Thursday, 7th December 2017

Firm oil prices give scope for more balanced economic decisions

Few can feel comfortable in a region where Gulf Co-operation Council (GCC) countries will need to borrow some $148bn next year to cover their budget shortfalls, as Moody’s Investors Service predicted in a report issued on 5 December. Fiscal deficits will not be closed any time soon, not least because new revenue generators like the value added tax (VAT) due to be introduced in Saudi Arabia and the UAE in January are often matched by new spending commitments to ensure social and political stability is maintained – such as the SR72bn ($19bn) private sector stimulus package announced by King Salman Bin Abdelaziz on 14 December. Meanwhile, sovereign ratings continue to erode, with Standard & Poor (S&P) the latest to take action by lowering its rating for Bahrain, due to its “extremely weak external liquidity”.

Among the few positives in the current macroeconomic environment is the consensus among analysts that oil prices – the key driver of economic performance in the Gulf region – will maintain their 2017 levels or perhaps even rise a little as global growth picks up in the next year. For politicians concerned with avoiding immediate crises it is oil that counts, despite all the talk of ‘disruptive’ renewable energy and other technologies reshaping Gulf policy-makers’ thinking. In economies that claim to be committed to reform, all the planned subsidy cuts, greater efficiencies and investments in diversification can contribute to stabilising balance sheets, but such is most exporters’ dependence on hydrocarbons revenues that the oil price remains the key variable.

The mid-December shutdown of the main UK North Sea pipeline system for several weeks to allow for emergency repairs helped to send the price of Brent Crude above $65 a barrel (/bbl) for the first time in more than two years, as GSN went to press. The oil price is thus unlikely to end 2017 in as sorry a state as it was in 2016 or 2015, with beneficial consequences for the economies of producers and those who depend on their rents (such as Bahrain and the UAE apart from Abu Dhabi).

Crude prices have not been at $65/bbl since the then Saudi petroleum minister Ali Al-Naimi persuaded leaders to back a policy of allowing prices to fall to ensure ‘market share’. That came in the wake of a boom in deep offshore and unconventional (shale) production – stimulated by $100/bbl-plus oil – that threatened the market dominance of the Organisation of Petroleum Exporting Countries (Opec) and even, some analysts argued, the cartel’s very existence. Naimi was determined to see off rivals, using the kingdom’s huge foreign reserves as ammunition (GSN 985/14). But Riyadh’s forecast that oil would reach a liveable-with price of around $65/bbl did not materialise by early 2016, prompting a change of direction and the veteran Naimi’s departure.

Since then an alliance of Opec and some large non-Opec producers has formed to curtail output and, because the motely group have generally adhered to the deal (unlike many similar arrangements in the past), prices edged up during 2017. Predictions that US shale output would also recover along with prices were also accurate, but this didn’t force a collapse of prices (GSN 1,030/8). On 30 November, the Opec/non-Opec alliance agreed to extend their production limits from the March 2018 expiry date until the end of 2018.

Global economic forecasts had been revised upwards since the previous Opec meeting in May, boosting global oil demand and contributing to stocks of crude falling by 140m bbls since May, according to Opec – providing a tangible reward for producers willing to live with reduced output. However, there are no guarantees prices will stay around $65/bbl. Markets will be watching closely for the impact of other variables such as Libya’s ability to maintain output near 1m b/d, Russia’s willingness to maintain its production-cutting pact with Opec as President Vladimir Putin enters another election year (and seeks to pay for his costly venture in Syria), and the progress of electric cars and other ‘disruptive’ technologies.

Having said that, few analysts believe crude prices will dip below $50/bbl any time soon. Turn-of-the-year global macroeconomic forecasts are generally bullish, or at least cautiously optimistic. Bank of America (BoA) Merrill Lynch Global Research forecasts global GDP will increase by a solid 3.8% in 2018, with “above trend growth” expected in most major economies. JP Morgan Global Research on 14 December forecast global GDP growth at 3% in 2018 – still “comfortably above the 2.6% potential growth rate” – with global consumer price inflation rising towards 2.5%.

One important indicator for oil producers, the US dollar, is also expected to rise in H1 18, supported by rising interest rates and market enthusiasm for ‘Trumponomics’. But JP Morgan warned “US dollar weakness could play out as policy normalisation elsewhere comes into focus” in H2 18.

In this environment, BofA believes “robust global demand and tight supplies should see Brent crude oil rise to $70/bbl by mid-year”, while “diesel fuel pricing could reach $90/ bbl on rising demand”. JP Morgan is more circumspect, expecting Brent to average $60/bbl in 2018.

BofA is also bullish about natural gas, with US prices forecast to reach $3.30/m Btu in 2018; structural demand, especially from liquefied natural gas (LNG), is outpacing production growth, it said. However, JP Morgan saw a more stable $3.08/m Btu price. There is a more short-term lift for global leader Qatar and other LNG exporters: another BofA report saw Asian spot LNG prices rallying strongly going into winter with China “gobbling up LNG imports” However, it added “balances will ease once new supply comes online over the next two years”.

Despite this relatively benign pricing environment, Gulf economies are far from secure entering 2018, riven as they are by political differences and the legacy of deficits inflated by the previous oil price slump,. Borrowing is becoming more costly, but there is continued momentum for sovereign debt issuance, including sukuk (Islamic bonds). In a clear sign of the region’s need to borrow, GCC borrowers accounted for the majority of global sukuk issues in 2017, led by Saudi Arabia – which is likely to continue issuing the bonds next year, as will Bahrain and Oman, as the Islamic market grows further.

Banks will be encouraged to lend based on macroeconomic forecasts underpinned by higher oil prices. The devil will come in the detail of how accompanying macro- and microeconomic reforms are implemented, and whether that can be done without jeopardising political stability. “The Arab world is going through rapid political and economic changes, and countries that cannot keep up with the changes risk falling behind for many years,” UAE Vice President and prime minister Sheikh Mohammed Bin Rashid Al-Maktoum warned the 12 December Arab Strategy Forum in his emirate Dubai.

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