Riding out low oil prices

04 December 2014

GCC nations brace for budget deficits as Opec offers no oil price support

Speaking to a packed hall of journalists on 27 November, Hasan Hafidh, Opec’s head of public relations, revealed the much-anticipated conclusion of the oil producer group’s 166th meeting:

“In the interest of restoring market equilibrium,” he said, “the conference decided to maintain the production level of 30 million barrels a day as was agreed in 2011.”

The news that Opec would not act to support oil prices, which have been on a downward slide since June, sent a shock wave through global energy markets. The benchmark West Texas Intermediate crude saw its biggest decline in more than five years, slumping by 10 per cent to $66.15 a barrel, as the Opec meeting concluded.

The drop capped a 38 per cent fall in six months, and analysts warned that the scene was set for a prolonged period of low oil prices, due to reduced demand from Europe and China and the US boom in shale gas.

For the GCC, the economic impact of the erosion in prices is formidable.

Well prepared

Lower oil prices have cut total government revenue for the region by more than $480m a day and the bloc has already lost in excess of $110bn in potential revenue.

In the 1980s and 1990s, periods of low oil prices and low government revenues were met with dramatic budget cuts across the region, but this time major decreases are likely to be avoided in the GCC’s bigger economies, although smaller producers will have some difficult decisions to make.

The Gulf’s largest exporters have built up substantial financial reserves over the past 15 years, which puts them in a better position to ride out low oil prices compared with less frugal producer nations such as Russia, Venezuela and Nigeria.

Saudi Arabia is well prepared to deal with the drop in income thanks to its large pool of foreign reserves, worth $757bn, limited government debt, and the low cost of producing its oil.

The GCC’s four biggest economies can all afford to keep spending… the question is: will they just sit back and wait?

Steffen Dyck, Moody’s sovereign risk group

The Abu Dhabi Investment Authority, the UAE’s biggest sovereign wealth fund is worth $773bn, while the Qatar Investment Authority is worth $170bn. Kuwait, meanwhile, has fiscal reserves of about $34bn and a sovereign wealth fund, the Kuwait Investment Authority, worth $548bn. The scale of these financial reserves would enable these nations to maintain existing spending commitments while running budget deficits for several years should they choose to, without having to make politically awkward cuts to capital projects, public sector wages, subsidies, the military, welfare or education.

Speaking ahead of the Opec meeting in Vienna, Saudi Arabia’s Finance Minister Ibrahim al-Assaf told reporters that the slump in oil prices would have no direct impact on the country’s budget for 2015, due to be announced later this month.

“The global oil situation usually in one way or another affects countries’ revenues and debts, but the kingdom has always been keen on building its budgets on estimates that take all possibilities into consideration,” he said.

In light of this statement and similar signals from other senior Gulf politicians, analysts are expect Saudi Arabia, Kuwait, the UAE and Qatar may trim spending in some areas, but will ultimately sustain a high level of expenditure, even if oil prices stay depressed for a number of years.

“Compared with 1986 or 1999, the coffers are full… they can hold their ground for a longer period of time without making cuts,” says Martin Hvidt, economics and politics professor at Zayed University in the UAE.

Spending review

Saudi Arabia-based Jadwa Investments forecasts that the kingdom will run a budget deficit for the next three years, of 1.3 per cent of GDP in 2015 and 3-4 per cent in 2016. It says the government will sustain high levels of spending on both public sector wages and large construction projects.

“There are projects that are already either ongoing or in early phases of contracting with the private sector and these will go on… spending in other areas, like public sector wages, will also remain around current levels,” says Fahad al-Turki, chief economist and head of research at Jadwa Investments.

In October, Abu Dhabi signalled it also had no qualms about running a budget deficit and approved increased federal spending for 2015, making it likely that money will continue to flow into strategic megaprojects such as the federal railway, which will link the country’s seven emirates, and the $3bn Fujairah refinery.

Spending areas likely to see cuts include non-strategic projects such as speculative real estate developments and possibly subsidies.

“Even in Saudi Arabia there is likely to be a slowdown in new projects if oil prices remain at the current level for the next 12 to 18 months,” says Al-Turki. “Non-essential projects will be reviewed and revaluated in light of the recent declines in oil prices before moving forwards.”

When projects are being reviewed, social infrastructure schemes will be given the highest priority, followed by housing and transport.

Jadwa Investments says any delayed projects will only have an impact on spending levels in 2016 and 2017. In November, Abu Dhabi reduced state spending on water subsidies, asking its citizens to pay for water for the first time, although the cuts were primarily concerned with addressing a looming capacity crunch rather than being driven by fiscal pressures.

However, the reduction in water subsidies in Abu Dhabi is likely to become seen as the start of an ongoing trend, according to some analysts, who predict that even the GCC’s wealthier countries will use a period of low oil prices as an opportunity to implement gradual reforms to some of their most wasteful subsidies.

“Theoretically, the GCC’s four biggest economies can all afford to keep spending close to current levels, even if oil prices stay low for 2015-16,” says Steffen Dyck, senior analyst and vice-president at the US’ Moody’s sovereign risk group. “The question is: will they just sit back and wait? I think there is an increasing willingness to address some underlying structural issues.”

Among the larger GCC states, Kuwait’s government has shown some of the most enthusiasm for reforms. It has already revealed a politically unpopular proposal to cut fuel subsidies and plans to reduce subsidies on electricity and water are also being considered.

For Oman and Bahrain, the impact of falling oil prices will to be more troubling due to lower financial reserves, smaller oil reserves, and the higher crude prices required to balance government budgets. The Washington-based IMF has forecast Oman and Bahrain’s fiscal breakeven prices for 2015 at $107.5 and $116.4 a barrel respectively compared with $90.7 for Saudi Arabia and $73.3 for the UAE.

Of all the GCC states, Bahrain is the most vulnerable to a sustained period of low oil prices. Bahrain has been running fiscal deficits since 2009 and total government debt stood at 43.5 per cent of GDP in 2013. On top of its precarious finances, ongoing discontent among its Shia Muslim community, which represents the majority of the population, means that any cuts by Manama risks increasing instability.

Bahrain has seen persistent unrest since 2011, a factor that has made it difficult for the government to implement much-needed reforms, such as reductions in fuel subsidies. In December 2013, Manama announced a scheme to double diesel prices by 2017, but due to political opposition the programme has yet to be implemented.

Oman also lacks a sizeable financial cushion to help it weather lower prices. As a result, the government is preparing to make some uncomfortable policy adjustments. Muscat has made it clear that low oil prices will have a direct impact on the 2015 budget, which is due to be published in December or early January.

In October, the country’s Minister for Financial Affairs Darwish al-Balushi warned subsidy cuts should be expected. The sultanate’s Shura Council has already recommended increasing royalties paid for mineral exploration, as Muscat scrambles to boost revenue. Also being considered are new taxes on liquefied natural gas exports, telecommunications operators, and expatriate remittances.

Bahrain and Oman received support from the other GCC nations during 2011, when they were each pledged $10bn to be distributed over 10 years. Much of this has been spent on creating jobs and pushing ahead with social infrastructure projects to appease angry communities.

New era

Further financial hand-outs may be seen in the coming months or years if the introduction of austerity measures threatens stability.

“A prolonged period of low oil prices is likely to usher in a new era for the GCC,” says Hvidt. “There is no way around structural adjustments in the public sector for some states, something that will be unpopular and could have unpredictable consequences in the bloc.”

Just how much appetite the GCC has for cuts and reforms will be clear from their 2015 budgets, due to be released in coming weeks.

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