Managing Oil Revenue Stabilization Funds: A Framework for Developing Policies

About the Project

Strategies can be developed to mitigate the effects of oil price shocks on the Kingdom’s economy. Oil stabilization funds provide short-run protection against oil revenue fluctuations – in the way that Saudi government deposits and reserves at the Saudi Arabian Monetary Authority (SAMA) have historically served as a buffer to decouple government budget from oil revenue fluctuations. Sovereign wealth funds create income for future generations to replace revenue streams from depletable resources – one of the purposes of Saudi Arabia’s Public Investment Fund. We have developed a framework for optimizing policies for adding to and withdrawing from stabilization funds, which we applied to Saudi Arabia as a case study. We will pursue this work by creating an integrated framework for linking stabilization funds with sovereign wealth funds. Recent data show the dependence of the non-oil sector’s growth to the oil price, whereas the non-oil sector growth is key in achieving the Kingdom’s economic diversification objectives. We will study this dependence with a deep dive in data, national accounts and economic theory.

Key Points

Oil revenue stabilization funds provide short-run protection against oil revenue fluctuations – in the way that Saudi government deposits and reserve at the Saudi Arabian Monetary Authority (SAMA) have historically served as a buffer to decouple government budget from oil revenue fluctuations. By contrast, sovereign wealth funds create income for future generations to replace revenue streams from depletable resources – one of the purposes of Saudi Arabia’s Public Investment Fund.

We developed a framework for optimizing policies for adding to and withdrawing from stabilization funds, which we apply to Saudi Arabia as a case study based on publicly available data. The quantitative results are sensitive to the specific assumptions on the likelihood of particular oil prices arising but the overall results are robust to a wide range of assumptions.

In general, the results match intuition: Withdrawals from the fund occur when oil prices are low and these withdrawals are larger when the fund is larger. However, general intuition is not sufficient to capture the value of optimizing the policies.

In our simulation, assuming that the Saudi government had applied the policies with the benefit of hindsight during the period 2003-2015, we find that the optimization approach can provide the same aggregate economic welfare during the period, but with a reserve fund that is $115 billion larger than the actual outcome at the end of the period.

Looking forward, and assuming random paths for oil prices, the simulated policies lead to fund sizes that fluctuate over time with an average level of $14,512 per capita ($307 billion in total, using the 2015 Saudi population). There is less than a 5 percent probability that the fund exceeds $41,000 per capita ($866 billion in total) and the fund balance falls to zero 16 percent of the time during the simulation period.

By dividing the fund into tranches, we estimate the probability distribution of the first time each tranche would be tapped (i.e., when the lower tranches have been fully used) and show that the higher tranches can be invested in longer duration assets that provide higher returns. This demonstrates why the boundary between a sovereign wealth fund and a stabilization fund is not a bright line.