'Saudi Arabia may go broke before the US oil industry buckles", screamed a headline at the traditionally staid UK newspaper The Telegraph.
But contrary to the article’s alarmist assertions, the Arabian Gulf countries have many tools to cope with lower oil prices. They do, however, need strength of will, a sense of urgency, and some imagination.
Oil about $60 per barrel, as futures curves imply for 2020, should not be a crisis. In the 155-year history of the oil industry, inflation-adjusted prices have been above this level in only 26 years, 10 of them since 2005, and nine in the 19th century. High prices this century have been a historical aberration that seemed sustainable only because of geopolitical upsets and the mistaken prognostications of “peak oil” theorists. Any country that faces an existential crisis because oil falls to $60 per barrel has more to worry about than Texan wildcatters.
The Telegraph correctly notes the impressive cost reductions achieved by US shale oil companies. More threatened are high-cost producers in areas such as the North Sea and deep water. Opec peers such as Venezuela, Nigeria and Algeria face not only economic malaise, but political unrest that might disrupt their output.
Commentators frequently mix up the government budget with the wider economy. Ninety per cent of Saudi government revenues come from oil, but only about 46 per cent of GDP. Admittedly, the “non-oil” economy is heavily dependent on the government pumping oil revenues through it, in areas such as construction and consumer spending.
But the IMF forecasts Saudi growth at 3 per cent this year and 2.7 per cent next year, down from the recent breakneck pace, but very respectable compared to developed countries. For the UAE, predicted growth is 3.2 per cent for both years.
Gulf governments do have a problem of funding their heavy spending commitments. Saudi Arabia has drawn down its foreign currency reserves, and begun issuing bonds to domestic banks.
Although this approach is ultimately unsustainable, the kingdom’s current debt is low and it could continue for a long time – as when the debt-to-GDP ratio peaked at 103.5 per cent in 1999 after an 18-year price slump.
The UAE has been the most proactive, reducing expenditure even before the oil price drop, and raising fuel prices to market levels. Yet electricity and water in Abu Dhabi are still sold at about half of production costs, while subsidies in the rest of the GCC have barely been trimmed.
The IMF has proposed various other revenue-raising measures for Gulf governments, including a value-added tax – likely to be difficult to coordinate between GCC members – a land tax, and extending corporate taxation to all companies. Along with privatising non-essential assets, shelving white-elephant projects and controlling government salaries, these should be enough to make deficits manageable.
The bigger problem, with few easy solutions, is how to simultaneously diversify the economy, develop genuinely competitive international companies, and create high-quality private-sector jobs for Gulf citizens. Massive spending on diversification this century has shown only limited gains, with Dubai the shining exception.
And there is not infinite room for more financial, trade and tourism hubs. Energy intensive industrial facilities, refineries and new mines play to the Gulf’s natural strengths, but are suffering from shortages of cheap gas, and now slumping demand in their main intended Asian markets. Removing subsidies and raising taxes, though essential, have to be compensated by other improvements to the business climate.
High-tech, value-added exports in energy services and petrochemicals are promising, but the Gulf needs a Mittelstand of robust and diverse small and medium enterprises to generate employment and innovation.
Radical changes will include tackling monopolies, changing citizens’ expectations from their government, and rethinking the relationship between business and state. Such reforms are essential for the Gulf ultimately to prevail in its confrontation with the frackers.
Robin Mills is head of consulting at Manaar Energy, and author of The Myth of the Oil Crisis.
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