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

Since real oil price is positively correlated with real consumption and domestic income in Saudi Arabia, a risk premium needs to 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 reducing the aggregate risk. 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. Keywords: Risk premium, Oil, Public investment, NPV, Domestic income, Saudi Arabia

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JEL Codes: Q42: Alternative Energy Sources, Q31: Nonrenewable Resources and Conservation: Demand and Supply; Prices, G12: Asset Pricing; Trading Volume; Bond Interest Rates, Q41: Energy: Demand and Supply; Prices, Q35: Hydrocarbon Resources

DOI: 10.5547/01956574.35.2.5

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Published in Volume 35, Number 2 of the bi-monthly journal of the IAEE's Energy Economics Education Foundation.


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