When the unexpected happens

14 March 2022
Supply chain disruptions caused by the war between Russia and Ukraine could represent a turning point for the economies of the GCC region

Despite the potent Omicron wave at its beginning, 2022 was widely expected to be a year of continued recovery for the global economy.

The Gulf countries were looking forward to a steady increase in oil production under the Opec+ agreement, along with broad-based non-oil growth as most activities disrupted by the pandemic return to normal.

By early March, however, we found ourselves looking at a very different reality due to events unfolding on the East European plain.

The most immediate economic effect of the crisis has been a spike in commodity prices. This reflects the status of the two belligerents as globally important producers of hydrocarbons, a range of minerals and many agricultural products.

The war has disrupted production and distribution and, through the imposition of sanctions and boycotts, raised important questions about future supply security. This elevated uncertainty has pushed up prices, not least through increased risk premiums.

While the search for alternative sources of supply is under way, the nature of most commodity markets means that the freely tradable supply is limited and not always easily accessible. Similarly, the capacity to push up production in the short term is minimal.

Gulf impact

What will all these new – and still evolving – realities mean for the Gulf countries? Here, the issue of hydrocarbons is of particular significance. Russia is the source of 25 per cent of global natural gas exports and accounts for 12 per cent of all oil exports. It was supposed to deliver 15 per cent of the planned Opec+ supply increases this year.

With some of this potentially at risk, the Gulf faces the prospect of an unexpected fiscal windfall. This will give the GCC governments flexibility as they all push ahead with their fiscal reforms. The pressures created by the pandemic are likely to diminish more quickly. The liquidity situation will improve and may help counter some of the monetary tightening that unexpectedly persistent inflationary pressures are pushing central banks – and, above all, the US Federal Reserve – to undertake.

The squeeze in the oil markets has resulted in calls for added production. Here, the main challenges stem from limited spare capacity that can be immediately tapped, as shown by the difficulties faced by several Opec+ producers when it comes to delivering their planned monthly increases.

Stepping to the plate at a time of crisis will further underscore the growing global stature of the Gulf

The ongoing nuclear talks with Iran, if successful, may deliver some relief. By most estimates, however, this will not be much more than 1 million barrels a day (b/d). The US shale sector is facing growing pressure to ramp up production after a period when the local operators prioritised profitability.

The main countries with significant ability to ramp up extraction are the Gulf producers – Saudi Arabia, the UAE, Kuwait and Iraq. Their estimated spare capacity exceeds 4 million b/d, or two-thirds of the Opec+ total excluding Russia.

Stepping to the plate at a time of crisis will further underscore the growing global stature of the Gulf. But decisions in this regard must factor in an unusual cluster of uncertainties that include not just the current crisis but also the ongoing global energy transition.

Overall, however, the crisis is likely to serve as an important reminder of the need for a balanced, phased approach that ensures short-term energy security along with longer-term policy goals.

Beyond hydrocarbons

Agricultural commodity prices are another major consideration in a part of the world that imports 85 per cent of the food its residents eat, and more than 90 per cent in the case of grains. Ukraine and Russia combined account for more than a quarter of global wheat supplies, 20 per cent of corn and 80 per cent of sunflower oil.

Global food prices rose by an annual 24 per cent in February and hit a new record, partly because of post-pandemic strains on supply chains and mounting transportation costs. This may cause some people to modify their diets and calls for enhancing local food security will likely grow louder, as was seen during the pandemic.

More generally, the high import-dependency in the case of many other products will transmit the supply chain challenges into higher prices. However, subdued housing cost pressures and some remaining labour market slack in the wake of the pandemic will likely help to significantly contain price pressures.

Leveraging and further developing the region’s connective infrastructure is a source of enduring strength as flows of people, goods and capital shift

The East European crisis also entails potential complications for the Gulf region’s convalescent tourism industry. During a rebound year in 2021, helped by Expo 2020, Dubai received 13 per cent of its visitors from Russia. The plunging Russian rouble is likely to limit such flows, at least in the near term.

On the other hand, however, the crisis may push more East European professionals and businesses to seek new opportunities and partnerships in the region.

Economic consequences

The overall impact of the Ukrainian crisis on the Gulf is difficult to determine at a time when its duration and outcome are shrouded in uncertainty. However, it does serve as a further reminder of the importance of strategic thinking and diversification in a multipolar world characterised by often unexpected risks.

Some of the strategic choices made in recent years now appear even more important. Whatever else, building and deepening economic ties in multiple directions is vital to ensuring open economies.

Leveraging and further developing the region’s connective infrastructure is a source of enduring strength as flows of people, goods and capital shift.

Maintaining a flexible posture in the energy markets – and securing appropriate spare capacity – is critical. The recent efforts to boost natural gas production will likely be redoubled. Establishing more local production capacity in the food sector, where it can be economically sustainable, is also essential.

The Gulf countries ably demonstrated their resilience, agility and strategic foresight during the Covid-19 pandemic. Strengthening these good qualities remains a wise choice, whatever the future may hold.

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