The GCC in the Era of Cheap Oil
The latest round of talks with regards to an oil production freeze ended in a stalemate in Doha on April 12, pushing markets into further freefall. They also framed the current state of oil geopolitics. Principal opposition came from Saudi Arabia, which agreed to freeze its oil production at January 2016 levels, only if all other producing nations followed suit, especially Iran.
The collapse of the talks probably means that 2016-2017 will continue to see low oil prices, boosting current accounts of energy importing economies at the cost of wreaking havoc elsewhere.
As an outcome of OPEC behemoth Saudi Arabia’s policy to maintain its stronghold on global oil supply, energy markets have witnessed their deepest downturn since the 1990’s. The Saudi effort to push down oil prices by increasing its production was an attempt to check the growing presence of US shale. It not only underestimated the North American region’s energy players but inevitably caused a steep decline in the economies of oil producing countries around the world like Canada, Venezuela, Nigeria and Russia.
Meanwhile, US shale accounted for 80 percent of global supply growth between 2011 and 2014, and has managed to stay in the game. The re-entry of Iran sans sanctions last year further undermined Saudi estimates, resulting in gross oversupply, with excess oil stockpiled in ships. While the collapse of the Doha talks does not bode well for oil prices, Iran can ill afford to back down having just restarted its channels of production and export.
The credit ratings of more than ten oil producing nations in the developing world have been reviewed for a downgrade by Moody’s Investors Service. The list is a long one and includes Russia, Kazakhstan, Nigeria, Angola, Gabon, and Trinidad and Tobago. The credit outlook for Venezuela was also recently lowered to negative from stable. Oil companies throughout the world have watched their earnings decline even below production costs, causing fresh cuts to investments and exploration.
This impact of depressed oil prices has been uniform across all producing and refining economies. Five of the six Gulf Cooperation Council nations — Kuwait, Saudi Arabia, the United Arab Emirates, Bahrain, and Qatar — have been put on review for a credit rating cut; Bahrain’s rating was downgraded a while back.
Now more than ever, the hydrocarbon-rich Gulf region has come to realise the need for strategic diversification – not just of its economic growth but also its energy mix. If peak oil can safely be labelled as a theory from the past, peak demand could enter the new geopolitical lexicon. The global conscience has been forced to reckon with the impact of carbon emissions, and countries around the world are increasingly investing in renewable energy alternatives.
The uniqueness of the Gulf region is defined not by its hydrocarbon wealth alone but also by its political design and rentier paradigm. All six GCC nations are monarchies, dependent on oil revenues to facilitate an extensive system of subsidies and social welfare policies, from womb to tomb. The goal is stability in a perpetually unstable region. Falling oil incomes have threatened this status quo.
Facing growing budget deficits, all GCC states have agreed to adopt a path of fiscal responsibility and cutback on subsidies. Oil scarce nations in the region – Bahrain and Oman – have had little choice since much before, but their wealthier neighbours have had to make overnight changes. Kuwait’s finance ministry, for instance, forecast a budget deficit of US$ 40.2 billion in 2016-2017, pushing its sluggish parliament to become more responsive. The country has continuously delayed privatising its stock exchange, but this year’s budget plans have a greater sense of urgency and include developing capital infrastructure through public-private partnerships (PPPs).
Keeping in mind the changed geo-economics of the region, GCC governments have approved the introduction of a region-wide value added tax (VAT). Next up on the agenda must be the diversification of their economies. A great disparity exists on this front. While the UAE derives 69% of its GDP from non-oil sectors, Saudi Arabia depends on oil earnings for 73% of its GDP. This is why Saudi Arabia cut its oil price earlier in the year. Other plans include cutting down subsidies and public sector salaries and investing in renewable alternatives like solar power. Big spending projects like revamping the transportation system and building football stadiums have been put on hold. Indirect taxes such as VAT, soda tax, sin tax, etc. are the new reality. More bewildering is how the country’s flagship oil company, Saudi Aramco, has pushed ahead with an initial public offering (IPO), choosing J P Morgan and Banker Klein as its advisors. Some of these moves would have been unthinkable five years ago.
Regardless of their sovereign wealth funds (SWFs), some Gulf economies have suddenly understood that over-dependence on one model of growth, i.e. hydrocarbons, does not make much sense in a world increasingly looking to replace oil or diversify energy sources. Not changing the industrial make-up would make GCC states vulnerable to the Dutch disease syndrome, and economic challenges are the most formidable threat to monarchical regimes.
The UAE and Qatar have pursued development plans that focus on their finance, education, travel and tourism, and manufacturing sectors, and provide for leading examples in the region. It remains to be seen if the rest of the GCC catches up even as oil prices race to the bottom.