Gulf businesses must plan for growth and volatility

29 August 2010

Oil prices are forecast to rise by almost 100 per cent in the next 25 years in real terms. Volatility will be the biggest challenge facing companies serving the boom markets of the Middle East

The latest oil price forecast from the US Energy Information Administration (EIA) shows oil prices at 2008 prices rising to $133 a barrel in 2035. Assuming inflation trends seen in the past two decades continue over the period, that means we will be paying at least $200 a barrel for oil in 25 years’ time.

Sceptics will take comfort in the enormous margin for error in the EIA’s projections. It forecasts that oil could sell for as little as $51 a barrel (at 2008 prices) or, alternatively, more than $200 a barrel if the energy demand balance tightens significantly in the forecast period.

The EIA reference case also shows world oil demand rising by 30 per cent to 112 million barrels a day (b/d) in 2035. Opec is expected to deliver about 10 million b/d of this increase and Gulf states – notably Saudi Arabia and Iraq – are projected to be responsible for the bulk of the forecast increase in Opec oil production.

You can mock the EIA or quibble about its conclusions. But it is difficult to dispute that the oil exporting countries of the Middle East and of the Gulf in particular, notably Kuwait, Qatar, Saudi Arabia and the UAE, are in an enviable position. Their governments can with confidence prepare long-term development plans on the assumption that their oil sectors, still the most important component of the Gulf economy, could grow by more than 150 per cent in real terms in the years to 2035.

The EIA projection reinforces the view that the GCC could be one of the world’s fastest-growing regions for a generation and will have a combined GDP of at least $2 trillion in real terms within a generation. Despite encouraging signs in other parts of the Middle East, the six countries of the GCC will in 2035 still account for about half the region’s GDP. By that point, average per capita GDP in the GCC will be about what Europe’s is today. Some parts of the GCC will be, on a per capita basis, the richest on earth.

This autumn, the IMF will declare that the downturn that rocked the world economy in 2008 is now officially over. Governments and business will now be able to start thinking long-term rather than reacting. And next year is likely to be the first since 2007 that will allow decision-makers to be confident about the context in which they are working.

For those doing business in and with the GCC, the good news is that growth in the region will be strongly positive and higher than in North America, Europe and Japan. Only the markets of China, India, Russia and Brazil will work in a more benign environment. No other part of the world will be more solvent or liquid.

And yet, the experiences of the final half of 2008, when oil prices fell by half in less than six months, are too recent to be easily forgotten. And fears of a double-dip in Western economies that could precipitate another round of oil price weakness are too well entrenched to be lightly dismissed.

Should those running businesses in the GCC, therefore, devise budgets for 2011 based on the consensus that oil prices will average close to $80 a barrel next year, or should they work on the assumption that oil could fall to $50 a barrel or even lower?

The answer is that this is a false choice. Wise managers make plans assuming high oil prices, but will ensure there are robust alternative plans that can be quickly implemented if oil slumps. This will require defining a preferred budget and then working out a radically different one should prices fall below a particular level for at least three months. It should be comparatively straightforward. Most service businesses can swiftly eliminate or defer discretionary expenditures.

The big challenge is reacting with sufficient speed to a sudden collapse in oil prices, which history shows almost immediately leads to a slump in consumer and business confidence in the GCC. The lesson learned painfully in 2008 is that conventional management information is of little value when oil takes a dive. By the time senior managers became aware of the impact it was having on income and profits, it was almost too late to take appropriate remedial action. Often, knee-jerk cuts in expenditure did little to help the bottom line and only served to damage business’ capacity to respond effectively to the recovery, which quickly arrived in parts of the GCC.

Those running businesses in the GCC need to pay more attention to the pronouncements of those responsible for managing the world economy and global energy markets. They should also listen more to their employees who are closely engaged with customers. Both actions require a different kind of strategic management philosophy, one that is more intuitive than analytical and that allows the customer perspectives to be properly heard.

It is possible that some businesses serving the GCC already have the structures that will make this happen. But it’s more likely that most still rely on historic management accounting figures. If that is the case, then Gulf businesses are once again riding for a fall. This probably won’t happen in 2011 or in 2012, but the oil price busts of 1986, 1998 and 2008 suggest that it will come – and probably sooner than we expect.

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