Saudi Arabia witnessed another dip in its GDP growth due to a slump in oil exports.

That was caused by several reasons:

1. The Asian Crisis that was present at that time in several countries in Asia which resulted

in less demand of oil.

2. El Nino affected the western hemisphere resulting in a warm winter, thus the lack in

usage of oil-dependent heating systems.

3. Increase of production of oil by countries who were not a member of the OPEC which

threatened Saudi Arabia’s monopolizing role.

4. A flood of the Saudi Arabian oil in the countries due to Saudi Arabia’s reasoning o of

gaining a wide market share and compete heavily with its main competitor at that time,

Venezuela.

The mentioned incidents resulted in a decrease in the oil prices by more than one third and in

addition to a decrease in demand.

a. Saudi Arabia’s Competitive Advantage

Saudi Arabia lacks of competitive advantage on any of its exports. Crude oil consists of 90% of

its exports and the 10% left is consistent of food and machinery which are losing their

competitive edge due to the Dutch Disease that’s engulfing Saudi Arabia.

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X. Steps for the future

a. Constraints against the calculated development

Currently, Saudi Arabia’s exports depend heavily on oil. Only 10% of Saudi Arabia’s export

constitute of non-oil production and employ 6% of the population. Saudi Arabia is aiming

toward diversifying its economy and not to make it highly contingent on oil production.

Agricultural and non-oil industries are being established but, nonetheless, there is still a

mismatch existent between the specialization of Saudi graduates and the jobs’ requirements.

This is mostly visible by the fact that 4.6 million non-Saudis are employed in Saudi Arabia.

In 1970s, Saudi Arabia focused its government spending on

infrastructure. The outcome was paved roads and advanced

seaports that would facilitate the transportation of exports.

In the midst of 1980s, government expenditure was more

focused towards education, health, and social services.

Foreign universities were encouraged to form joint ventures

with Saudi institutes within the kingdom. Reap from

advancement in education is still to be fathomed.

Foreign investments were given tax incentives in order to invest in Saudi Arabia and form joint

ventures with local Saudi Arabian companies. However, they were conditioned to employ a

certain number of local Saudis in the company. This condition was called “Saudiization” and the

purpose of it was to combat the growing unemployment. Private sectors were also encouraged

and offered financing incentives especially if the industry which their business was focused on

was not oil-related. This resulted in a boom in financing and services sector.

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XI. Concluding Remarks

Saudi Arabia has been considered as a leading country in the Arab world. Its effects on the oil

prices oscillations can’t be denied. Nevertheless, numerous reasons have played a huge role in

constraining Saudi Arabia from “graduating” from being a developing country to a well-

developed country. Having oil may have generated extra revenues for the country but has not

substantially aided its economy.

The huge effect of Wahhabis has been hindering the country’s development. To cope with

industrialism, social changes have to take effect in order to adapt with the shifting in economy.

The discovery of oil may have theoretically brought huge wealth for the country but,

nonetheless, it has been used by the few elite, invested in few projects, and rarely used as an

asset to steer the society towards modernization.

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XII. References:

1.http://edocs.nps.edu/npspubs/scholarly/theses/2003/Dec/03Dec_Goetz.pdf

2.http://energy.pressandjournal.co.uk/Article.aspx/947447?UserKey =

3.https://www.res.org.uk/society/mediabriefings/pdfs/2011/03/tsui.pdf

4.http://www.the-saudi.net/business-center/exports.htm

5.http://www.nzibo.com/IB2/growth.pdf

6.http://en.wikipedia.org/wiki/Economy_of_Saudi_Arabia

7.http://www.theodora.com/wfbcurrent/saudi_arabia/saudi_arabia_economy.html

8.http://en.wikipedia.org/wiki/Saudi_Arabian_Monetary_Agency

9.http://www.mongabay.com/reference/country_studies/saudi-arabia/HISTORY.html

10. http://www.saudinf.com/main/e5.htm