Analysis: Adapting to change

The energy market is still reeling from the fall in the price of oil

Markets have been spooked by the fall.
Markets have been spooked by the fall.

The energy market is still reeling from the fall in the price of oil. In the current climate, a return to the days of $100 a barrel of oil seems unlikely

The slump in oil prices presents challenges but also opportunities for the Middle East and North Africa (MENA), a new report from the Institute of International Finance (IIF) has said.

It reported that while overall growth in the oil exporters will moderate and the large fiscal surpluses will decline or shift to significant deficits, low oil prices may encourage an acceleration and deepening of structural reform efforts to improve energy efficiency and diversify their economies. Non-oil countries in the region will benefit from the fall in oil prices through reduced oil import bills and lower fuel subsidies.

In IIF’s forecast, the price of Brent is projected to average $60 per barrel in 2015 and $72 per barrel in 2016. Assuming a pickup in oil prices from the second half of 2015 as demand growth responds to the price fall and supply growth is cut back, especially in the U.S.

However, the outlook remains highly uncertain, and could be affected by events in the region. In fact, oil prices could be lower if sanctions on Iranian crude oil exports start to be lifted after end-June of this year and if Libya’s oil production recovers significantly, according to the report.

The headline forecasts from the IIF are stark although the extent various members of the GCC and the wider Middle East region will be affected is likely to vary widely. But in general terms, the 40% oil price drop from 2014 prices implies a massive shift in external and fiscal accounts.

Exports from the MENA oil exporters will be reduced by $300bn in 2015. For the GCC, the aggregated current account surplus will shrink from $266bn in 2014 to about $40bn in 2015, and the fiscal position will shift from a surplus of 4.6% of GDP to a deficit of 7.4%.

The slump in oil prices has changed the growth setting for MENA. Lower oil prices will weigh on economic activity in the oil exporters. The 40% price drop from 2014 implies a $300bn reduction in exports from the MENA oil exporters in 2015. In the oil-importing countries, the IIF expects a modest pickup in growth in 2015.

Over the medium-term, a return to trend growth in the range of 4-5% will hinge on reducing geopolitical risks, achieving political stability, and the implementation of structural economic reforms – a position that would seem to favour the likes of United Arab Emirates, Qatar and (possibly to a lesser extent) Saudi Arabia.

But, encouragingly, GCC countries are thought to be in a far better position than in previous downturns in the 1990s and 1980s, although governments could still use this period as a springboard to reform and economic diversification.

“With gross public external assets estimated at about $2.2trn (120% of GDP in 2014) and gross government debt of 13% of GDP (excluding government-related entities), low oil prices are not expected to trigger government spending cuts in 2015,” the report stated.

“Nonetheless, the current low oil price scenario could be an incentive for governments in the region to make greater efforts to diversify sources of revenues, rationalise spending, and gradually reduce fuel subsidies. The impact of low oil prices on non-hydrocarbon growth will greatly depend on the policy response of the governments in the region. In the GCC countries, government spending, financed largely from external receipts, is pivotal in setting the pace for overall economic activity.”

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The fall in output from the US shale market has helped steady the price to around the $60 mark, having lurched below $50, while political instability in parts of the Middle East have raised doubts about the capabilities of countries such as Libya and Iraq being able to meet production targets.

The view from the IIF is that the Saudis and other Gulf producers have counted on to stabilise and ultimately raise prices could begin to materialise towards the end of this year and more decidedly in 2016, but that the ability of US shale operators should not be underestimated.

The organisation expects prices to recover on a more sustained basis, starting from the levels prevailing in 2015 Q4 and rising toward $78/bbl for the Brent by year-end for an annual average of $72.5/bbl.

However, risks to the downside remain prominent, including an agreement with Iran’s nuclear programme that could trigger market moves to bid up the price even as easing of sanctions would be gradual.

“In the meantime, oil inventories continue to swell and the buildup in stocks remains a source of downward pressure on prices. Over the medium term, prices could strengthen, although there are many unknowns. U.S. shale operators, which account for 50% of total U.S. crude output, are operationally agile and are able to quickly adjust production to market developments,” the IIF research reads.

“In a totally different but ironically comparable way, Saudi Arabia also has the flexibility to adjust rapidly to market developments due to its massive oil reserves and exceptionally low production costs, large financial resources, and spare oil production capacity. The global oil market will therefore resemble a ‘pas de deux’ involving Saudi Arabia and the U.S.

Russia can be expected to continue to produce to capacity, although if the present sanctions remain in place for long, that capacity will be degraded over time, along with Russia’s financial position.”

Given the recent state of the global oil and gas market, there are positives to be taken, but the likelihood of a return to $100 a barrel is stark.

“The $100/bbl price, however, will not return to the market on a sustained basis for many years,” said the report.

Our view is that while the annual incremental increases in oil supply from the U.S. will remain modest, the U.S. will maintain its position as one of the world’s three largest crude oil producers, along with Russia and Saudi Arabia, supplying between nine and 10 mbd of crude through the end of the decade, with oil output oscillating back and forth in response to price developments and improvements in technology”.

The full report can be found at iif.com

Facts
- 40% The price of a barrel of crude has fallen dramatically since last summer.
- $40b The predicted current account surplus of GCC nations in 2015.
- $113 Oman's tight reserves means its breakeven price is over $100.
- $62.8 By contrast, Kuwait’s breakeven is far lower than average.

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