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The Impact of Oil Price Volatility on Welfare in the Kingdom of Saudi Arabia: Implications for Public Investment Decision-Making

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Abstract

Since real oil price is positively correlated with real consumption and domestic income in Saudi Arabia, a risk premium should be considered when assessing the net present value of oil-related public investment projects. For projects generating additional oil exports, this risk premium quantifies the cost of increased dependence on oil revenues. For projects transforming oil into products whose prices are less correlated with the Saudi economy, it quantifies the benefit from economic diversification. The value of this risk premium depends on expectations about future consumption and oil price. By considering alternative assumptions, we show that over a one-year horizon this risk premium could range between 1.3% and 5% of the expected oil-related cash flow, with higher premia for longer planning horizons. We discuss the implications of these calculations for energy-related public projects in Saudi Arabia and, more generally, for public decision-making in resource-rich countries.

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... We use the same figure for the year 2050. In line with the value determined by Pierru and Matar (2014) for Saudi Arabia, we use a discount rate of 4%. By applying Eqs. ...
... For instance, it can be used as an input in projects that contribute to economic diversification (which lessens a country's dependence on oil revenues). The economic diversification benefits attributable to these projects are then directly included in the projects' net present value calculation (Pierru and Matar, 2014). The oil used in these projects has to be valued at the opportunity cost, such as determined in this paper. ...
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... The uncertainty surrounding the rate of economic growth has a social cost for risk-averse agents, usually measured as the loss of welfare that a representative agent is willing to incur to remove fluctuations in consumption. Though this cost might be negligible in certain economies, it can be significant for countries that rely on commodity export revenue, as shown by Pierru and Matar (2014) in the case of Saudi Arabia, where they calculate a risk premium of up to 5% on export revenues. Furthermore, Aghion and Banerjee (2005) find that revenue volatility impedes economic growth by creating two problems. ...
... Following Pierru and Matar (2014), who consider a coefficient of relative risk aversion of 2 for Saudi Arabia, we use the following constant-relative-risk-aversion utility function: ...
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... In the last 60 years, when the role of oil in the world economy began to increase rapidly, most of the economic scientists and specialists, politicians, national and international financial institutions and research centers touched on this topic. Grennes and Winokur (1974), Lienert (1981), Jan Fabritius and Petersen, (1981), Jones (1982), Shaffer and Fischer (1982), Helliwell et al. (1982), Looney (1985), Stauffer (1985), Hammoudeh (1988), Adelman (1989), Choucri et al. (1990), Smith (1992), Huntington (1998), Acemoglu et al. (2013), Caselli and Michaels, (2013), Kennedy and Tiede (2013), Pierru and Matar (2014), Brueckner and Gradstein, (2016), Usman (2017), Hassler et al. (2017), , , Murshed (2018), Baumeister et al. (2018), González (2018), Boyd et al. (2000), Zallé (2022). Al-Abri et al. (2019) have identified and examined the phenomenon of the "oil curse" for Oman, the long-and short-term interactions between economic growth from non-extractive sectors, oil revenues and government expenditures by using quarterly data covering the period 2000-2015 together with the use of a vector autoregressive regression (VAR) co-integration model. ...
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... Case study method Direct distribution allows to change the country's perceived inability to effectively manage it vast natural wealth Pierru and Walid (2012) Energy-related investment opportunities for social-oriented decision-making ...
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... Using the parameter estimates given in the previous sections (with r ¼ 0:04=12 based on Pierru and Matar (2014)), Equation (6) gives the same annual value for OPEC's spare capacity to the world's economy as the one calculated by Pierru et al. (2020). Expressed 13 in 2019 prices, the annual value of OPEC's spare capacity amounts to 193.1 billion US dollars. ...
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... For an idle facility located in Saudi Arabia with 40 wells and combined production capacity of 200,000 barrels per day, QUE$TOR estimates annual maintenance cost to be $410 per daily barrel, or $34.17 on a monthly basis. Thus, for an annual real discount rate of 4%, in line with Pierru and Matar's (2014) The incremental barrel of buffer capacity would only be used if there otherwise would be a shortfall. To calculate the expected incremental revenue, we consider the average price ($45.24 per barrel) observed during the three months when Saudi Arabia ran out of spare capacity (from August to October 2004) and use that price (along with the usual formula for marginal revenue) to determine the parameter f as the sum of expected monthly net financial gains over the 240-month life of the facility discounted at 4%, assuming $2 production cost per barrel 13 . ...
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... Matar et al. (2015) consider different policy scenarios for reducing energy consumption in the KSA without increasing administered energy prices using a multi-sector equilibrium model with a mixed-complementarity formulation and Matar et al. (2016) use a similar approach to consider the prospects for coal-fired power generation in the KSA. Two further studies took an econometric approach: Gately et al. (2012) considered the future evolution of oil consumption and its impact on oil exports in the KSA and Pierru and Matar (2014) explored the impact of volatile oil revenues on public investment. ...
... schools, hospitals), as well as paying government employees (Bourland & Gamble, 2011). As a result, income and spending have tended to increase (decrease) during times of high (low) oil prices (Alsweilem, 2015;Pierru and Matar, 2012). Table 1 displays oil revenue as a percentage of export earnings, state budget and overall GDP in several oil-exporting countries. ...
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The rapid growth of domestic oil consumption in Saudi Arabia and the opportunity cost of oil exports forgone
  • D Gately
  • N Al-Yousef
  • H Al-Sheikh
Gately, D., N. Al-Yousef N. and H. Al-Sheikh (2012). "The rapid growth of domestic oil consumption in Saudi Arabia and the opportunity cost of oil exports forgone." Energy Policy 47(August): 57-68. http://dx.doi.org/10.1016/j.enpol.2012. 04.011. Gollier et al. (2011). "Le calcul du risque dans les investissements publics." Report 36, Centre d'Analyse Strategique, Paris. Gollier, C. (2012). Pricing the planet's future: the economics of discounting in an uncertain world. Princeton: Princeton University Press. pp. 177-179.