In normal circumstances, the capture of one of the world’s largest super-tankers would register a major shock in the world’s energy markets, triggering a sharp spike in oil prices over fears of a disruption to supplies.

But the situation surrounding the capture of the 318,000-tonne, Saudi-owned oil tanker Sirius Star in the Gulf of Aden on 17 November was anything but normal. Such had been the turmoil on the energy markets in the four months leading up to the theft that the taking of a ship carrying one-quarter of the kingdom’s daily oil output caused barely a murmur in oil prices.

After a five-year bull market when oil prices climbed from $29 a barrel in early 2003 to a peak of $147 a barrel in July 2008, prices collapsed in August, reaching $50 a barrel on 17 November, the day of the Sirius Star capture, and crashing below $40 a barrel in early December, their lowest point in four years.

Rising prices

The lack of response highlights the turnaround that took place in the global and regional economies in mid-2008. The region started the year on a high. Oil prices scored a record average of $72 a barrel in 2007, and crossed the $100 a barrel threshold in early January 2008.

In March, US investment bank Goldman Sachs predicted $200 a barrel was not too far off. The US and other energy importers called for the oil producers to take action to reduce prices by pumping more oil, and to invest in additional capacity.

The producers countered that there was plenty of oil available and no need to pump more. For them, it was the weak dollar and the irrational exuberance of speculators that were pushing oil prices far above those dictated by the supply and demand fundamentals.

Nonetheless, following a visit by US President George W Bush to Riyadh in June, and an extraordinary Opec summit, also in Riyadh, in July, Saudi Arabia agreed to boost production by 500,000 barrels a day (b/d) to about 12.5 million (b/d). As if trying to prove the oil producer’s argument that the market was following no logical pattern, oil prices rose further.

For anybody working in the region, the chief concerns throughout the first half of the year all related to an overheating economy and oversupply of money. Rampant inflation was driving up the cost of doing business, and a chronic lack of resources was undermining project delivery. And despite the year-long contraction in the credit markets that was pushing up the cost of debt, profit margins were rising and business opportunities plentiful.

Everything changed in August. The collapse in oil prices in the second half of 2008 was the result of a growing realisation that the global economy was facing a sharp slowdown in 2009, leading to a huge drop in demand for oil. The fears of a global recession started with the failure in September of US investment banking giant Lehman Brothers, a victim of the credit crunch. The failure triggered panic in the world’s financial markets.

Many of the Middle East’s main financial markets and leading institutions, and even governments, are significantly exposed to the US property market through secondary debt bought from US investment houses such as Lehman. The ramifications of that exposure will rumble on into 2009 and beyond.

But the biggest impact of the global financial crisis on the Middle East will come from falling oil prices, which will derail the region’s spectacular economic growth. The Gulf’s latest oil boom, which began in 2003, has been characterised by a sharp rise in construction activity as governments have sought to reinvest their oil gains into the development of much-needed infrastructure, and create jobs for a growing young population.

Since 2003, there has been a surge in the construction of power stations, roads, airports, energy infrastructure and water facilities in the Gulf. In parallel, there has been a wave of private investment in commercial and residential real estate development in centres such as Dubai, Abu Dhabi, Doha, Jeddah and Riyadh.

According to Gulf projects tracker MEED Projects, the value of major projects planned or under way in the Gulf at the start of 2008 was $1.8 trillion, up 400 per cent in the three years since the start of 2005, from about $360bn.

For the first seven months of 2008, the rate of projects growth accelerated. By the end of October, the value of projects planned or under way in the Gulf had reached a staggering $2.9 trillion, an increase of 62 per cent in the first 10 months of the year. At that rate of growth, the value of major projects in the region was due to hit $3.2 trillion by the end of the year.

The first sign of just how badly the oil falls would hurt the Gulf came in early November, when the region’s real estate sector, which had characterised the boom for so many years, started to crash. The situation was worst in Dubai and Abu Dhabi, where property developers were already shelving major new developments, and cutting back on staff numbers.

A report by HSBC published in late October claimed that property prices in Dubai fell by 4 per cent in August. More surprisingly, HSBC reported an even greater fall of about 5 per cent in neighbouring Abu Dhabi over the same period.

The reason for the sharp falls in the real estate sector was the high proportion of property purchases being made by speculators, buying not yet built properties off plan on the expectation that a rising market would enable them to sell at a profit once the property was built. As soon as these investors lost confidence that the market was going to keep rising, the investments stopped and prices fell sharply.

As the gloom surrounding the global economy spread through the autumn and oil prices continued to fall, it became clear that governments would also have to start reining in their project spending.

Most governments in the Gulf based their 2008 budgets on an estimated oil price of $45-55 a barrel. As long as oil prices remained comfortably above $60 a barrel, there would be no let-up in activity.

As oil prices fell below $50 a barrel in mid-November, it became clear that a sharp slowdown in project activity was looming.

While most projects under way would be completed as planned, it became clear that all but the most essential future projects would be shelved.

The list of projects at risk of postponement includes energy projects that were fast-tracked to meet growing demand. With no more calls for increased oil production, there is less urgency for refineries.

The drying up of the debt markets as a result of the credit crunch has led to the postponement of many debt-financed schemes across all sectors, but in particular private-backed property and industrial developments.

However, amid the gloom, there are strong reasons to remain optimistic. The region’s governments are committed to long-term investment strategies aimed at nullifying the political time bomb created by the region’s rapid demographic expansion.

Some 65 per cent of the GCC population are under the age of 25, and governments need to attract huge levels of investment to create jobs. The development of modern physical and institutional infrastructure is essential if they are to deliver this goal.

Market volatility

The rapid growth of the economies of China and India means that global demand for energy will remain high over the long term, despite the short-term volatility in the market. The region’s governments are also sitting on huge sums of cash as a result of the record windfalls of the past few years. These will be used to sustain essential project activity.

A slowdown will be good for the region, provided it is not prolonged. With inflation of about 15 per cent in the UAE, 20 per cent in Qatar, and approaching 10 per cent in Saudi Arabia, where it is traditionally low, governments and businesses alike were struggling to keep a lid on spending.

For businesses, the problem of rising costs had threatened to wipe out profits. Such was the speed of the cost rises that contractors and suppliers found themselves lobbying hard throughout the first half of the year to enter into profit/cost-sharing partnerships with project clients. By November, clients were back in charge of contract pricing and those in the state-run energy and power sectors were seeking to renegotiate costs downwards.

It is a dangerous time for contractors, who by the end of the year were finding themselves in the position of having to accept lower payments while being stuck to long-term fixed-price agreements with suppliers. They were also faced with a sharp rise in contract cancellations, and even payment defaults by overstretched clients.

It is certain that in 2009 there will be a marked rise in contract disputes and bankruptcies as companies struggle with cash flow.

The middle and long-term prospects for the region remain bright. But there is likely to be a lot of pain in the short term as the real estate boom stalls.