[David Fickling] Looming fall of Gulf’s oil empire

For much of the world, oil wealth is a curse. Endowed with ample reserves of hydrocarbons, the likes of Nigeria, Angola, Kazakhstan, Mexico and Venezuela frittered the benefits away.

Only in the Persian Gulf has oil been a nation-building blessing. The discoveries of petroleum in the mid-20th century turned an anarchic, desperately poor region into one of the most affluent places on the planet. Qatar, Kuwait and the United Arab Emirates are all richer than Switzerland. Even Saudi Arabia, Bahrain and Oman are on a par with Japan or the UK.

The transformation has been so complete that it’s easy to believe the wealth derives from some eternal law of nature. That’s not true, though. The current price war in oil markets will only hasten the moment when the unsustainable nature of Gulf economies faces a brutal reckoning.

Right now, all six monarchies are joining with Russia in opening the taps to flood the crude market and flush out higher-cost producers. While the planned 2.5 million barrels per day increase from Saudi Arabia is by far the biggest wave in this tsunami, its neighbors aren’t holding back. The UAE will daily add about 200,000 barrels or more, according to consultancy Rystad Energy, while Kuwait will lift output by 110,000 barrels. Russia will raise daily production by 200,000 barrels.

That splurge of supply isn’t due to geopolitics. Instead, it’s a mathematical result of the decline in the oil price. With fewer dollars coming in for each barrel of crude, Gulf monarchies need to pump much more to maintain something resembling current revenues.

In principle, there’s ample firepower to fight this war. It costs about as much to pump a barrel of oil from a Gulf oilfield as it does to buy a bottle of fancy mineral water. Even in an extreme scenario where crude prices fall as low as $10 a barrel and almost the entire global oil industry loses money, Gulf producers would remain in the black. The problem, as we wrote last week, comes for their economies, which need a far higher price to balance their budgets and support dollar-linked currencies.

The region’s central banks and sovereign wealth funds have assembled vast sums to see them through such a crisis, as well as the longer-term risk of declining demand. Faced with lower prices, however, these buffers could disintegrate quickly.

Take the net financial assets held by Saudi Arabia’s government -- central bank reserves, plus sovereign wealth fund assets, minus government debt. These declined to just 0.1 percent of gross domestic product from 50 percent over the four years through 2018 as crude plunged from levels of around $100 a barrel at the end of 2014. The kingdom is now likely to be a net debtor for the foreseeable future, even if prices rise back above $80.

Over the same four years, net financial assets held by the six Gulf monarchies fell by around half a trillion dollars, to around $2 trillion, according to a study last month by the International Monetary Fund. Even if peak oil demand doesn’t hit until 2040, that remaining sum could be depleted by 2034, according to the IMF. Oil at $20 a barrel would run it down even faster, emptying the coffers as soon as 2027.

With oil prices in the range of $50 to $55 a barrel, Saudi Arabia’s international reserves would fall to about five months of import coverage as soon as 2024, according to an IMF report last year. That should be a deeply alarming prospect, bringing the kingdom within months of an unthinkable balance-of-payments crisis and the abandonment of the dollar peg, which has underpinned the global oil trade for a generation. Yet the prices we’re now seeing make this look almost like an optimistic scenario.

There’s still time to avert this future, but it will involve major changes to our ideas about the Gulf and its role in the global economy.

Governments in the region enacted vicious budget cuts in the wake of the 2014 price decline, removing subsidies and adding sales taxes in a way that’s fraying the edges of their sumptuous welfare states. If they fall to an even lower ledge, there will be pressure to add further taxes and shrink bloated civil services. Neither will be popular with citizens, who have never been allowed a democratic vote. Lavish defense and security spending, which accounts for nearly a third of Saudi Arabia’s budget, may have to shrink.

The era when the Gulf nations and their sovereign wealth funds were magic cash machines prepared to pay top dollar for assets on every continent may be coming to an end. They may even have to turn into net sellers. That will affect institutions from the US Treasury market, where Saudi Arabia holds about $183 billion of securities; to Softbank Group Corp., which may find Riyadh a less generous partner for funding Masayoshi Son’s expansive visions.

The monarchies have surfed a remarkable tide of wealth over the past half-century or so, but every wave eventually crashes. Future generations will never again see the wealth that current subjects enjoy. Perhaps the Gulf wasn’t spared from oil’s curse, after all. That moment was only deferred. 


David Fickling
David Fickling is a Bloomberg Opinion columnist covering commodities, as well as industrial and consumer companies. -- Ed.

(Bloomberg)