Oil and gas in the capitals

	Vol. 229 No. 12
DR. A. F. ALHAJJI, CONTRIBUTING EDITOR, MIDDLE EAST

The shock of lower oil prices

If the recent declining trend in oil prices continues, the oil-producing countries in the Middle East are heading toward a crisis similar to those of the mid-1980s and late 1990s. Government officials thought that their accumulated foreign currency reserves would shield them during periods of low prices. They are shocked by the sudden, steep and painful decline in oil prices. They did not expect a financial crisis that would force them to bail out their own banks and provide billions of dollars in aid to local businesses and populations.

The oil and gas business in the region has started to contract. Already Saudi Aramco is rethinking several long-planned upstream projects, including multibillion-dollar developments at Manifa, Karan and Shaybah Fields, according to Khalid Buraik, the company’s executive director of affairs. And on Nov. 6, Saudi Aramco and ConocoPhillips announced they would halt bidding for construction of the planned 400,000-bpd export refinery at Yanbu, Saudi Arabia, citing the contracting market. Fears that planned projects in the region will be mothballed are becoming more reasonable by the hour.

At the time of this writing, oil prices were about $65/bbl. This price is confusing. We have a major worldwide financial crisis and a crisis in the real economy. Even so, oil prices remain in the range that was prevalent when the US was growing at 3-4% per year, China at 11% per year, and India at 7% per year. If prices are too high, then they must decline in the following weeks to levels that will be remembered for years to come. If not, then the $60 range is likely to be the new floor.

The dependence of many countries in the Middle East, especially in the Gulf region, on oil revenues has not changed substantially in the last two decades. While key economic indicators in some countries suggest otherwise, most of the new industrial sector consists of petrochemicals and energy-intensive industries. The growth in other sectors depends heavily on government spending, which is fueled by oil revenues. Therefore, a large decrease in oil prices necessarily has a profound impact on these countries.

The experience of collapsing oil prices in the mid-1980s and late 1990s allows us to draw several conclusions about the probable impact of low oil prices on the oil-producing countries in the Middle East:

Decline in oil revenues. The decline in oil revenues will set a new record. If oil prices continue to drop, the coming period will be more like the mid-1980s than the late 1990s. Like that of the mid-’80s, the current decline came after a long period of price increases. Prices were relatively low in the late 1990s before they declined further in 1998 and early 1999.

Gulf countries do have a cushion of foreign reserves, which did not exist in 1998. However, given population growth and increasing budgetary demands, Middle Eastern countries will sell more oil for lower real revenues compared with either the mid-’80s or the late ’90s. More oil for less money!

Budget deficits. Despite conservative estimates of oil prices in government budgets, a continued decline in oil prices will result in budget deficits in all the Middle East’s oil-producing countries. Some market analysts believe that these countries will defend the oil prices found in their budgets by cutting production. Theory, statistical analysis and history indicate otherwise.

In theory, countries that relate oil prices to their budgets are price takers. Therefore, they cannot be price makers by cutting production to raise prices. Some of these countries will continue to produce to maintain the flow of oil revenues at any price. They will use their foreign reserves or borrow money to finance their budget deficits.

Saudi Arabia, for example, registered an unprecedented budget deficit of $16.7 billion in 1986 and $14 billion in 1987. In 1998, the Saudi budget deficit reached $10.7 billion. Kuwait’s budget deficit was $4.53 billion in 1987 and $5.73 billion in 1998. Iran registered budget deficits of $17.7 billion, $9.8 billion and $6 billion in 1986, 1987 and 1998, respectively.

Budget cuts and canceled development. Lower revenues translate into canceled, curtailed or postponed contracts. In 1987, Saudi Arabia had to cut defense and security expenditures by 5.9%. Saudi Arabia’s 1999 budget slashed spending by 15.8%, the largest budget cut ever. Education and health services both suffered 6% cuts. In the late 1990s, Iran closed several embassies, citing budget cuts. During the same periods, Abu Dhabi cut back its building contracts by 35%.

Lower or negative economic growth. Economic growth in Middle East oil-producing countries correlates highly with oil prices. High economic growth accompanies higher oil prices in the same manner that low economic growth is associated with low oil prices. For example, Saudi real economic growth averaged 7.4% between 1974 and 1981. It declined to less than 1% between 1984 and 1989. It turned negative in 1999, but higher oil prices in recent years raised growth rates to more than 5%. Kuwait experienced 7.3% real growth between 1974 and 1979. Growth declined to 5% between 1984 and 1989, despite revenues from its foreign investments. Kuwait suffered from a recession in 1999. The average growth between 2002 and 2007 exceeded 10%. The same applies to Iran, the UAE, Bahrain, Qatar and Oman.

In a low-price environment, there is no incentive to spend money on new oil and gas projects and oilfield maintenance, even if that money exists. The result is declining production capacity and poorly maintained facilities. Consequently, the world will soon experience another cycle of bust and boom in the oil business.

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