But even if Saudi Arabia is safe atop the global energy food chain, it will need to undertake substantial reforms in the coming years. For the most part, Saudi Arabia has managed its oil wealth sensibly and prudently. Within just two decades, it has seen an impressive improvement in many of its human development indicators. Its dependency ratio -- the ratio of working-age people to non-working-age people -- has dropped from 79 percent in 1990 to 49.5 percent in 2011, a figure that is below the OECD average. Likewise, between 2003 and 2012, per capita GDP increased 250 percent, while the economy expanded close to three and half times.
But the future of the kingdom hinges on its ability to curb its domestic appetite for energy. That oil bears the brunt of government and export revenues is undeniable. Encouragingly, however, the contribution of oil to the country's GDP is falling -- from 65 percent in 1973 to under 30 percent last year. Still, Saudi Arabia will have to cut down on domestic consumption in order to preserve its export capacity. Over the last few years several observers, first and foremost Saudi Aramco CEO Khalid Al-Falih, have alerted the world to Saudi Arabia's alarmingly high rate of domestic oil consumption.
On an annual per capita basis, Saudi Arabia's consumption is twice that of the United States and around four times that of Germany, which has an economy that is five times the size of the kingdom's. Energy use per head is also rising, and between 2000 and 2010, domestic oil consumption jumped by around 30 percent -- a considerable opportunity cost for Saudi Arabia. In 2012, 22 percent of total Saudi oil production was consumed domestically, where heavily subsidized fuel encourages energy profligacy.
The situation in the kingdom is worrisome, but fixable. The United States faced a similar predicament prior to 1973, when energy consumption was growing at a rate of more than 3 percent annually. Following the oil prices shocks in the 1970s, the economy became more energy efficient and energy consumption post-1973 grew at less than 1 percent annually. Saudi Arabia appears to be taking similar steps to improve efficiency. For example, 2010 saw the establishment of the King Abdullah City for Atomic and Renewable Energy, as well as the involvement of Saudi Aramco and the Saudi Center for Energy Efficiency in efforts to help foster a national debate about reducing costly energy subsidies and directing them to those most in need.
If Saudi Arabia is indeed going to rise to the challenge, however, it will need to adopt price incentives that alter the mindset inside the kingdom. Already, a public transport strategy -- including a metro and bus system -- is being implemented in major urban areas and power production is becoming more efficient. Still, more is required. Efficiencies at the household level are a must, since that is where around 55 percent of all electricity is consumed (mostly on air conditioning). In particular, energy-saving homes should be standard, since around 70 percent currently have inadequate insulation. Oil consumption could also be reduced through aggressive adoption of renewable energy sources like solar, where Saudi Arabia's has a comparative advantage.
But time is running out for reforms. According to Fitch Ratings, Saudi Arabia's breakeven oil price, the price at which oil revenues cover the cost of expenditures, has spiked from just over $40 per barrel in 2008 to $76 per barrel in 2012. And if public spending continues to rise at the present clip, the breakeven price will soar to unsustainable levels. Saudi Arabia could curtail expenditure at a breakeven price of $50 per barrel and still address all its public sector wage obligations and adhere to a conservative spending program. If oil prices drop to $80 in 2014, existing surpluses would be sufficient through 2030, and last far longer once expenditures taper off in accordance with medium-term stated spending targets. The kingdom does have considerable breathing room on account of its net foreign assets, which are close in size to its $711 billion economy in 2012. These are enormous fiscal buffers that can be deployed should the government want to smooth expenditures over the medium term.
Some analysts have gone as far as forecasting a possible oil shock on the order of the 1986 glut, when prices dropped from $27 per barrel to below $10 per barrel. But the likelihood of oil prices dipping to $50 a barrel in the coming years is low because the era of cheap oil is most likely over. Much will turn on demand, which is set to grow to between 100-112 million bpd by 2035, from just over 89 million today, according to the IEA and the EIA, respectively. The marginal cost of oil for the 50 largest oil and gas producers globally, meanwhile, has been increasing by 11 percent year-on-year -- in line with historical trends. Currently, the marginal cost hovers around $100 per barrel. The claim that prices will be pushed down by alternatives to oil in the transportation sector -- such as compressed natural gas, methanol, and electricity -- might be true, though these alternatives have been around for a long time and they all have their drawbacks. However, Saudi Arabia's oil policy objective is not high prices at any cost in order to fund its fiscal obligations. Fiscal discipline can be applied when necessary without imperiling the country's development needs. The U.S. energy boom is positive and transformative for all, but unlikely to power a shift from a global energy scarcity to a paradigm of plenty.