Saudi Arabia: VAT and OPEC+ Policies of Increasing Oil Supplies

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Table of Contents

Background
VAT Policy
VAT Simulation
Companies’ Response to VAT
OPEC+ Policies
Saudi’s Oil Production
Saudi’s Potential Adaptations and Adjustments
Summary
References

Background

Crude oil is one of the highly demanded products globally, but its price is susceptible to macroeconomy fluctuations. One of the essential members of the Organization of the Petroleum Exporting Countries (OPEC), the Kingdom of Saudi Arabia (KSA), introduced several policies to balance the economy and control the budget deficit (Alsughayer, 2021). Currently, Saudi Arabia is also the largest oil exporter worldwide (Blazquez et al., 2021). The reason for the new regulations was the heavy dependence of Saudi’s economy on oil exports. Indeed, 75% of exports and 44% of its GDP are produced by the oil sector (Blazquez et al., 2021). The first strict policy was implementing a 5% Valued-Added Tax (VAT) for for-profit organizations that was introduced in 2018 (Alsughayer, 2021). The OPEC+, oil exporters and their allies, had to make critical decisions due to the global economic recession caused by the COVID-19 pandemic. This paper aims to evaluate VAT and OPEC+ policies in Saudi Arabia. The government of KSA believes that these regulations will become the primary source of non-oil revenue and stabilize the country’s economy to make it less dependent on oil export.

VAT Policy

The strict VAT policy was introduced in Saudi Arabia to create additional income for the country’s revenue. According to this policy, all purchase orders, contracts, cash flow, and import and export notes require proper documentation and annual reports to the government (KPMG, 2018). This regulation was modified several times since its implementation to approximate Saudi’s system to international standards, and VAT was increased to 15% last year in most business sectors except real estate (Alsughayer, 2021). The introduction of VAT resulted in a sharp increase in point of sale (POS) transactions (Figure 1). Moreover, this policy classified the companies registered for VAT into two groups: organizations with more than SAR 40 million annual sales and firms with less than this amount per annum (Alsughayer, 2021). The former is obliged to submit monthly VAT returns, while the latter pay quarterly (Alsughayer, 2021). If a company fails to make payment on time, significant penalties are applied. Indeed, the implementation of strict regulations resulted in a high compliance rate.

VAT Simulation

Implementing VAT in various sectors can have different outcomes for the country’s income. For example, Figure 2 illustrates the simulation scenario of applying 5% VAT to the electricity and energy sectors. As the graph shows, the introduction of VAT negatively impacts the domestic consumption of these goods both in Government Consumption (GC) and transfer to KSA household (TR) scenarios (Blazquez et al., 2021). In fact, according to Blazquez et al., 2021, “in both scenarios … households respond by decreasing their labor supply, reducing savings and investment” (p. 153). Similar trends were found in other sectors, too, to a varying degree (Blazquez et al., 2021). Overall, it appears that a 5% VAT can diminish Saudi’s household consumption despite unchanged purchasing power.

Companies’ Response to VAT

The Saudi organizations’ perception of VAT was mixed, but overall compliance with the policy was found to be high. The survey among company owners demonstrated that most find the new system relatively complex (Alsughayer, 2021). Furthermore, it revealed that the written regulations and guidelines about VAT are not entirely clear to more than 50% of respondents (Alsughayer, 2021). Nevertheless, almost 90% of the participating firms replied that the cost of complying with the VAT policy is tolerable, and nearly 95% agreed that high costs positively influence compliance (Alsughayer, 2021). It appears that KSA’s companies accepted the new terms without resistance, creating an additional revenue stream for the country through VAT payments.

OPEC+ Policies

OPEC’s complexity and varying nature made it difficult for researchers to clearly define and predict its behavior and responses to market fluctuations. Indeed, Saudi Arabia did not reduce oil production, maintaining its market share regardless of significant price drops over the last several decades (Ansari, 2017). Furthermore, it convinced other OPEC+ countries to keep their shares on the same level (Ansari, 2017). This strategy allowed KSA to attain a relatively favorable state of “low debt and high position in foreign assets” (Ansari, 2017, p. 173). Notably, Saudi Arabia is not interested in too low or extremely high prices for crude oil because the latter results in the acceleration of the development of the field of alternative energy sources (Ansari, 2017). It seems that KSA’s decisions are driven by the desire to preserve its market share.

Saudi’s Oil Production

Although KSA strived to maintain its oil production unchanged, particular periods and events demanded Saudi Arabia diminish it. For instance, as shown in Figure 4, the country had to produce less crude oil in 1985 and 2020 (Oxford Institute for Energy Studies [OIEE], 2021). The former situation was caused by the dramatic oil price drop, while the latter resulted from the COVID-19 pandemic. Furthermore, OPEC+ countries agreed to cut their activity on oil mines due to the pandemic. Hence, it is expected that Saudi Arabia will produce only three million barrels per day in the first quarter of 2022 (Arab News, 2021). It appears that global crises forced KSA to revise its policies regarding this sector.

Saudi’s Potential Adaptations and Adjustments

The coronavirus-induced crisis forced Saudi Arabia to make adjustments to its economy. KSA agreed with other OPEC+ countries that oil production should be minimized (OIEE, 2021). Furthermore, it will likely invest in this sector to assist companies during the recession (OIEE, 2021). Moreover, Saudi’s government will need to implement reforms to diversify its economy, apart from VAT policy (OIEE, 2021). Indeed, the country’s effort should preserve its current oil market share and develop other fields.

Summary

In summary, even though Saudi Arabia had to cut its oil production, it successfully preserved the market share during the disturbing times. Furthermore, KSA’s attempt to diversify the economy produced the VAT policy, which is perceived as a complex but effective system that created an additional source of revenue. Still, Saudi’s government should further develop other sectors to minimize the economy’s dependence on oil export.

References

Alsughayer, S. A. (2021). VAT compliance challenges among SMEs: evidence from Saudi Arabia. Journal of Accounting, Finance, and Auditing Studies, 7(3), 34-59.

Ansari, D. (2017). OPEC, Saudi Arabia, and the shale revolution: Insights from equilibrium modeling and oil politics. Energy Policy, 111, 166-178. Web.

Arab News. (2021). OPEC+ sees little impact from SPR on market. Web.

Blazquez, J., Galeotti, M., Manzano, B., Pierru, A., & Pradhan, S. (2021). Effects of Saudi Arabia’s economic reforms: Insights from a DSGE model.Economic Modelling, 95, 145-169. Web.

KPMG. (2018). Kingdom of Saudi Arabia budget report. Web.

Oxford Institute for Energy Studies. (2021). Saudi oil policy: Continuity and change in the era of the energy transition. In J. Sfakianakis (Ed.) The economy of Saudi Arabia in the 21^st century: Illusions and realities (pp. 1-21). Oxford University Press.

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