Difficult times ahead for Abu Dhabi

08 February 2015

The slump in oil prices will slow growth in the emirate’s economy, which is still highly reliant on hydrocarbons revenues

As one of the world’s top five oil exporters, Abu Dhabi faces some tough decisions over the coming year, following the crash in global crude prices.

The UAE’s fiscal breakeven oil price stands at about $80 a barrel, but Brent crude has been trading below $55 a barrel since the start of January.

There have been wide-ranging forecasts of how oil prices might change throughout the rest of 2015. UAE Economy Minister Sultan Saeed al-Mansouri predicted on 26 January that prices would start recovering by the middle of the year.

Revised forecasts

However, analysts at UK bank Barclays have just downgraded their average oil price forecast for 2015 to $44 a barrel, from $72 a barrel in early December.

Analysts appear to disagree on whether the lower prices will cause a short-term boost to demand from slower-than-expected growth in economies such as China and the eurozone.

“We assume Opec will maintain its position, non-Opec supply growth will stay firmly in positive territory, and oil consumption will be slow to respond to lower prices,” says Michael Cohen, an analyst at Barclays.

Abu Dhabi’s economy is the least diversified in the UAE, with the emirate relying on oil for about 55 per cent of its total GDP, compared with 39 per cent for the country overall. Manufacturing, which is the main growth target sector in Abu Dhabi’s diversification strategy, accounted for just under 6 per cent of GDP in 2013, according to official statistics.

Contributions to economic growth from the emirate’s oil and gas sector in the coming years are limited. Abu Dhabi is aiming to expand crude production capacity to 3.5 million barrels a day (b/d) by 2017, from just over 3 million b/d currently, although it is unclear whether Abu Dhabi National Oil Company (Adnoc) is on track to achieve this, given the delays to some of its upstream expansion projects.

Lower revenues

Despite the increase in production, the projected lower oil prices over the coming years will still mean lower revenues for the energy sector. The emirate must therefore look to other areas of its economy to drive growth.

US ratings agency Moody’s Investors Service estimates Abu Dhabi’s real GDP growth was 4.1 per cent in 2014 and expects it to slow to below 3 per cent in 2015. Meanwhile, nominal GDP is expected to drop by 18 per cent if oil prices average $55 a barrel, and by 25 per cent if they average $40 a barrel.

Key fact

The UAE’s fiscal breakeven oil price is $80 a barrel, while Brent crude has cost $55 a barrel since January

Source: MEED

About 90 per cent of Abu Dhabi’s government revenues came from the hydrocarbons sector in 2014, according to Moody’s. If prices average $55 a barrel on stable volumes, revenues will drop by 45 per cent, leading to a fiscal deficit of 1.1 per cent of GDP in 2015, “and a considerably larger deficit when considering the UAE’s consolidated emirate government accounts”, says Steven Hess, senior vice-president at Moody’s.

Fiscal deficit

“A prolonged period of low oil prices would see Abu Dhabi’s fiscal buffer gradually weaken, unless the government limits spending increases and continues to manage effectively contingent liabilities residing in Abu Dhabi’s and other emirates’ public sector corporations,” he says in a recent ratings report on Abu Dhabi.

“At the same time, the government’s large net assets position provides a transition period of several years to adjust to oil price cycles.”

The falling price of oil will have a different impact on the major global oil exporters, and Abu Dhabi is better prepared than most to weather a sustained period of lower crude
revenues. The emirate benefits from strong reserves stemming from an estimated five years of fiscal surpluses, political stability and high per-capita income.

That said, Abu Dhabi’s second-largest sector, construction and real estate, might also have a difficult time in 2015 as the market looks to be stabilising after a period of growth.

Real estate

Average prices for real estate in the emirate were flat in the fourth quarter of 2014, following two years when growth averaged 25 per cent, according to a report by US real estate advisory group JLL.

“Average prime residential prices have remained flat for the first time since the first quarter of 2013 - principally due to the recent decline in oil prices, equities markets and investor sentiment,” says David Dudley, regional director and head of the Abu Dhabi office at JLL. “The stabilisation of sales prices signifies that some of the excessive heat has now been removed from the market.”

Rental prices in the emirate are also expected to slow. Average prime residential rents increased by 4 per cent during the fourth quarter last year, compared with 11 per cent for the whole year 2013, and growth is expected to drop from double digits in 2014 to single digits in 2015 due to an expected slowdown in state spending.

“While we expect a reduction in government spending this year due to the recent decline in oil prices, we expect employment creation and residential demand growth to be sustained from projects commenced while the oil price was high,” says Dudley.

The decline in oil prices will highlight the extent of Abu Dhabi’s success in diversifying its economy to decrease its reliance on hydrocarbons exports.

The emirate’s strategy is enshrined in the Abu Dhabi Economic Vision 2030 report, which includes a call to boost manufacturing’s share of GDP to 10 per cent in 2020 and 24 per cent by 2030. But the proportion has only increased marginally since the plan was drawn up and still stands at less than 6 per cent.

Slow diversification

“The primary goals [of the Economic Vision 2030] are to dampen business-cycle volatility caused by oil price fluctuations and to raise productivity levels among Abu Dhabi citizens,” says Hess. “Nevertheless, diversification has been slow. In 2014, non-oil sectors made up 49 per cent of GDP, compared with 45 per cent on average over the past decade.”

Abu Dhabi’s attempts at expanding non-oil industries and manufacturing have been hampered by a lack of gas supplies as the UAE has moved from being a gas exporter to a net importer. Potential expansions at the emirate’s flagship gas-based petrochemicals and steel manufacturing sites have been slow to materialise and appear to be on hold until further gas supplies can be freed up.

Abu Dhabi is now set to generate increased revenues from the utility sector through a reform of its tariffs. The emirate, which heavily subsidises electricity and water usage, implemented revised tariffs from 1 January, with separate charges for nationals and expatriates.

The Washington-based IMF estimates that subsidies and transfers accounted for nearly 20 per cent of Abu Dhabi’s annual budget, or AED47.8bn ($13bn), in 2014.

The motivation behind the overhaul of its tariff system has been put down to the tightening supply and demand balance for power and water, and the rising pressures on state funds from the drop in oil prices.

Demand for utilities in Abu Dhabi has grown at a rapid pace as its population has more than doubled over the past decade and energy-intensive industries have been developed. As a consequence, a shortfall of both electricity and water is expected in the next few years unless new capacity is brought online or demand growth is effectively controlled through government policy.

Focus on diversification

Beyond hydrocarbons, construction and the target of boosting manufacturing, Abu Dhabi is also focused on expanding its transport, tourism and finance sectors. The emirate has grown in these sectors at a much slower pace than Dubai, but many of the capital’s key projects are aimed at emulating and, in some cases, surpassing its neighbour.

In the first 10 months of 2014, passenger traffic at Abu Dhabi’s airports increased by 19 per cent and the number of hotel guests grew by 21 per cent, according to Moody’s.

Abu Dhabi has strong hotel occupancy rates compared with most major destinations in the Middle East and North Africa region. According to Lebanon’s Bank Audi, the emirate had an occupancy rate of 78 per cent in the first 11 months of 2014, putting it just behind Dubai and ahead of all other rated regional cities including Riyadh, Jeddah and Doha.

However, falling room rates have offset the increase in guests, with average rates estimated to have dropped to $197 a night in the first 11 months of 2014, from $206 in the same period in 2013.

Difficult climate

Abu Dhabi will face a difficult economic climate in 2015, with oil prices expected to remain far below the $100-plus average of the previous four years. The fall in crude prices will not only hit government revenues, but will also have a detrimental impact on private companies serving the oil and gas industry.

Furthermore, it could have a knock-on effect on real estate prices and may prevent some major planned projects from moving into the construction phase.

But the sizeable financial reserves built up during the years of high oil prices place Abu Dhabi in a relatively strong position to ride out the trough market and should ensure the emirate does not require major budget cuts to balance the books.

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