Oil prices will be much lower for much longer

17 January 2016

Companies will have to change to meet the needs of a region where oil income will be lower for longer than expected

The world is finally coming to terms with the prospect that world oil prices will be lower than previously supposed, and for longer.

Last week, the US’s Energy Information Administration announced it had revised down its 2016 oil price forecast to $40 a barrel. The same week, the IMF’s report on economic prospects for Iraq was based on the assumption oil would be $45 a barrel.

Both projections, nevertheless, still look optimistic. On 14 January, Opec’s basket of crudes was priced at $25 a barrel. The feeling in the market, where the bears are dominant, is that oil could hit $20 a barrel this month in the wake of the relaxation of sanctions on Iranian oil exports. Royal Bank of Scotland said that it could soon go down to $16 a barrel.

Contrarians affirm that oil will be back to $70 a barrel or more by the end of the year. But for this to happen, world oil demand will have to be higher than forecast; Iran, Iraq and Saudi Arabia must reach an oil market-share deal; Opec will have need a credible policy and collaborate with Russia about making it work and oil production in the US must fall.

It is possible that all these things may transpire. But those that banked on oil holding at $60, $50 and $40 a barrel will be sceptical. It will take a change in the fundamentals of the global energy market and time to restore confidence wrecked by tumbling prices. The moment for quick fixes has long passed.

This is unwelcome news for those doing business in and with the Middle East. It’s hard for companies that invested on the assumption oil will be permanently at least $50 a barrel to adjust to the new realities. Careers have been built and investment decisions made on the expectation that the region’s biggest markets, the six states of the GCC, will continue to grow robustly for the foreseeable future.

That is why we are likely in the months to come to see strong reactions in the corporate sector to oil market trends since November, when Opec’s inability to stop the oil price drop became undeniably obvious. Investment and spending decisions will be deferred. Employment vacancies will be left unfilled. And jobs will go.

This will have a knock-on effect across all GCC markets.

So how should companies working in the GCC deal with what is coming in 2016?

The answer is that they need to adjust to the new realities in the way that GCC governments are.

First, non-oil activities will become the engine of the region’s economy, particularly those associated with the needs of its permanent population. These include healthcare, education and housing.

The second is that businesses will have to deal with the fact that domestic energy – from retail gasoline to desalinated water– will cease being relatively cheap. It’s unlikely the GCC will price fuel for domestic consumers in line with world levels. But the implicit subsidy will be reduced and in some places removed.

Third, GCC governments are cutting spending to align it with permanently lower oil prices. This will be complemented by action to increase government income. Indirect taxation, notably value-added tax (VAT), is coming. Lower public spending, including on projects, and higher taxes will affect every business. No one should be under the illusion that their sector will be protected. It will not be.

Fourth, the GCC in general and Saudi Arabia in particular will intensify efforts to reduce the number of foreigners living and working in the region. Not only do they buy foreign goods, many send most of their earnings home. Halving the foreign labour force in Saudi Arabia would drastically reduce its import bill and slash the current account deficit. It makes long-term economic sense. And it will have a profound impact on every GCC economy and every business in the GCC.

Companies that recognise the new realities soonest will withstand what is coming better than those that do not. But all will be affected.

There is a fifth reality and one that is perhaps the toughest to digest. The restructuring needed will take time, something most business leaders do not have and cannot create.

The prudent will recognise that it could be five years before oil returns reliably to $50 a barrel and more. In the meantime, income, growth and profits will be lower than they were in the GCC heyday of 2003-14.

That means the successful will be those capable of competing effectively. If you are not the best in the market, you had better be the cheapest.

And you cannot be both.


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