By Ronan Downie
On October 3, the Saudi Arabian Oil Company (Saudi Aramco) completed a issuance of U.S. dollar denominated Sukuk bonds worth $3 billion, just months after raising $6 billion through a similar bond offering in July 2024. The Saudi government itself issued $12 billion of sovereign debt in January of 2024, followed by another $5 billion more recently in May, both in the form of Sukuk bond offerings. This most recent announcement marks a commitment from Saudi Aramco, and by extension the Saudi government, towards a new debt strategy aimed at increasing and diversifying cash flows for Saudi Vision 2030, the kingdom’s plan to diversify the oil-dependent Saudi economy through a wide range of economic projects.
Saudi Vision 2030 was launched in 2016 by Crown Prince Mohammed bin Salman and aims to achieve non-oil GDP growth through projects such as NEOM, a massive urban megaproject with costs estimated at $1.5 trillion. The Saudi government has primarily used the profits of Saudi Aramco, of which it owns 84%, to fund these projects. The petroleum sector has been incredibly profitable for Saudi Arabia, as it possesses 17% of global petroleum reserves and has some of the lowest production costs for a barrel of oil. It costs Saudi Aramco $10 to produce a barrel of oil, compared to a cost of $26 per barrel of oil in the United States. Since oil was first drilled in 1938, the industry has turbocharged the kingdom’s economy into the 17th largest in the world. However, the petroleum industry contributes 64% of government revenues, meaning what the government is able to spend each year is largely reliant on global demand for oil. This is especially true for its investments in Saudi Vision 2030.
The impact of the petroleum industry on Saudi Arabia’s fiscal budget highlights the necessity of the Kingdom’s push to diversify its economy. The kingdom has made significant strides so far with Saudi Vision 2030. A recent milestone announced by the Saudi Ministry of Economy and Planning, Saudi Arabia’s non-oil revenues have reached 50% of GDP, a major goal of Saudi Vision 2030. Foreign direct investment in the nation has also continued to grow, reaching $7.8 billion in 2023. At the same time however, other projects have been delayed or scaled back. NEOM, a giga-project funded by the Public Investment Fund (PIF), Saudi Arabia’s sovereign wealth fund, consists of tourism developments, ports, and most notably, a futuristic city called “The Line” planned to stretch over 170-kilometers in the Saudi desert. The scale of the project is massive, and when announced was the crown jewel of the Saudi Vision 2030 project. However, the project has been met with repeated delays and in April of 2024 has been reportedly scaled back.
As Saudi Vision 2030 has become more and more expensive, profits from the petroleum industry, on their own, are becoming insufficient to fund the project. Amidst a global economic slowdown, demand for oil and natural gas has fallen sharply, most notably from Saudi Arabia’s largest trading partner, China. This lower demand has pushed the price of oil down significantly, trading at $71.21 on September 27. This price is far below the suggested break-even price of $96.20 by the IMF for Saudi Arabia to avoid taking on a fiscal deficit this year, which it already projected at $21 billion in its 2024 budget.
In the past, Saudi Arabia has embarked on multiple strategies to combat lower oil prices. Most notably is its pivotal role in OPEC. The organization has in the past mandated production cuts in order to drive up prices. This strategy had largely been successful, however, following the COVID-19 pandemic, production cuts failed to support oil’s weakening price. The global economic slowdown following the pandemic, which many developed nations failed to shake off, significantly impacted the demand for oil. This is especially true for the Chinese economy which has faced a marked economic slowdown. Not only that, as OPEC has attempted production cuts in the past few years, the United States has simultaneously ramped up its own oil production, overtaking Saudi Aramco’s market share and becoming the world’s number one oil producer at over 13 million barrels a day.
The recent Sukuk bond issuances are a clear indicator of a shift in Saudi’s strategy towards the use of public debt markets to help fund its efforts of economic diversification. Make no mistake, the petroleum industry is still a significant portion of government revenues, and despite weak oil prices, is still enormously profitable. However, rather than pushing for further production cuts to drive up oil prices, Saudi Arabia has decided to use debt to help support its fiscal budget. This debt comes in the form of the sukuk—a debt instrument similar to a bond. Because Islam forbids interest payments from debt, sukuks instead represent partial ownership of a particular asset or project and entitles owners to a share of cash flows resulting from this ownership. The income from the asset ownership supplants the typical interest payment of a bond, making a sukuk bond halal—permissible. The issuance of these bonds offers a unique opportunity to both open up new income streams for Saudi Vision 2030, and also ease the increasing federal deficits opened up by the project’s expenses.
Following a raise of $6 billion earlier this year, the most recent offering raised $3 billion. $1.5 billion of this raise will mature in 2029 at a rate of 4.25%, with the other half maturing in 2034 at a rate of 4.75%. This follows a £650 million bond offering by the PIF in June that received heavy interest from foreign investors. Denominating these bonds in foreign currencies makes them quite attractive to foreign investors, especially due to the relative safety of the U.S. dollar and British pound. The large demand for the most recent offering, eight times the size of the deal, suggests future demand for further offerings. However, future sukuk offerings run the risk of oversaturating the market and damaging demand.
The long-term sustainability of the debt itself for the Saudi government is also a matter of debate. Saudi Arabia’s current debt-to-GDP ratio sits at 27%, giving the Kingdom ample room to take on more debt. However, the yield of the economic projects funded by these issuances will largely determine the efficiency of the debt. The growth of non-oil sectors from Saudi Vision 2030 will have to be closely monitored as their success will impact the value of future debt issuances. While the project has made great strides so far in growing non-oil GDP, more expensive projects such as NEOM have received large amounts of scrutiny.
The future of this strategy also rests on global economic conditions. The success of the Chinese government’s recent economic stimulus package could mean higher demand from Saudi’s largest trading partner, undermining the relevance of the sukuk. The recent U.S. election could shift U.S. policy regarding domestic oil production and tariffs on Chinese goods, both of which would have significant implications for Saudi Aramco. Recent rumors of an oil production increase in December suggest that Saudi’s confidence in oil prices is weakening, likely increasing the importance of debt issuances in funding Saudi Vision 2030. Regardless of this uncertainty, the massive economic diversification projects of Saudi Arabia continue to progress, with the next giga-project beginning production last month.
The views expressed in this article are the author’s own, and may not reflect the opinions of The St Andrews Economist.
Image source: Bloomberg