In June 2014, crude oil was trading at $115 a barrel, riding a nearly five-year-long wave of relative stability. Within six months, oil prices halved, undercutting global markets and re-defining the economic context for countries in the Gulf Cooperation Council (GCC). The sharp fall in prices was mainly driven by a combination of excess supply and weakened global demand. Despite this, the Organisation of the Petroleum Exporting Countries (OPEC) decided in November 2014 not to cut production in response to declining prices.

The slide in oil prices has wide-ranging effects for the GCC region. Despite increased competition from shale gas producers in North America, the Middle East remains central to the global oil market. Conversely, the oil market is the core driving force behind many Middle Eastern economies. In the GCC, hydrocarbons represent more than 50% of the GDP and 80%–90% of government revenues. With the price of oil collapsing 50% in the past six months, the most since the 2008 financial crisis, the IMF estimates that oil export losses in 2015 will reach $300 billion, or 21 percentage points of the GDP, in the GCC. Low oil prices are also expected to lead to a slowdown in remittance outflows from GCC countries to the rest of the region, including India, as per the World Bank.

In light of market volatility, companies in the GCC region are placing IPO plans on hold until the markets settle. Businesses in oil producing countries depend on economic activity stimulated by government spending, which in turn is driven by oil revenues. In the near term, governments should be able to limit any severe spending cuts due to the substantial fiscal reserves they have built up, thanks to years of high prices. However, governments will face significant losses in exports and revenues, if prices stay low for a sustained period. According to the World Bank, the combined fiscal surplus of around 10% of the GDP (in 2013) could turn into a deficit of 5% of the GDP (in 2015) for GCC countries.

Stock markets in several Middle Eastern countries, including Kuwait, Saudi Arabia, and the United Arab Emirates (UAE), declined sharply in late 2014 on rising concerns about how their economies will be affected by lower oil prices. The IMF estimates that growth in the GCC will be around 3.4% in 2015, a downward revision of 1 percentage point relative to their forecast in October 2014.
Despite a recent rally in the oil prices, analysts are hesitant to suggest that a prolonged rebound is on the horizon. Jeffrey Currie, Global Head of Commodities Research at Goldman Sachs, said recently that the benchmark price could drop to as low as $42 a barrel. Furthermore, Citi and Barclays recently forecasted a renewed plunge in prices, in respective notes to clients. According to Barclays’ Kevin Norrish, the oil price will average $40–$50 a barrel for the year. If that is the case, most GCC countries will need to reassess their spending plans in the medium term.

There are signs that regional governments are already beginning to rethink their policies. Saudi Arabia is planning to increase energy and fuel prices, and improve efficiencies in non-oil revenues. Lower prices have prompted the UAE to look for other sources of income such as a tax on remittances.

Although most GCC countries have made improvements on diversifying their economies away from oil production over the last decade, budget revenues are still vulnerable to continued price changes. Structural reforms to diversify the revenue base away from oil, and policies encouraging growth and job creation will become increasingly important for GCC economies. If lower oil prices persist for a prolonged period, these countries will have to adjust to the new realities of the global oil market.


Murugan Sankaran

Murugan Shankaran is Chief Executive Officer of IGFSL, ME. IGFSL,ME is a 100% subsidiary of IL&FS Financial Services. The views expressed in this article are his personal views.
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