Responding to the ‘New Normal’: Gulf Economic Strategies in an era of Low-Cost Oil
● Dr. Samuel Greene and Kiani Raets
Responding to the ‘New Normal’:
Gulf Economic Strategies in an era of Low-Cost Oil
Global oil prices have decreased significantly since their 2014 peak on June 19, when the price of Brent crude stood at USD 115.19 per barrel of oil. Only six months later, the price fell to just USD 58.87 on December 19, 2014. Throughout 2015, the price of a barrel of Brent crude has ranged from about USD 45 to USD 65, closing at USD 49.45 on October 9. Futures prices for delivery of Brent crude in October of 2020 show that the markets expect oil prices to remain low for the following five years. Its October 13 price of about USD 64 stood in the middle range of expected 2020 prices between USD 60 and USD 70 per barrel in September and October. Thus, in the near term, low oil prices are expected to be the new normal.
Low Oil Prices and Budgeting in the Gulf
These prices will put considerable pressure on the budgets of most Gulf Cooperation Council (GCC) members, given their dependence on oil revenue. Although most states in the Gulf have attempted to diversify their economies, funds from oil remain a vital component of government budgets. In 2014, every state except for Qatar, which also has large reserves of natural gas, relied on oil revenue for more than 75 percent of government revenue.
Further, most states in the region have increased their public spending over the past six years. Fiscal break-even prices, which refer to the price of oil required for a balanced budget, have risen significantly in most Gulf States since 2009. In 2009, Kuwait and Qatar both had breakeven points below USD 30 per barrel. Currently no Gulf state has a projected 2016 breakeven price below USD 60 per barrel, with the exception of Kuwait’s projected breakeven price in the USD 47 range, while three states, Bahrain, Oman, and Saudi Arabia, have projected breakeven prices of USD 89 per barrel or higher in both 2015 and 2016.
In the past, Saudi Arabia has led efforts within OPEC to manage the price of oil by controlling its supply. However, the growth of oil supply outside of OPEC, particularly from fracking and other technologies that increased the North American share of the market, as well as Saudi concerns about discipline within OPEC, made constraining oil prices a challenge. Further, Saudi Arabia may have believed that low oil prices would be more damaging to its geopolitical competitors and to new market entrants in North America. Thus Saudi Arabia sought to protect its market share rather than the overall price of oil, continuing its current levels of production rather than seeking to restrict supply. However, while low oil prices badly damaged the Iranian and Russian economies, improvements in technology have made shale oil profitable at prices significantly less than the USD 70-80 per barrel range that had previously been seen as fracking’s price floor, while low interest rates kept many shale oil producers afloat.
Moreover, global demand for oil has been falling considerably, given slowing economic growth in China and an anemic economy in much of Europe, without offsetting growth in other parts of the developing world. This combination of reduced demand and increased supply has created the perfect storm for oil-reliant economies, leaving the states of the Arabian Peninsula with difficult choices.
State Responses to Low Prices
States facing budget deficits have a range of choices to increase revenue or reduce spending. States with shortfalls are frequently encouraged to increase revenue and reduce spending, particularly subsidies, by international financial institutions such as the IMF. Yet increased taxes and fees are unpopular, particularly among citizens accustomed to a tax-free lifestyle, while the elimination or reduction of subsidies on basic goods have frequently provoked unrest in states in the Middle East that have attempted it. For example, unrest gripped Jordan in 2012 when fuel prices were increased. If budget shortfalls are projected to be temporary, given an expected future increase in the price of oil, expending reserves can be a useful bridging strategy. However, if shortfalls continue, this risks greatly weakening a state’s fiscal position. States might also choose to issue debt. Should this debt be used to improve competitiveness or to diversify an economy or as a short term bridging measure, assuming debt can be a useful measure. Conversely, if debt is only used to continue current rates of spending, it risks long-term economic consequences if oil prices do not return to previous levels.
Saudi spending in the wake of the Arab Spring in 2011 and the accession of King Salman in early 2015 increased its breakeven price with public spending targeted at salary increases, low-income housing, and job programs considered by many analysts to be vital for the Kingdom’s stability. With 2015 budgets predicated on oil prices of USD 90 per barrel, Saudi Arabia responded to lower prices by issuing bonds and by spending reserves in order to decrease the budget deficit and to bolster the weakening riyal rather than reducing subsidies and other spending commitments. It is the first time in eight years that the kingdom issued bonds, and the issue raised about SAR 35 billion (USD 9.3 billion) during the first eight months of this year. Saudi Arabia moreover started to sell reserves in response to the low prices – some accounts estimate at a rate of USD 12 billion USD per month.Officials in Riyadh have also considered the possibility of capital spending reductions and potentially unpopular reductions in public spending.
Kuwait also intends to issue bonds before the start of 2016 to compensate for decreased oil revenue. However, Kuwait additionally worked to both reduce its already modest spending and increase its revenue by decreasing subsidies on gasoline prices. The country is planning to increase its revenues by imposing a number of fees and taxes ranging from road tolls and parking meters to fees on luxury goods and levies on local companies. Additionally the Kuwaiti government is reportedly examining the prices of essential goods that are subsidized and services that are provided for free, and has already lowered its welfare spending.
Bahrain already faced a challenging economic environment due to its relatively limited oil reserves and limited financial resources, as well as an economy still weakened by political unrest in 2011, before oil prices dropped in the 2014. In response, it has sought to reduce subsidies. Bahrain eliminated subsidies on meat on September 1, but is considering providing compensation for its nationals in the form of cash payments instead of direct payments through distributors. The cuts in subsidies will thus mainly affect the country’s large expat community and will be minimal for the nationals – however, cash payments to citizens will reduce the benefits of subsidy reductions. Bahrain is moreover considering the possibility of cutting other subsidies on goods and services.
Oman also faced economic challenges before oil prices dropped in 2014, given a 2013 breakeven price of nearly USD 100. Oman looked to both reduce its subsidies and make substantial reductions to national spending, reforming its subsidy policy by cutting the subsidies on industrial gas. Oman slashed its spending on defense and national security by 25 percent while decreasing spending on “participation and support” to the private sector by 48 percent. The Omani government furthermore increased the national prices for natural gas. Other measures such as a “fair tax” on liquefied petroleum gas and a tax on telecommunications incomes are under consideration, as well as a general review of the tax rates, national and international loans and the issuance of Islamic bonds. In early 2015, officials in Muscat introduced a levy of 2 percent on the international money transfers of foreign nationals working in the sultanate.
The UAE was the first GCC member that started to cut subsidies, despite its strong economic position relative to many of its neighbors, given its substantial currency reserves. The Emirates deregulated fuel prices by lifting subsidies on gasoline and diesel, decreasing the 2015 state spending by about 4.2 percent. Notably, this decision was supported by an effective campaign framing the lifting of subsidies as a measure that would improve national competitiveness. Further, early reports suggest that the relatively modest increase in fuel prices will not significantly affect the standard of living of citizens or most expatriates. The UAE is additionally drawing up plans to initiate a new sales and corporate tax that will help to further improve the state’s economic position. Ultimately, the UAE’s aggressive courting of foreign direct investment – it attracted the second highest amount in the Middle East and North Africa (MENA) region after Turkey in 2013 – may allow the Emirates to continue to pursue its development strategy with less reliance on public spending.
In contrast to the other GCC members, Qatar will not downsize large infrastructure projects that are linked to economic development, nor decrease subsidies on food and fuel. Qatar’s policy is possible because of the government’s very strong financial position, particularly because of its deep reserves, and its revenue from natural gas, which has lessened the impact of fluctuation in the oil markets on national budgets. Qatar also has one of the lowest breakeven prices for oil in the entire Gulf region and will face the region’s smallest budget deficit this year, which will allow it to continue its growth model that is heavily reliant on state spending to finance projects.
The implications of these strategic choices for the short and medium-term are instructive. While Qatar will likely be able to maintain its current spending path, and the UAE’s reforms are likely to bring its revenue close to its breakeven price, the other states in the Gulf may be forced to reduce spending and subsidies or raise significant revenue from non-oil sources. Kuwait has proactively sought to both contain spending and increase its revenue, putting it in a relatively strong position. However, Oman and Bahrain face a more austere future, as both states struggled to balance budgets even before oil prices dropped.
The future of the Saudi economy, given its regional importance and scale, looms over the choices of many other Gulf States. Will it be able to maintain its current levels of spending? Some analysts such as AmbroseEvans-Pritchard have made the provocative argument that the current rate of spending could exhaust Saudi reserves and cause capital flight by 2018. While this analysis may be too pessimistic, if oil prices average in the USD 50-60 per barrel range over the next five years, the Saudi government will face difficult choices absent other unforeseen revenue, evidenced in its ongoing consideration of painful reductions in public spending.
Bahrain’s move to shelter its nationals from the consequences of its elimination of subsides demonstrates the obstacles to implementing reform in countries with a history of state subsidies and no or low taxes. Yet half-measures are unlikely to resolve Bahrain’s economic challenges. The UAE has successfully appealed to its citizens to accept measures that will improve the state’s economic position. Yet modest increases in fuel prices will not affect the high standard of living of Emirati citizens as removing subsidies may do in states such as Bahrain and Saudi Arabia. Kuwait’s relatively modest budgets and quick steps to reduce spending and seek increased revenue provide a possible model for other Gulf States without the economic advantages of the UAE and Qatar. It remains to be seen if this approach is palatable for Kuwait’s neighbors.
Dr. Samuel Greene is Assistant Professor of Political Economy and Strategic Studies at the UAE National Defense College and the Near East South Asia Center for Strategic Studies. Kiani Raets is Research Intern at the Near East South Asia Center for Strategic Studies. The views expressed in this piece are the authors’ own and do not pertain to any other entity.
This article was published by Gulf State Analytics on December 18, 2015
Ljubljana, December 23, 2015