Between July last year and January this year the price of a barrel of Brent crude, the main benchmark in international oil markets, fell by around 60 per cent, from more than $110 a barrel to just over $45. Since then it has ebbed and flowed between $42 and $66 a barrel. At the end of October, a barrel was swapping hands for just over $46.
The expectations in the market are that the price will start to recover in 2016 and 2017 but only at a relatively slow pace. Luciano Jannelli, Head Investment Strategy Asset Management at Abu Dhabi Commercial Bank, says the bank does not expect the oil price to exceed $60 a barrel next year, which is in line with the thinking of many other observers. Fitch Ratings, for example, is also predicting an average oil price of $60 next year and a further rise to $70 in 2017.
The consequences of the subdued oil market are becoming ever more apparent in the Gulf region. Governments are cutting back on their investment budgets, cancelling some projects and delaying the implementation of others. They are also starting to reduce subsidies. The UAE was the first in the region to do so, when it announced in July that it would start setting petrol prices in line with market rates. The Saudi Oil Minister Ali al Naimi suggested in late October that his government was considering a similar move.
However, the large savings built up by many governments during the preceding oil price boom means that a lot of spending can continue. Governments have been able to draw down some of their savings to help balance their budgets and some, such as Saudi Arabia and Oman, have also been raising money by selling bonds. As a result, overall economic growth is set to continue, albeit at a reduced rate. ADCB expects growth in the UAE to come down from 4.6 per cent in 2014 to close to 3.5 per cent in 2015.
A further piece in the fiscal jigsaw is also being talked about, in terms of raising taxes to boost non-oil income. The main focus of this at the moment is on a Gulf-wide sales tax, but the speed at which any such VAT could be imposed remains open to speculation.
This tighter economic environment is having a knock-on effect on private investors. There is a close correlation between oil prices and optimism in the Gulf region and sentiment has undoubtedly taken a hit. That can be clearly seen on the stock market. The main indices around the Gulf such as Saudi Arabia’s Tadawul All-Share Index and Dubai’s DFM Index have been moving in line with the oil price since August last year and the number of new share offerings has dried up.
In the rest of the economy there are further consequences. Lower government spending is liable to hit growth in the non-oil sector in a number of ways. There will be less project activity, which will hit areas like construction and transport in particular. And reduced government deposits in the banks will mean that financial institutions will have to reduce their lending activities, which in turn is likely to have a dampening effect on the real estate sector.
In the longer-term, however, there are some reasons to suppose that the oil price slump could boost investment opportunities. The cuts to oil revenues have emphasised once again how important it is for the countries in the region to diversify their economies and reduce their reliance on oil and gas revenues. That ought to mean encouragement for new sectors of the economy, particularly in highly skilled service industries.
Overall, the Gulf economies have not done particularly well with their efforts to diversify in the past, although there are some notable exceptions such as Dubai. The push to develop more varied economies should continue in the years ahead, spurred on by events such as the Dubai Expo 2020 and macro-economic growth strategies like the Abu Dhabi Economic Vision 2030. Elsewhere in the region, the football World Cup that is due to be hosted by Qatar in 2022 will also mean continued infrastructure investment there.
The oil market is of course a very dynamic one and prices have swung even higher and lower in the recent past. In the second half of 2008 the price of a barrel of Brent crude fell from over $140 to less than $40 per barrel, before steadily recovering to reach over $100 in May 2011. Predicting any short-term movements is all but impossible, but there are reasons to support the idea that there again will be an improvement in prices next year. The consequences of the cuts that international oil companies have made to their investment programmes should start to feed through, as will the pressure on higher-cost US shale producers. Such things could dampen supply and thus encourage a modest pick-up in prices. On the other hand, demand growth is likely to remain subdued in some key markets like China and major European economies. The combination of these supply and demand factors means that, while prices are expected to recover in 2016 and 2017, it is likely to be a gradual rather than a rapid change. Even a modest, sustained uptick in prices will help
to ease the pressure on budgets though, and if governments continue to pursue the structural reforms that are needed that should provide a boost to general economic activity. For investors, a gradual recovery in the price of a barrel of crude should also make life easier, with asset prices stabilising and then starting to grow over time.
This is a sponsored article written for Abu Dhabi Commercial Bank
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