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memri
February 6, 2009 No.
475

Oil-Producing Countries in Middle East Face Plummeting Oil Prices

Introduction

After a hefty spike in oil prices in the preceding year, reaching as high as $147 a barrel in July 2008, prices plummeted in the subsequent four months to below $55 a barrel on the close of trading day of November 14 – a a sharp price decline of close to two-thirds. The decline is quite far-reaching, given that oil revenues provide 70 to 80 percent of government revenues in OPEC countries. According to the International Monetary Fund (IMF) a decline of $1 in the price of crude would translate into a loss in revenues of $3.5 billion in Saudi Arabia, $300 million in Qatar, $1 billion in the United Arab Emirates (UAE) and $960 million in Kuwait, calculated in an annualized basis.[1] Some of the countries concerned, such as Saudi Arabia, Kuwait, and the United Arab Emirates, have deep pockets and would survive the dip in revenues, certainly in the short term. According to data from the Institute of International Finance, GCC governments had foreign assets of $1.8 trillion at the end of 2007, and the tally was expected to top $2 trillion by end of the 2008.[2] In other countries, particularly Iran and Iraq, oil shocks could trigger serious economic dislocation.[3]

Falling Crude Price and the Financial Crisis

The sharp decline in the price of crude has coincided with, and perhaps resulted from, a global financial crisis, and the two issues have become intractably intertwined. Through November 12, the stock exchange of Dubai, Saudi Arabia and Kuwait declined by 62.5 percent, 50.4 percent and 29.5 percent, respectively.[4] On November 14 alone, the Saudi stock exchange declined by more than 7%. A Kuwaiti court took the unprecedented step of ordering a closure of the Kuwaiti stock exchange for a few days, to stop the hemorrhaging.[5] The broad MSCI Arabian Market Index recorded a loss of $256 billion in the market capitalization of the 15 MENA (Middle East and North Africa) stock exchanges in the month of October.[6] By one estimate, the losses in the various stock markets, the decline in the price of real estate, and the losses suffered by the sovereign wealth funds on their investments in both Western and emerging markets were estimated at $750 billion.[7]

Moreover, the Arab oil producing countries have parked between $1.6 and $1.8 trillion in the West in liquid assets, and financial experts in the region are in no position to assess the impact of the financial turmoil on these assets. Equally as troubling has been the withdrawal by Western investors of a vast amount of cash invested in liquid assets in the Gulf countries to cover obligations in their home countries. [8]

OPEC Cuts Production

To stem the sharp and sudden decline in the price of crude, the Organization of Petroleum Exporting Countries (OPEC) decided, in its emergency meeting in Vienna on October 24, to cut output by 1 million b/d (barrel/day), effective December 1. The problem for OPEC has always been whether members "strictly comply" with production targets. "Cheating," particularly during periods of falling prices of crude, is common.

The role of Saudi Arabia during this time of crisis is unique. Saudi Arabia is OPEC's lynchpin and its largest oil exporter by far. The Saudi position has been that it would supply its customers as demanded, and the country has the capacity and the willingness to balance markets with incremental crude, and this position has been firm regardless of what OPEC decides. For example, before the recent plunge in prices, the Saudi were producing 700,000 b/d over their quota of 8.94 million b/d. The position was reiterated by Saudi King Abdullah at the recent economic summit held in Washington. King Abdullah said: "We will continue to fulfill our role in ensuring the stability of the oil market."[9]

IMF's Break-Even Price

A recent study by the International Monetary Fund (IMF) suggests that the average break-even oil price at which a country would achieve a fiscal balance is $57 per barrel in 2008, "demonstrating the most oil exporters can easily absorb lower oil prices." Exceptions include Iraq, which is expected to run a small fiscal deficit with the current oil prices levels, and Iran where the fiscal position may turn into a deficit if oil prices dip below $90 per barrel, which they already have.

The following is a list of selected oil exporters' break-even prices for 2008 Fiscal Accounts (in US$/barrel):[10]

Algeria

56

Iran

90

Iraq

111

Libya

47

Kuwait

33

Bahrain

75

Oman

77

Qatar

24

Saudi Arabia

49

UAE

23

Average GCC

47

The Risk of Faltering Reforms

For most oil producing countries, oil revenues are the backbone of their national revenues and a major source of financing of their oil and infrastructure projects. In the case of Iran, oil revenues serve to bolster the regime's populist programs, including the subsidies for key food items as well as for gasoline – more than half of which is imported due to limited refining capacity. For the others, the decline of revenues will cancel or put on hold a variety of both upstream and downstream oil projects, including exploration and the development of the oil-based integrated refinery-petrochemical links as well as the gas-based petrochemical and fertilizer links.

The financial turmoil may also have more fundamental consequences for the Middle East economies beyond the reduced financial sector profitability and the losses suffered by investors. One particular analysis warns against "faltering reform" which is far more significant than the real threat of faltering asset prices. In most MENA countries, there has been a move in recent years towards economic and financial reform. Foreign investors have been encouraged to take significant stakes in state-owned banks. The fact that Western governments are taking control of private sector banks "hardly strengthens the hand of the Middle East reformers keen to privatize their own lumbering state-owned institutions."[11] There is also a greater concern that, as a result of the perception of market failure in the West, the drive for a free-market economy will be stalled, if not abandoned.

How to Live on $20 a Barrel

Abd Al-Rahman Al-Rashed, director-general of Saudi satellite TV Al-Arabiya and columnist for (and former editor of) the London daily Al-Sharq Al-Awsat offers an uncommon perspective on the challenges facing the Gulf countries in the event that crude prices dip all the way down to $20 a barrel. He considers the shock a blessing in disguise, a warning for self-reliance, and an opportunity for reform. The reform, according to Al-Rashid, must focus on the education system: "We do not need $100 a barrel to reform our education. Teaching students more chemistry, physics and mathematics will not require a single additional dollar, but will produce more than our existing educational system…Weak instruction produces [an] emaciated society."[12]

Crisis Spillover

In a study by the Gulf Finance House in Dubai, senior economist Hany Genena wrote that the global financial crisis was spilling over to the GCC (Gulf Cooperation Council) countries via three main channels[13]:

First, lower crude prices. The key risk to the GCC growth story is the longer-term outlook of crude oil prices rather than short-term volatilities. However, the Brent (benchmark) price would have to fall to about $60 per barrel before GCC fiscal surpluses start to erode. At this price, GCC oil revenues will be marked down by no less than 40% in 2009, compared with 2008, resulting in lower fiscal and current account surpluses.

Second, the exit of foreign capital has resulted in a significant fall in bank reserves and rise in interbank rates across the GCC. This was particularly pronounced in the case of the UAE, where the ratio of banks' foreign liabilities to total liabilities jumped fourfold, from 6.5% to 25%, between early 2007 and March 2008.

Third is the faltering demand for energy-intensive industrial and building materials, which are the largest sectors in the GCC after oil. Downward pricing pressures are occurring amid a build-up of excess capacity in the GCC.

A mitigating factor for the GCC countries is the fact that their currencies are pegged to the U.S. dollar, which has recently registered a sharp appreciation against the euro and the British pound. As a result, inflation, which was a major concern for these countries while oil prices were rising, has begun to diminish.

Looking Into the Future

Oil prices, like the prices of many other commodities, are cyclical and hence subject to sharp fluctuations. The recent slide in the price of crude has come at the heel of five years of prices moving in the opposite direction. Most likely, this pattern of sharp price fluctuations will continue into the future. No less than the International Energy Agency, which represents the interests of the large Western consumers, has projected that oil prices will rebound to more than $100 a barrel as soon as the world economy recovers, and will exceed $200 by 2030.[14] This view was understandably shared by oil-producing countries, and was articulated by UAE Energy Minister Mohammad Al-Hamli, who told reporters: "It is very important to continue investing to maintain and increase capacity in order to be prepared for the next [price] cycle." He characterized the decline as just a "price cycle."[15] The consensus in the GCC countries is that, barring a protracted fall in oil prices, the six GCC economies will not be exposed to systemic shocks due to solid macro and banking system fundamentals.[16]

A similarly optimistic view was expressed by Abdullah Jum'ah, the outgoing chief executive officer of the Saudi national oil company Aramco: "Global energy demand is set for a sustained increase, notwithstanding the current dip in consumption and the widespread uncertainty we see in the global economy."[17]

Conclusion

The global financial turmoil has impacted the oil-producing countries, particularly the members of the GCC, in at least three ways: crude price has declined by almost two-thirds in a three-month span, foreign investments have dried up, and the demand for the region's energy-intensive industrial and building materials will likely slow down the pace of economic growth. Major development projects may have to await better times.

The various economies of the oil-producing countries are in different stages of readiness for the sharp decline of revenues. Most obviously, how these countries would fare depends on the duration of the financial crisis and how much deeper, if at all, oil prices will plunge.

Iran, the second largest oil producer among OPEC members, is likely to feel the pain of declining oil prices more severely than any other oil-producing country in the Middle East. Unlike the GCC member countries, Iran's price stabilization fund, which was to receive windfall profits to be used when oil revenues decline, has been nearly depleted as a result of poorly managed economic policies by the regime of President Mahmoud Ahmadinejad. The criticism in the Iranian press of Ahmadinejad's stewardship of the national economy is a daily occurrence.

While further decline in the price of crude cannot be discounted, the long-term prospects remain quite positive for the oil-producing countries. After the financial crisis exhausts itself, economic growth will resume and so will the demand for energy. This is a matter of years, not decades.

The major risk for the industrialized countries is that the sharp dip in crude price has a tendency to dampen official enthusiasm and correspondingly shelve promising programs in the search of alternative sources of energy.

ANNEX

Table 1: Crude Oil Production and Exports (in brackets)

(millions of barrels)

Average

Est.

Proj.

Proj.

2000-04

2005

2006

2007

2008

2009

Algeria

1.0 (0.5)

1.4 (1.0)

1.4 (0.9)

1.4 (0.9)

1.4 (0.9)

1.4 (0.9)

Iran

3.6 (2.3)

4.0 (2.4)

4.1 (2.4)

4.1 (2.5)

4.2 (2.5)

4.3 (2.6)

Iraq

1.9 (1.4)

2.0 (1.4)

2.0 (1.6)

2.3 (1.8)

2.5 (1.9)

Kuwait

2.0 (1.2)

2.6 (1.7)

2.6 (1.7)

2.6 (1.6)

2.6 (1.6)

2.7 (1.7)

Libya

1.4 (1.1)

1.7 (1.3)

1.8 (1.4)

1.8 (1.5)

1.9 (1.5)

2.0 (1.6)

Qatar

0.7 (0.7)

0.8 (0.7)

0.8 (0.7)

0.8 (0.7)

0.9 (0.8)

0.9 (0.8)

S. Arabia

8.1 (6.2)

9.4 (7.2)

9.2 (7. 0)

8.8 (7.0)

9.5 (7.5)

9.6 (7.6)

UAE

2.2 (2.0)

2.4 (2.2)

2.6 (2.4)

2.7 (2.5)

2.8 (2.6)

2.8 (2.6)

Source (adapted), IMF, op.cit. p.40

Table 2: Oil and Non-Oil GDP Growth from Oil Exports

(annual change in percentage)

Average

Est

Proj.

Proj.

(2000-04)

2005

2006

2007

2008

2009

Iran

6.0

5.3

6.2

7.0

5.9

5.4

Kuwait

11.7

11.4

9.0

9.8

9.9

8.3

Libya

0.2

15.8

10.7

14.7

10.2

11.4

Oman

6.7

7.3

8.4

9.0

8.5

7.3

Qatar

9.4

13.1

19.9

14.5

14.0

12.4

Saudi Arabia

3.7

5.2

4.9

4.9

5.3

5.5

UAE

9.2

10.8

10.4

8.8

8.1

7.1

Source, IMF, op.cit., p. 39S

*Dr. Nimrod Raphaeli is Senior Analyst (emeritus) at MEMRI.


Endnotes:

[1] Al-Sharq Al-Awsat (London), November 16, 2008.

[2] Gulfnews.com, November 16, 2008.

[3] With regard to Iran, see Nimrod Raphaeli, "Plummeting Oil Prices – Iran’s Options," MEMRI Inquiry &Analysis No. 471, October 30, 2008, http://www.memri.org/bin/articles.cgi?Page=archives&Area=ia&ID=IA47108.

[4] Al-Jazeera TV news program, November 13, 2008.

[5] Al-Sharq Al-Awsat (London), February 14, 2008.

[6] BusinessIntelligence, November 11, 2008.

[7] Al-Dustour (Jordan), November 3, 2008. The estimates were provided by Dr. Mohammad al-Khalaiqa, former Jordanian deputy prime minister.

[8] The Peninsula (UAE), November 12, 2008.

[9] 'Okaz (Saudi Arabia), November 17, 2008.

[10] International Monetary Fund, Regional Economic Outlook—Middle East and Central Asia, Washington, D.C. 2008. P.30.

[11] Andrew Cunningham, "The Real Threat to Middle East Economics: From Global Financial Market Turmoil: Not Falling Asset Prices But Faltering Reform," Middle East Economic Survey, 51:42, 20 October 2008.

[12] Al-Sharq Al-Awsat (London), November 13, 2008.

[13] BusinessIntelligence, November 5, 2008.

[14] The Financial Times, November 6, 2008.

[15] BusinessIntelligence, November 4, 2008.

[16] Arab News (Saudi Arabia), November 5, 2008.

[17] BusinessIntelligence, November 8, 2008.