How Petro Economies Are Coping with $40 Oil

With oil prices trading below both their January and March lows, questions have begun to emerge about the fiscal condition of the world’s primary oil exporters, especially in the Persian Gulf. Saudi Arabia, with massive oil reserves, is facing its biggest budget deficit in almost three decades. And oil-industry Petromatrix GmbH says that Saudi Arabia’s plan to produce oil at full throttle was a “strategic mistake,” according to a Bloomberg report. (See also: Top Factors & Reports That Affect The Price Of Oil.)

The chart below from the US Energy Information Agency (US EIA) shows the large drop in OPEC’s net export revenues following its peak in 2013 because of collapsing oil prices, with its revenues essentially halved from 2013 to 2015. The year marked “forecast” is 2014 and the low point is 2015, before a slight expected recovery in 2016, according to the EIA.

Fiscal Balances

The drop in revenues presents specific challenges to each country’s finances, and for some, their stability. The chart below from the IMF’s July 2015 World Economic Outlook illustrates this point particularly well. It shows the projected fiscal deficit of the six countries in the Gulf Cooperation Council (Saudi Arabia, UAE, Oman, Kuwait, Bahrain and Qatar) in April 2014, when oil was trading at $100 per barrel, and the current fiscal deficit with oil around $40 per barrel.

Before the current drop in oil prices, the IMF expected these countries to maintain consistent fiscal surpluses into 2019. Now, the opposite is true and the Fund expects consistent fiscal deficits, with government spending consistently outstripping income. This year is projected to be the worst, with an average deficit of 7.9% of GDP. This is a new problem for many of these countries, and will require a careful policy response.

A Long Way from Breaking Even

For these countries, an even greater challenge is their newfound inability to rely on oil revenues to fill the gap. Another chart from the IMF shows the fiscal breakeven   oil price required by different countries with oil-centric economies. With world oil prices hovering around $40, not even the strongest GCC member, Kuwait, is able to balance its budget. In fact, no major petroleum-producing country can balance the books with such low prices.

This is a big change from 2014, when oil prices were around $100 per barrel. At that price,

only Algeria, Yemen and Libya were facing fiscal difficulties. In the current price environment, however, no GCC country or other petro economy is able to generate enough oil-driven revenue to support its spending commitments.

Saudi Sovereign Bond

The drop in revenues leaves most of these governments with two choices. The first is cut spending and run the risk of social unrest, which must appear unpalatable, especially given the lessons of the Arab Spring in 2011. Youth unemployment is an issue across the region, and making sure the local population has enough well-paid government jobs is essential to maintaining stability.

The other option is to borrow money, and this is the course Saudi Arabia has chosen, despite having foreign currency reserves of around $660 billion as of June 2015 according to Trading Economics. In July 2015, the Kingdom announced the $4 billion issue of its first sovereign bond since 2007 according to Reuters. The same article reports that the IMF estimates Saudi Arabia’s 2015 fiscal deficit will be a whopping 20% of GDP, or approximately $150 billion. With expenditures of that magnitude, the government will run down its reserves in a little under 5 years. So to prevent this, it is turning to the international capital markets to build a financial buffer.

Credit rating agencies don’t seem to be worried yet. Standard and Poor’s affirmed Saudi Arabia’s credit rating in May 2015 saying, “In our view, Saudi Arabia's government and external balance sheets currently remain strong and provide a buffer to withstand external shocks, including a drop in oil prices.” It remains to be seen how much of a sustained drop its buffers are prepared for. (See also: Long on Oil? Hedge Falling Oil Prices with Options.) 

The Bottom Line

Oil exporting countries are facing tough times in the current oil-price environment. Most countries are not able to balance their budgets with $40 per barrel oil, and face tough policy decisions about cutting spending, increasing borrowing or a combination of both. This is a new dilemma for wealthy countries like Kuwait and Qatar, who until recently didn’t have any such concerns. The most interesting thing to watch over the next year is the policy response. Will governments keep borrowing and spending - hoping oil price increases are just around the corner, or will they bite the bullet, tighten their belts and risk social unrest