Saudi Arabia, Where Even Milk Depends on Oil, Struggles to Remake Its Economy

Low crude prices and the war in Yemen have sent a shock through the kingdom’s budget and forced it to revise its social contract even as it seeks to diversify its businesses.

Prince Mohammed’s plan for an economic overhaul has sent tremors through a nation whose citizens have long enjoyed a cosseted lifestyle underwritten by the state. “The government is moving very fast at reforming things in Saudi Arabia, while the people are finding themselves left behind,” said Lama Alsulaiman, a businesswoman and board member of the Jidda Chamber of Commerce and Industry. “Life as usual and business as usual can no longer continue.”

Rewriting the social contract carries high risks for the 31-year-old deputy crown prince, who has staked his reputation on transforming the economy. “People are looking to see if he can do it,” said Ibrahim Alnahas, a political-science professor at King Saud University in Riyadh, the capital. “If so, his future would be king. If not, his future would be lost.”

The vast subterranean seas of petroleum here have seeped into almost every part of the Saudi economy. Crude oil does more than deliver billions of dollars in profits to Saudi Aramco, the state oil company, and Sabic, the chemical giant; it also buttresses energy-intensive sectors like cement production and aluminum smelting.

Saudi Arabia burns barrel after barrel of crude oil for electricity, one of the few countries to do so in large quantities. Commercial air-conditioners cool shopping malls as temperatures outside soar past 100 degrees in the summer, and children go sledding at Snow City, a frigid new recreation center in the capital. Much of the drinking water needed to keep this desert nation alive comes from energy-draining desalination. And the S.U.V.s idling in Riyadh’s enormous traffic snarls drain gasoline.

“It is striking the extent to which every major industry relies on cheap energy, whether directly or indirectly,” said Glada Lahn, co-author of a study for Chatham House, a London think tank, that warned that the kingdom could become a net importer of oil within a few decades if it did not make significant changes.

Saudi Arabia’s about-face last month at a meeting of the Organization of the Petroleum Exporting Countries in Algeria, agreeing to cut production to raise the price of crude, showed the urgency policy makers here are feeling. Prince Mohammed announced plans this year to sell off a small piece of the country’s economic crown jewel, Saudi Aramco, to free up money for investment.

The budget deficit was nearly $100 billion last year. The country’s foreign reserves have dropped by a quarter since oil prices started falling in 2014. The government has taken loans from foreign banks and will try to borrow more from the global bond market.

Hedge funds are wagering that the Saudi central bank will be forced to revalue its currency, the riyal. Zach Schreiber, the head of PointState Capital, which made $1 billion betting that oil would fall, told investors in May that the Saudi riyal was “massively overvalued” and that the country had only “two to three years of runway before it hits a wall.”

The government has abruptly cut construction projects, forcing contractors to lay off workers. This year, foreign laborers set fire to buses in protests demanding months of back pay. The sudden jump in water bills this spring led to such an outcry on social media that the minister for water and electricity was fired after telling customers to dig their own wells if they were unhappy with prices.

“If you’re a Saudi, you’ve grown up with that expectation of the financial largess that’s dished out,” said Adel Hamaizia, the vice chairman of the Oxford Gulf and Arabian Peninsula Studies Forum. “Things are likely to get more difficult for the government in terms of managing frustration from the everyday people.”

Adding to the pressure, the kingdom’s population has nearly doubled since 1990. With half of all Saudis younger than 25, the private sector does not offer enough good opportunities for the estimated 300,000 young people entering the work force each year, especially women. Fewer of the public sinecures that have sustained earlier generations are available, with plans for deeper cuts.

Despite Saudi Arabia’s image as a haven for Ferrari-driving sheikhs with stables full of racehorses, oil revenue is much lower per capita than in small states like Qatar or Kuwait. There is poverty in the kingdom as well as an increasingly anxious middle class.

One evening last month, it was a stifling 99 degrees in Riyadh after sunset, with dust hanging in the air. Um Rashed Al-Rashed was selling jewelry and baskets of seeds at a small souk, hoping to supplement her husband’s modest pension.

“The prices are increasing for everything,” Ms. Rashed said. The couple’s electricity bill after the Ramadan holiday was so high they could no longer afford it, so the power was shut off. “Only a camel can live without electricity,” she said.

On billboards across the country, the king, crown prince and Prince Mohammed appear, eyes toward the horizon, with a purple 2030 logo with the national emblem — a palm tree and crossed swords — above them. The Vision 2030 plan calls for a steady diversification of the economy over the next 14 years.

That would include expanding the country’s mining industries to exploit gold, phosphate and uranium deposits, and building up the financial, technology and entertainment sectors. And while many countries declare that they will generate added revenue through tourism, only Saudi Arabia has Mecca, which more than 1.6 billion Muslims worldwide are instructed to visit on a pilgrimage before they die.

Prince Mohammed gathered business leaders, government officials and even athletes and artists at the palatial Ritz-Carlton in Riyadh late last year to discuss the economic targets his team was developing. Consultants with tablet computers fanned out across the country, surveying Saudis to determine how far the government could pare back subsidies without setting off protests.

After decades of rule by octogenarian kings, some young Saudis said in interviews that they felt energized by the role played by a prince from their generation. “Subsidies should have been done a long time ago. Things are still so cheap,” said Salman M. Al Suhaibaney, a Saudi entrepreneur, holding up his drink to demonstrate. “This bottle of water is more expensive than the same amount of gas.”

Mr. Al Suhaibaney founded an app for tow trucks called Morni, like an Uber for roadside assistance, including fixing flat tires, delivering gas and jumping batteries. His business is in a government-supported start-up incubator in a Riyadh office building. Staffed by 20 young Saudis, Morni is a model for the kind of business the government, and in particular the tech-savvy young deputy crown prince, hopes will buoy the work force.

But more public funds are needed right now to close the budget gap. The government has announced plans to more than triple non-oil revenue by 2020, starting with rising fees for visas, higher fines for traffic violations, and a sin tax on sugary drinks.

Officials have seized on every opportunity to squeeze costs. After cutting pay for ministers, freezing hiring and curtailing regular bonuses and overtime for the entire public sector work force, the government announced last week that workers would be paid according to the Gregorian calendar (as in the United States and Europe), instead of the slightly shorter Islamic Hijri calendar, adding roughly one unpaid workday a month.

“If your salary is going down and your costs are going up, something’s got to give,” said Mr. Hamaizia of the Oxford Gulf and Arabian Peninsula Studies Forum.

Less spending by government, businesses and increasingly strapped consumers means less growth and fewer jobs. The only way to create more jobs for Saudis in such an environment may be by getting rid of foreign workers and replacing them with locals. That policy, known as Saudization, has been pursued at least since the early 1980s and always failed, with the number of foreign laborers ballooning from roughly one million to 10 million.

Now, though, the government is pressing companies harder. Foreign workers cost less, but the government levies fines and refuses to renew visas for foreign workers if business rosters dip below a certain percentage of Saudis. The kingdom’s targets for increasing employment include more than 450,000 new private-sector jobs by 2020.

The Almarai dairy employs 8,000 Saudis among its work force of more than 40,000. On a recent morning, 150 Holsteins moseyed into the milking parlor where workers from Kenya, the Philippines and elsewhere hooked them up to automated pumps. The business — which also produces yogurt and cheese and includes a bakery — has its own training academy for Saudis, drawing 15,000 applicants annually for just 400 slots.

Prince Sultan bin Mohammed bin Saud Al Kabeer, a member of the extended Al Saud royal family and one of those rich Saudis with a stable of thoroughbreds, founded Almarai in 1977 with the help of Irish dairy farmers.

“We try to keep it to a standard that if the prince wants to come in tomorrow with his friends, he’s welcome,” said Tony Gavin, the Irish manager of the largest Almarai dairy farm, in Al Kharj, southeast of Riyadh. Wearing brown shorts and Ray-Ban sunglasses, Mr. Gavin gave a tour of the sprawling farm.

The cows rest under a cooling mist scattered by large fans, the temperature and quantity of water computer controlled. A nutritionist optimizes the cows’ diet with cottonseed from Greece, sugar beet pellets from the Netherlands and locally grown alfalfa.

But the government has dictated that dairies must phase out local feed production because water is so scarce. Despite its arid environment, Saudi Arabia once pursued large-scale farming, even becoming a wheat exporter before all but abandoning cultivation to save water. Almarai has bought farmland in Argentina, California and Arizona to produce alfalfa to ship here.

Still, the business is getting squeezed. While utility and feed prices are rising, the dairy has not been allowed to raise the price of milk.

“We’ve tried in the past, and the king sort of tapped us on the shoulder and said, ‘What are you doing?’” said Stuart Gouk, manufacturing manager at the plant here. Higher milk prices could have political repercussions.

The kingdom’s subsidy cutbacks are expected to deepen. There may well come a point where, as with wheat farming, policy makers will have to decide whether it really makes sense to produce milk in the desert.

“People who visit can’t believe there are cow herds here,” Mr. Gavin said, “but they never thought about where the milk comes from.”