Saudi Arabia’s budgets for 2007 and 2008

CGES | FEBRUARY 2008 | SOURCE: Global Oil Insight

When the Saudi budget for a specific year is published — usually in the preceding December — a lot of essential information is missing.

On the revenue side, details regarding the funds obtained from hydrocarbon sales are not available; only a general split into oil and non-oil revenues can be found in the Saudi Arabian Monetary Agency’s (SAMA) Annual Report — and this only for prior years. Nor do we have any information on how much income is likely to be generated for the state from the sale of oil products and natural gas to domestic consumers.

Finally, we have no idea what non-oil revenues consist of — that is, the actual contribution of investment income, taxes, fees, charges, customs duties and the zakat to the Saudi government's non-oil revenue stream.

On the expenditure side, the published budget estimates do not inform the public about the respective allocations made for current and capital expenditures; once again, the split can only be found in SAMA’s Annual Report — and then a few years in arrears.

Although some information on the nature of the expenditure involved is divulged in the appropriations for the major sectors (education, health, municipalities, transport, infrastructure, etc…) and public institutions, these do not add up to the estimate of total expenditures.

Significantly, a breakdown of current expenditures by category — such as wages and salaries, supplies and services, subsidies and foreign aid, interest payments, etc… is not shown, which is an important omission given that wages and salaries typically make up at least 65% of total current expenditures.

One other important item is not included in the budget at all: it concerns the financing of the so-called special projects. These special projects and the amounts of money allocated to them are considered off-budget items and are shrouded in complete secrecy.

One such project is the long-standing al-Yamamah arms contract with the UK’s BAE Systems, while other projects are thought to cover the expansion, upgrading, renovation and maintenance of the two holy sites in Mecca and Medina, the construction of underground oil product storage sites and additional arms-related deals.

The published Saudi budget figures Table 1 shows the 2007 Saudi budget versus the actual outcome. Revenues last year of $165.7 billion exceeded the budgeted amount by no less than $59 billion.

As is customary, no breakdown was given for actual revenues and expenditures in 2007, which will be published eventually in SAMA’s annual report during the second half of 2008. To provide a reasonable estimate of non-oil revenues, we have to make projections from the values given for previous years.

In 2005 non-oil revenue was $15.9 billion and in 2006 it amounted to $18.5 billion, as published in SAMA’s 2007 Annual Report. According to SAMA’s notes, however, non-oil revenues in 2006 included a SR 9.4bn ($2.5bn) surplus from 2004 and 2005; deducting this surplus yields a figure of $16bn for the year 2006.

It has been observed that the share of oil revenues in the total has been increasing in line with the increase in the Kingdom’s oil revenues. This is to be expected, since non-oil revenues move very slowly upwards from year to year due to their limited sources. The share of oil revenues in 2005 and 2006, according to SAMA’s published figures, amounted to 89.4% and 89.7% respectively (see Figure 1).

It therefore seems reasonable to assume that the share of oil revenues in 2007 reached 90% or $149.2 bn, leaving $16.5 bn as non-oil revenues.

Gross and net Saudi oil revenues

It is not immediately obvious how the $149.2 bn figure for oil revenues accruing to the Saudi government is derived, since a back-of-the-envelope calculation yields a much higher figure for Saudi revenues earned from selling oil abroad (assuming domestic sales merely cover costs).

Saudi oil exports for 2007 are estimated by the CGES at 7.34 mbpd [given oil production of 8.72 mbpd and domestic oil consumption of 1.38 mbpd]. Based on a sales price of $64.2/bbl for the Saudi blend of crude oils, these exports should have generated oil revenues of $172 bn for 2007, way above the $149 bn we have estimated after accounting for non-oil income in the manner described above.

One explanation for the $23-bn discrepancy suggests itself straight away: the $172 bn figure represents ‘gross’ revenues, whereas the oil revenues entering the Saudi government’s coffers are net of costs (see Table 2).

There are two kinds of costs involved: on the one hand, Saudi Aramco has to meet its operating costs, for which it must receive compensation from the Saudi government; on the other, the company has to fund its capital expenditure (including capacity maintenance), which it can do either by borrowing from the capital markets at home or abroad, or by seeking finance from the Saudi government.

Decades ago, the state oil company received all the proceeds from exporting Saudi oil and then handed to the fiscal authorities the surplus funds that were left over after deducting operating costs and capital account spending.

However, for many years now the Saudi government has been receiving the oil export revenues (via SAMA) and Saudi Aramco has had to seek recompense from the government for the cost of producing the oil and natural gas liquids (NGLS) and submit a request for additional funds for its investment programme (presumably by means of the company’s annual budget, which naturally has to be approved by the Saudi government).

What, then, was the average cost of extracting oil in Saudi Arabia in 2007? According to oil industry lore there was a time in the 1950s and early 1960s when the precise cost of producing Saudi oil was not known, because it was so cheap that no one cared how much it really cost to produce. Those days, however, are long gone.

During the 1970s and 1980s there was much gold plating of oil-production facilities, which obviously led to rising costs. Even so, average operating costs at Saudi oilfields were thought to be around $1.50/bbl as late as 2005, with the cost of maintaining and adding to capacity assessed at about $1/bbl.

Since then, however, the world has experienced severe upstream cost escalation, especially regarding daily rig rates and wages, but also with respect to steel tubing, casing, drilling muds and cement.

We estimate Saudi Aramco's operating costs were around $2.30/bbl last year and maintenance and capacity enhancement costs amounted to $2/bbl, yielding overall average supply costs of $4.30 per barrel.

As a check on the validity of the assumed $2-per-barrel cost of expanding Saudi output capacity consider the following. In a report issued a few years ago, 3 Bernstein Investment Research estimated that the capital cost of adding 2.4 mbpd of Saudi production capacity by 2012 would be $19.5 billion.

On the basis of this estimate and assuming that Saudi Aramco borrows this money at 6.5% (roughly LIBOR + 1.5%, which is also indicative of the opportunity cost involved should Saudi Aramco use government funds), the annual payments to amortize the sum of $19.5 billion over 20 years at an interest rate of 6.5% per annum would be $1,770 million per year.

At an output rate of 2.4 mbpd, or 876 million barrels per annum, the unit costs of boosting Saudi oil production capacity amount to $2.02 per barrel.

NGLs, direct crude burning and special projects

Accounting for the costs in 2007 of producing oil and maintaining and enhancing output capacity in Saudi Arabia reduces the gross revenue figure of $172 bn by $14 bn, but we are still $9 bn short. However, before we seek other means of reducing the Kingdom’s gross oil export revenues further we must first move in the other direction and boost these gross revenues by taking into consideration NGL sales abroad.

Saudi Arabia exported 635,000 bpd of NGLs last year, which we estimate yielded $15.3 bn of gross revenues (at $66.1 per barrel) at a supply cost of $1.9 bn, resulting in net revenues to the government of $13.4 bn. We thus have to find around $22 bn [i.e., $9 bn plus another $13 bn] of ‘costs’ in the broadest sense to arrive at the $149.2 bn figure for net Saudi government revenues from oil in 2007.

One way of doing so is by considering the issue of the direct burning of crude oil in the Kingdom.

The domestic oil consumption figure of 1.38 mbpd for 2007 that was mentioned earlier does not include the burning of crude oil to generate electricity and desalinate water. It is thought that around 250,000 bpd of crude oil was used for these purposes last year, an amount of oil that must be subtracted from the 8.72 mbpd of crude produced in the Kingdom because it was not available for export.

Incidentally, we subtract the direct crude oil burn from the oil produced in the Kingdom without considering the cost side, because we have assumed that this crude oil is priced into the power stations and desalination plants at cost — i.e., no net revenues accrue to the Saudi government from the use of crude oil for power generation and water desalination.

Reducing the amount of oil available for export by around 250,000 bpd due to the direct use of crude oil means that a further $6 bn can be subtracted from the gross oil revenues of the Kingdom, but we are still left with $16 bn unaccounted for.

al-Yamamah and other ‘off-budget’ projects

As already mentioned in the introductory paragraphs, there is an off-budget item — special projects — that has to account for the missing billions. The Kingdom of Saudi Arabia signed an agreement with the United Kingdom in September 1985 for the purchase of 72 Panavia Tornado fighter aircraft, 30 Hawk trainer aircraft, 30 Pilatus trainers, Sea Eagle and ALARM missiles, specialised naval vessels and other arms.

This deal, known as al-Yamamah I (meaning ‘dove’ in Arabic), was accompanied by al-Yamamah II (signed in Bermuda in July 1988) for a further 48 Tornadoes.

Finally, in August 2006 a contract was signed between Saudi Arabia and the UK for the supply of 72 Eurofighter Typhoon aircraft and their weapons systems (al-Yamamah III), and a month later another deal was agreed between the same parties for the upgrading of 80 Saudi Tornado fighters. The value of al-Yamamah I & II was estimated at over £40 bn 4 , while al-Yamamah III (including the Tornado upgrades) is thought to involve contracts worth at least £25 bn.

Payment for the planes, weapons and related systems covered by the al-Yamamah contracts was to be effected by offering oil in kind. In the initial stages the barter oil supplied by Saudi Arabia was lifted and sold by UK-based BP and Shell for a fee; however, later on Saudi Arabia preferred to handle the oil sales itself and pay the UK contractor (BAE Systems) directly in cash.

The CGES estimates the annual value of the first two Yamamah contracts at £2.15 bn and Yamamah III at another £1.0 bn annually. Since payment was based on physical oil, the amount of oil sold each year to fulfil the contract depended on the average price of oil. In a low-price year, such as 1986, 625,000 bpd of oil had to be exported to generate $3.16 bn, whereas in a high-price year such as 2005 only 225,000 bpd of crude oil exports were needed to yield the required amount of oil revenues.

We estimate that last year around 150,000 bpd of Saudi crude oil had to be exported to generate $3.5bn of export revenues to pay for the Yamamah contracts.
Although obviously a lot of oil, 150,000 bpd still leaves us needing further amounts of ‘off-budget’ oil to account fully for the gap in 2007 between the gross oil revenues generated by Saudi Arabia’s implied oil exports and the net oil revenues actually declared by the Saudi authorities.

The volume of Saudi oil exports required to fill the gap, so to speak, is around 550,000 bpd, which clearly remains a considerable amount of oil. Candidate ‘special projects’ that come to mind are the long-standing undertakings by the Saudi government (a) to maintain and upgrade the two holy mosque complexes at Mecca and Medina, and (b) to build underground storage facilities to hold the Kingdom’s strategic reserves of oil products.

While such projects, which ought to have been completed years ago, can — indeed, must — account for the aforementioned revenue gap, the lack of budgetary transparency regarding no less than $13 bn of missing revenues (around 9% of the total) makes the twin tasks of understanding the Kingdom’s finances and judging its economic policies unnecessarily complicated.

Oil revenues and the Saudi budget in 2008

What about oil revenues in the 2008 budget? As Table 1 showed, the Saudi fiscal authorities expect oil revenues of around $108 bn in 2008, on the assumption that oil revenues are 90% of the total projected revenue stream.

Based on our methodology and assuming Saudi oil production of 9 mbpd, local consumption of 1.45 mbpd, direct crude burning of 0.26 mbpd and special projects accounting for 0.7 mbpd (as last year), the implicit OPEC basket price that would generate $108 bn of oil (and NGL) revenues is $50/bbl. Since we expect the OPEC basket price to average around $75/bbl in 2008, Saudi Arabia’s revenues from sales of crude oil, products and NGLS will be much, much higher than $108 bn. How much higher?

The ultimate figure depends on the overall costs of producing crude oil and NGLs in the Kingdom. We have assumed a modest cost escalation of 5% for oil and 2% for NGLs to yield $170.7 bn of revenues for the Saudi state's coffers from exporting 6.6 mbpd of oil (net of the direct crude burn and oil set aside for special projects) and 0.75 mbpd of NGLs, as given in Table 3.

With expected oil-derived revenues of $170.7 bn in 2008 and non-oil income of $17 bn, how large will Saudi Arabia’s budget surplus be this year? The answer to this question depends on the expenditure side of the equation and here there is an inconsistency, for Saudi Arabia’s budgeted expenditure of $109 bn for 2008 is $9 bn below the actual level of expenditure in 2007.

We have therefore assumed that there will be an expenditure overrun against budget this year similar to previous years, yielding aggregate expenditure of $134 bn and a budget surplus of $54 bn — $6 billion more than the surplus in 2007.

Saudi Arabia’s fiscal fortunes thus look set for another bumper year in 2008 on the basis of a predicted OPEC basket price of $75/bbl. What if the oil price ends up lower, though? How low can the Kingdom afford to let the price go before it hits the oil output panic button? With oil production at 9 mbpd and non-oil income not less than $17 bn, Saudi Arabia needs $53/bbl to cover projected aggregate expenditure (including debt interest) of $134 bn.

To retire $14 bn of national debt (the same as in 2007) as well as spend $10 bn on special government programmes brings the desired OPEC basket price to $62/bbl.

The CGES believe that this is the oil price floor for 2008, below which it is unlikely the oil price will stay for long. The equivalent floor price for both 2006 and 2007 was $60/bbl, so we can expect Saudi Arabia this year to follow the general pattern observed over the last two years — namely, of curtailing production (unilaterally, if need be) when the OPEC basket price falls below $60 or so per barrel and boosting output when it surges above this level.

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