As oil prices fell sharply in recent weeks, consumers may have breathed a sigh of relief. But for Gulf governments, the drop was a reminder of their increasing dependence on energy prices remaining at historic highs.
With increased domestic spending pushing up the revenues Gulf countries need to fund their budgets, the energy-rich states have become more vulnerable to volatility in the oil markets. It is no longer unforeseeable, some say, for the days of budget surpluses to come to an end.
“It comes down to the degree to which countries are willing to live with budget deficits, to what extent they can afford these deficits,” says Farouk Soussa, chief regional economist at Citigroup in Dubai.
While oil prices remain high by historic standards, market jitters about an economic slowdown in China, a potential Greek exit from the eurozone and cracks in the US economic recovery have all exposed the potential fragility of the current era of expensive oil, on which Gulf state budgets depend.
In the US, where a glut of oil has formed at its physical delivery point in Cushing, Oklahoma, prices for a barrel of the benchmark West Texas Intermediate fell to a six-month low of $92 last week. At the same time, Brent crude, used as a benchmark for Middle Eastern oil, completed is largest three-week fall since May last year, dropping more than $20 to 2012 lows of less than $110.
In the recent past, crude prices in that range would have meant giant surpluses for the region. But spending surges have changed that. Government expenditure in the Gulf is forecast to reach $500bn by next year, a fourfold increase in less than a decade, according to HSBC estimates.
According to the International Monetary Fund, the United Arab Emirates now needs oil to remain higher than $92 to stay in the black, up from just $23 in 2008.
In the Gulf, only Bahrain needs prices higher than that. Wracked by political turmoil that hit its tourism and financial sectors, the island’s break-even price last year rose to $114, the IMF estimates. Even Saudi Arabia, the region’s economic giant, has seen the price it needs to avoid deficits rise to $80, more than double the 2008 level.
The break-even figures, which are difficult to estimate for states where government budgets are often opaque, can differ widely from one source to another. But they illustrate how state spending has risen in tandem with the rise in oil prices – and onlookers doubt whether such spending can fall as easily.
“It’s just very risky to build an economy based on these kind of oil prices,” says Robin Mills, an analyst at Dubai-based Manaar Consulting. “In the short term you have all sorts of threats that could drive prices down and in the long term $100 oil is just not sustainable.”
While all Gulf oil exporters have become more vulnerable to oil price shocks, some are better placed to weather the volatility than others, onlookers say.
Saudi Arabia, with the largest population in the Gulf, will continue to spend on its socioeconomic programmes regardless of risking budget deficits, because it cannot shelve domestic issues such as unemployment and wealth disparity, says Citi’s Mr Soussa. With a cushion of $500bn in reserves, the country has the flexibility to fund its deficits in the medium-term.
Analysts group the UAE alongside Qatar and Kuwait as countries that would be less affected by a drop in oil prices. With smaller populations and less pressing social demands, the countries have increased flexibility to reduce spending if the need arises.
But Bahrain and Oman are singled out for the need to continue to spend domestically, teamed with a lack of the abundant petrodollars enjoyed by other Gulf states. Although both are under pressure to spend to stave off domestic dissent, funding budget deficits is likely to require higher borrowing costs than their Gulf neighbours.
The structure of government spending across the Gulf has changed over the past five years, from dealing with the fallout of the global economic crisis to a new focus on spending to salve domestic disquiet.
While cash transfers through government handouts and pay increases were one early example of such spending, the bulk is going into infrastructure projects to tackle what many consider to be root causes of unrest, such as unemployment, housing and state services.
“There’s a real desire that the national economic growth plans aren’t knocked off track,” says Nick Tolchard, head of Middle East at Invesco, the asset manager.
Governments are funding directly the kind of projects that may in the past have been supported through leverage. The result is less oil money being put away for future generations.
Invesco’s recent sovereign wealth fund report concluded that cash entering the region’s sovereign investment funds will grow an estimated 8 per cent this year, despite a 31 per cent increase in government revenues. The reduced saving is another symptom of the rapid rise in government spending.
“With spending levels rising at this rate, the risk of a sharp and painful adjustment when oil prices fall is increasing,” wrote Simon Williams, chief regional economist at HSBC in a recent economic report.