GCC Economies Struggle with Post-COVID Options, with instability on the Horizon
The future of so-called rentier states, countries with their economies based on extractive resources such as oil, gas and minerals, is under severe pressure. The impact of the Covid-19 black swan event, the resulting oil and gas demand destruction and a possible moving forward of peak oil demand scenarios are causes for concern in the overwhelming majority of Gulf Cooperation Council (GCC) member states. In addition to this group, which includes OPEC producers such as Saudi Arabia, UAE and Kuwait, other countries in the MENA region are feeling the brunt too. From Morocco in the west to Iran in the east, the region is waking up slowly to a new reality threatening its normal way of working. Lower revenue, increased government budget deficits and higher unemployment are not only resulting in a larger call on hydrocarbon-based revenue providers but are also affecting the countries’ own financial institutions, such as sovereign wealth funds (SWFS) and local banking systems. The total pressure on governments, economies and societies is expected to forge new realities but it also potentially threatens the historical basis of regime-societal frameworks. More instability could ensue very soon.
On 19 October 2020, the International Monetary Fund (IMF) published a very hard economic analysis of the effects of the Covid-19 pandemic, global lockdowns and lower oil prices on MENA oil export revenue. In its report, Regional Economic Outlook: Middle East and Central Asia, the IMF stated that oil exporting countries in the Middle East and North Africa (MENA) region would see a $224bn shortfall in revenue this year. According to IMF Middle East and Central Asia department director Jihad Azour, “2020 was a year like no other. Nobody was expecting the severity of the first and second shocks that have deeply affected the economy of the world, and economies of the region”.
At the same time, the IMF indicated that the whole region would be confronted with a GDP contraction of 6.6% this year, reflecting the pandemic-induced collapse in global oil demand and the necessary measures taken by OPEC+ to cut oil production in May 2020. This toxic combination of demand destruction, lower oil price settings and unilateral production cuts has been biting hard into projected government revenues, overall investments in the region and the options for financial institutions to stay afloat. At the same time, the main oil producers, such as Saudi Arabia and Abu Dhabi, have been increasing their calls on national oil companies, such as Aramco and ADNOC, to provide additional financial backups for ongoing and future investment projects. As the IMF reported, the Covid-19 crisis has been a double whammy for oil-exporting countries. Not only were their own economies and societies hit hard by lockdowns and economic slowdown, but oil and gas revenues declined very steeply. In the rentier state environment, the combination has been debilitating to say the least.
For 2020 the total picture is very bleak, although with some relief at present from slightly more stable or higher oil prices. In its October report, the IMF stated that it expects the combined growth in the 11 MENA countries to show a rebound to 3.4% in 2021. This slightly normal picture, however, is still not so good for the six GCC member countries, as with a 6% GDP contraction in 2020 growth will only be hitting around 2.3% in 2021. Some changes could still be expected if oil and gas prices are higher, but the indicators are not yet on green.
In its latest Monthly Oil Market Report (OMR) in November, OPEC showed a very cautious optimism. OPEC stated that oil prices are still not showing any real surge. The OPEC reference basket (ORB) fell by $1.46, or 3.5%, month-on-month, to average $40.08/b in October. In the year to date, the ORB averaged $40.57 per barrel, or $23.34 lower than the same period last year. With the ongoing Covid re-emergence, renewed lockdowns and instability in the US and other economies, future developments are still vague. In recent weeks, oil and gas prices have shown an upward tendency but the overall situation is still dire. This is substantiated by an OPEC assessment that the global economic growth forecast continues to show a contraction of 4.3% for 2020, while the 2021 forecast has been revised down to growth of 4.4%, down from the 4.5% forecast last month. The oil cartel’s views on the US economy are not positive either. The OMR states that even though the US economic forecast has been revised up to show a contraction of 3.6% in 2020, growth in 2021 has been revised down to 3.4%. The eurozone forecast for 2021 has been revised down to 3.7%, while China‘s economic growth remains at 2.0% for 2020 and 6.9% in 2021. These figures are a direct threat to oil and gas demand, and specifically the demand for OPEC and GCC oil exports. OPEC has again revised its global oil demand forecast for 2020 down due to weaker than expected demand in the OECD Americas in the third quarter of 2020 and the recently announced additional Covid-19 containment measures. OPEC is now expected to contract by around 9.8 mb/d year on year in 2020. For 2021, oil demand will grow by 6.2 million bpd, which means that even in 2021 global demand levels will be around 3.6 million bpd below 2019 figures.
The picture painted above constitutes a direct threat to the stability of oil-exporting countries such as the GCC exporters. Demand is fledgling, while OPEC+ production cut agreements in 2019 and 2020 have not yet resulted in a stabilisation of the oil market or removed the urgently needed multimillion barrels from global storage. Lower income due to cuts combined with lower global oil and gas prices is still biting into the government budgets of countries such as Saudi Arabia, the UAE, Qatar and Kuwait.
At the same time, the global supply is once more becoming a threat to prices. OPEC’s latest assessments show that the non-OPEC liquids production forecast for 2020 is contracting by 2.4 million bpd. The oil supply in 2020 is forecast to decline, mainly in Russia, the US and Canada, but other production is still growing, such as in Norway, Brazil and even China. The total non-OPEC forecast for 2021 is showing an increase of 950,000 bpd and OPEC crude oil production will be increasing to an average of 24.39 million bpd in 2021. OPEC does not give any price forecasts for 2021 but reports that the IMF oil price forecast is between $42 and $45 a barrel in 2020 with a slight increase for 2021.
For rentier states such as the GCC members, economic diversification and non-hydrocarbon-based trade is essential to support a sustainable future. In a regional economic update, the World Bank (WB) stated that trade and integration — both within the MENA region and with the rest of the world — will be critical in lowering poverty, empowering the poor and igniting economic growth in the post-Covid era. In its report entitled “Trading Together: Reviving Middle East and North Africa Regional Integration in the Post-Covid Era”, it paints a comprehensive picture of the MENA economic situation six months into the Covid-19 pandemic.
As Ferid Belhaj, VP MENA of the World Bank, indicated, “the Mena region was already lagging behind economically before the Covid-19 pandemic struck. Six months into it, we can see — with stark clarity — the severity of the devastation on lives, livelihoods, and region-wide prosperity”. The WB reiterated that the latest data reflect an increasingly pessimistic outlook for the regional economy, which is expected to recover only partially in 2021. The international organisation also stated that, driven by lower oil export revenue, declines in other fiscal revenues and the high expenditure required to respond to the pandemic, the region’s current account and fiscal balances are all very negative (respectively -4.8% and -10.1% of GDP in 2020). The WB also warned that public debt is expected to greatly increase in the next few years, from about 45% of GDP in 2019 to 58% in 2022. Regarding the main underlying factors, in addition to the oil and gas revenue picture painted above, the WB also stated that the region lags behind in integration, both within the region and with the rest of the world. There are currently several significant reasons, such as poor logistics performance, inefficient customs, high infrastructure costs, inadequate legal investment frameworks and disparate regulations, which add up to high trading costs and have become non-tariff impediments to trade.
Not only are the oil and gas sectors in MENA being hit but its sovereign wealth funds are also struggling. Taking into account the fairly low level of transparency of the these funds, their values are being hit by lower income from non-OPEC countries, long-term threats continuing due to low oil and gas prices, and an increased call from the governments to finance and support government strategies and budget deficits. This situation is slowly but steadily showing its ugly face in the overall sovereign ratings of the MENA countries. International ratings agencies such as Fitch Ratings, are actively reassessing numerous countries at present. At the beginning of November 2020, Fitch Ratings stated that four of the fourteen Fitch-rated Middle East and North Africa (MENA) sovereign wealth funds have a negative outlook. These negative ratings are for Iraq, Jordan, Morocco and Oman, due to a hit to their public and external finances and growth as a result of the coronavirus pandemic and the fall in oil prices. Bahrain was also downgraded as early as August. The ratings agency also reported that the funding of much wider fiscal and external deficits remained a meaningful risk for lower-rated funds, even though debt market access and international liquidity have been accommodative and official creditor support has been strong.
The regional financial sector is also fighting an uphill battle. S&P Global Ratings reported that, as Gulf banks are entering an age of weaker profits based on lower oil wealth, overall lending is under pressure too. The ratings company also predicts that regional bank asset quality may deteriorate at a faster rate. A growing reluctance to lend will have negative effects on regional markets for a longer period. At the same time, consolidation is ongoing in the financial sector, partly aiming to strengthen the survivors but in the meantime constraining financing as competition is reduced and arousing fears.
The recent purchase of Samba Financial Group by the National Commercial Bank, Saudi Arabia’s largest lender, is the latest of the ‘first wave’ of transactions, which S&P said is motivated by shareholders wanting to reorganise their assets. S&P, like others, also stated that growth in lending in the region “will remain muted,” reaching about 5% for most countries in 2021. A warning is being given that the average ratio of non-performing loans is forecast to increase to about 5%-6% in the next 12-24 months in S&P’s sample of banks.
As Fitch and also others state, there are growing worries for oil-exporting countries, as their fiscal deficits will hit balance sheets. So far, only Qatar and the UAE are expected to show single-digit deficits; the others will all have larger ones. These assessments are made assuming an average oil price level of $41 a barrel. For most of the economies in the GCC, fiscal break-even is not even within reach.
As the WB and others indicate, fiscal break-even requires an oil price between $65 and $75 a barrel, with Qatar and Bahrain being outliers requiring below $50 a barrel and over $90 a barrel respectively. Saudi Arabia’s 2021 government budget is based on a price of $51 barrel but this is still unclear.
On 9 November 2020 Fitch Ratings also has downgraded Saudi Arabia, Saudi Aramco and SABIC to negative.
The foreseeable future is bleak, with possible economic and political instability being most worrying. A full-fledged economic crisis based on continuing lower oil and gas revenues or a breakdown in potential growth potential is expected to increase internal pressure on governments, leaders and reformists. As the region is confronted not only by Covid-19 but also by a two-dimensional threat – i.e. the end of hydrocarbon wealth and growing internal instability – security will have to be reconsidered. Internal instability is also a potential new roadblock against economic diversification and mediagenic projects such as the energy transition and decarbonisation of the economy. A perfect storm is building up, putting the young leaders in the region, such as Saudi Crown Prince Mohammed bin Salman, Abu Dhabi’s Crown Prince Mohammed bin Zayed and Bahrain’s new Prime Minister, under major duress. Their futures depend on total reconstruction of their economies, finances and societies. Without the urgently needed conventional revenue base, major projects will have to be put on hold. Weak oil and gas markets, stagnating economies and major delays in transformational projects will give new life to opposition on all sides. The Arab young could become disappointed, leading to a potential Arab Spring/Winter 2.0 or a re-emergence of conservative political powers.
Change in the region is needed in order to survive the coming decades. Change, however, also needs time and money, or, as consultants say, “time and materials.” The lack of change in the last 30 years, continuing societies of rentier states and social contracts made up of a mix of tribalism, clientelism and expatriate workforces, is now the main culprit. Without realism on all sides, instability is going to be a prime factor. With major external and regional conflicts already ongoing, this could be recipe for disaster. No hope should be put on a short-term saviour called oil and gas price hikes, as more is needed than oil prices hitting $70-80 a barrel. With lower demand and external party reluctance to invest due to a Catch 22 situation, it will be a tough task to get through without casualties. As long as the regional economy is driven by hydrocarbons, commodity prices will shape the region. With Covid-19, the energy transition and the new star in the firmament, ESG, drastic measures are needed. In a normal geopolitical and socio-economic environment change would not be an unfeasible target. Leaders now need to show that the future is their main strategy, not short-term political gain.
* Cyril Widdershoven is Founder and Sr. Advisor at Verocy, and Global Head Strategy & Risk Berry Commodities
From the same author, read also:
– The Russia-Saudi oil price war: How it could end?, 7 April 2020
– Is Saudi Arabia’s oil market dominance Pyrrhic Victory? 6 April 2020
– Geopolitics and conflicts hit Aramco’s IPO, Crown Prince turns East 2 December 2019