Oil prices: Caution is the watchword

24 February 2010

Oil price conservatism is likely to remain a key theme of Middle East states’ budget calculations

With oil prices at about $77 a barrel in mid-February, well within the “fair price” range of $75-85 a barrel set out by the international oil cartel Opec, the Middle East and North Africa’s (Mena’s) oil producers are likely to remain within their budgeted oil price forecasts this year – meaning many will end the financial year with budget surpluses.

But, for those producers who declare their oil forecast prices, caution remains the watchword. A rule of thumb for the Mena region is that government oil price forecasts for the following year are generally about two-thirds of what they actually think the price will be. Qatar, Libya and Oman’s official $45 a barrel projections for 2009 broadly reflect this trend – actual prices for the year ended at $62 a barrel.

Comfort zone

Most Mena oil states anchor their fiscal plans on conservative price estimates that allow them to register slight deficits or small surpluses, in a broad comfort zone that prevents shocks to the system. The last time that actual oil prices went below the budgeted level in Saudi Arabia was 1998, the year when oil prices plunged to about $10 a barrel.

This historical trend has allowed governments to raise spending above the officially budgeted forecasts, in the knowledge that actual oil prices on average come in significantly higher than initially forecast.

Saudi Arabiais a good example. The kingdom posted a fiscal deficit of SR45bn ($12bn) in 2009, the first time it has gone into the red since 2002. This deficit, however, was well below the SR65bn forecast deficit in the 2009 budget issued in December 2008, largely because oil revenues were comfortably in excess of those budgeted for.

In December 2008, the Saudi government budgeted revenues of SR410bn, against spending of SR475bn for 2009. The actual figures showed that revenues hit SR505bn for 2009, while spending was SR550bn.

“Ahmadinejad has been accused of wasting oil money in order to make himself more popular”

Manouchehr Takin, Centre for Global Energy Studies

So, while the low official oil price estimate for 2009, which the local Sabb bank calculated at just $37 a barrel for Arab Light, would have delivered SR95bn less revenue to Riyadh than actually transpired, the surge in prices in the second half of 2009 gave the authorities the leeway to sanction a substantial increase in spending (SR75bn higher than budgeted), which would not cause it to bust its own budget projections.

Actual oil prices last year averaged $62 a barrel, yet the figures from Mena oil producers’ budgeted oil price estimates were almost all lower, ranging from a cautious $37 a barrel from Algeria and Saudi Arabia to $60 a barrel from Iran.

The strengthening oil price climate since mid 2009 has encouraged governments to ramp up their 2010 baseline oil price projections, although caution has not been abandoned.

Saudi Arabia budget

Saudi Arabia budget

Middle East and North Africa - Budgeted oil price of a barrel of oil

Budgeted oil price of a barrel of oil - MENA

From MEED’s sample [see chart, above], Iraq is again the most optimistic, with a price forecast of $62.5 a barrel. Algeria has, inexplicably, stuck with the $37 a barrel price from the previous year. The overall sample (which excludes the UAE, from which no budgeted oil prices have been gleaned) suggests budgeted prices have increased from $40.9 for 2009 to $50.1 for 2010.

There are some heavily ingrained views held by key Middle East oil states about how oil markets should behave, and how this should influence oil price assumptions. As Saudi-based Jadwa Investment bank notes in its 2010 Saudi budget assessment, issued on 21 December 2009, the Saudi government has frequently raised its concerns about the impact of financial flows on oil prices and this view reinforced the importance of using a conservative oil price assumption.

On the other hand, Iraq, facing substantially diminished financial support from the US and the international community in future years, is heavily dependent on oil revenues and therefore requires a higher budgeted oil price to underpin its spending commitments.

Iraq’s 2010 budgeted spending, at $72.4bn, represents a substantial increase on 2009’s $58.6bn spending plan, and is the largest since the post-Saddam Hussein period. In 2005, the first year of full sovereignty since the 2003 invasion, the government submitted a $24.4bn budget. The 2010 projected deficit, at $19.6bn, is also high. With crude oil export receipts accounting for 95 per cent of Iraq’s income (forecast at $53bn for 2010), it is no wonder Baghdad is the most ambitious in its oil price budget forecast. To justify the increased spending, more than two-thirds of which will be absorbed by current spending, including public sector salaries and food rations, the government felt it had to factor in a higher oil price.

Market dynamics

Neighbouring Iran shows similar signs of oil price maximisation. Tehran’s $60 a barrel projection for 2010-11 fiscal year, which underlies a similarly expansionary budget, represents the sharpest break with tradition. In the previous year, Iran had forecast a price of $37.50 a barrel, and in the three preceding years it had budgeted within a $33-39 a barrel range.

The 2010-11 draft budget states that expenditure will reach $368.4bn, an increase of 31 per cent on the 2009-2010 fiscal year. 

“If the government is aiming for the $60 price, it shows they are very much reliant on using oil money for current expenditure,” says Manouchehr Takin, an analyst at the Centre for Global Energy Studies in London.

The $20 a barrel leap in Iran’s oil price projection underlines growing spending commitments, reflecting an economy facing growing isolation and domestic discontent over price increases. It is also clearly politically influenced. Takin says the higher budget suggests the greater tension between government and opposition. “Ahmadinejad has been accused by MPs of wasting oil money in order to make himself more popular and of not thinking about the long term,” he says.

It seems unlikely that the Iranian government has scrapped a conservative price assessment strategy due to a shift in the way it sees oil market dynamics playing out this year, even if prices will clearly remain stronger in 2010 than the previous year. Having proffered a big hike in spending in the draft budget, the Ahmadinejad government needed to recalculate the basis for projected growth in state revenues, about half of which are accounted for by oil export receipts.

If political calculations figure prominently in the budget-setting priorities of Mena oil producing states, there is also clear evidence of a relation between actual oil prices and actual spending patterns. In 2008, when the West Texas Intermediate traded oil price averaged $99.60 a barrel, Saudi Arabia boosted its spending by 24 per cent in excess of its original budget for that year. In contrast, last year, when the WTI average oil price slipped to $61.70 a barrel, Riyadh exceeded its budget by a smaller 15.8 per cent – and this in a year when Gulf governments had committed to launch counter-cyclical fiscal expansion programmes in order to stimulate economies hit by the global downturn.

This year, Saudi Arabia has issued one of its boldest budgets for many years, yet its oil price forecast still looks to be on the cautious side: Banque Saudi Fransi estimates the budgeted Saudi oil price in the 2010 budget to be just $43 a barrel, similar to National Commercial Bank’s $43-45 a barrel forecast.

However, Saudi Arabia has raised its expenditure target by 13.7 per cent to SR540bn in 2010, which would be the biggest spend in the kingdom’s history, on the back of the largest deficit – SR70bn – on record.

The likelihood is that Saudi oil revenues will exceed Riyadh’s spending target by a wide margin, particularly if oil prices retain their current strength. The fact that the budgeted spend for 2010 is still SR10bn below actual spending in 2009, suggests that spending restraint will not be the priority this year.

Nonetheless, official oil price conservatism is likely to remain a key theme in Middle Eastern budget calculations in future, although the consensus does look to be fragmenting at the edges. Iraq and now Iran threaten to break out from the self-imposed caution with higher oil price forecasts.

But, with oil demand remaining fragile and industrial stock levels equivalent to 60 days of forward cover, according to the International Energy Agency, most Mena states are likely to stick with their conservative price estimates for a while longer.

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