Reforms still needed in the Gulf
Strong oil prices have buoyed the economies of the GCC. But reforms are still needed
In 2001, Saudi oil minister Ali Al Naimi said $25 per barrel was a fair oil price for both consumers and producers. In 2004, he described $34/b as fair; in 2005, prices above $50/b were "too high"; in 2006, $27/b had become "reasonable"; and in 2008, $75/b was fair. In recent months, $100/b has been Naimi's fair value.
This escalation shows the almost limitless flexibility of the Gulf oil exporters' expectations. Their vast oil resources, extended reserves lives and low production costs should give them the luxury of the long-term view. But short-term expediency has too often tempted them from the path of strict fiscal rectitude.
Exact budgetary break-even prices for major oil producers are uncertain, clouded by lack of transparency; tendencies to overspend stated budgets; off-budget funds and defence expenditure; ad hoc stimulus packages; domestic consumption at subsidised prices; variations in oil production costs; gas exports; non-oil income and investment earnings; and varying exchange rates (particularly for Iran). Figuring out the number for the United Arab Emirates (UAE), a federal structure with only one major oil-producing emirate, is especially tricky.
One reasonable set of estimates, from the Arab Petroleum Investments Corporation (Apicorp), sees the prices major exporters require to balance their 2012 budgets ranging from $53/b in Qatar, through Kuwait and the UAE, to $94/b for Saudi Arabia and $127/b for Iran. With present prices not much above Saudi break-even levels, demand for Opec's crude rising only marginally, and an outlook of stagnant prices, the fiscal pressures are mounting.
It is also clear that break-even levels have risen enormously in recent years: Saudi Arabia's doubled between 2008 and 2011. This is often ascribed to a desire to appease citizens with lavish benefits during the wave of revolutions throughout the Arab world. In February and March 2011, Saudi King Abdullah announced a $130 billion package of social spending on jobs, housing and bonuses. But spending was rising rapidly even before political unrest took centre stage.
It is often assumed that major exporters' budgetary needs put a floor under oil prices. This may be true in the short-term, as they can cut production to defend their preferred price. But if Saudi Arabia needed $200/b, could it achieve it? It is easy to forget that budgets depend not only on price, but on export volumes. So Riyadh can break even this year at $89/b when producing 9 million barrels a day (b/d). But if it has to cut back to 8m b/d, it needs $103.
And higher prices today come at the expense of lower demand for Opec oil tomorrow - as the boom in high-cost North American output persists, OECD consumption continues its steady decline, fuel efficiency standards tighten and the use of now-abundant natural gas in ships and ground transport nibbles at oil consumption. Aside from Bahrain and Oman, all the Gulf's oil producers are members of Opec.
Demand for Opec's oil is hardly growing quickly. It is set to rise by only 2.2m b/d by 2020. Yet in that time the group may have to accommodate another 3 million-6 million b/d from Iraq, 1m b/d from Kuwait, 700,000 b/d from the UAE and 500,000 b/d from Libya. Other wildcards include a possible revival in Iran if a deal to ease sanctions is struck, a change of course by post-Chavez Venezuela, or large discoveries in Angola's pre-salt.
The key question is how easily Gulf countries' budgets could be adjusted downwards, if they had to contend with falling prices for their oil. Salaries and benefits tend, in a word favoured by economists, to be sticky. Capital spending can be cut back but at the cost of long-term growth. At least 65% of the Saudi budget this year was set aside for current spending.
The major Gulf producers (but not Iran and Iraq) retain huge sovereign wealth funds. But these can liquidate quickly when spending outpaces income - Riyadh had $180bn of net foreign assets in 1980, but by the end of 2002, the country was $176bn in debt. Now, after a decade-long boom, the Saudi Arabian Monetary Authority has $500bn of foreign savings, enough to keep it afloat until around 2030 if it can rein in spending growth.
The problem for Saudi Arabia is therefore serious, but not urgent. Its fiscal position is still enviably strong by the standards of the indebted US or Europe. The other, smaller states of the Gulf Cooperation Council (GCC) are better-placed: Qatar's budget surplus in the second quarter of the 2012-13 fiscal year was $26bn, more than half its GDP in that period. Bahrain and Oman, though, with much smaller per capita oil exports, are more exposed.
The threat is much more acute for Iran and Iraq, and for other major oil exporters outside the Gulf, notably Algeria, Venezuela and Russia. The GCC could hope that one of their major competitors will fall into political or economic disarray first - as happened to Iran in 1978-79, Iraq in 1990-91, and Venezuela in 1999. Indeed, revolution in Libya, then sanctions on Iran, have been helpful for the other members of Opec, keeping prices and production high over the past two years.
But counting on the misfortune of others is hardly a constructive strategy. Raising subsidised energy prices, to curb runaway energy consumption, would be a better early step. Iran's late 2010 reform was surprisingly well-planned and executed, replacing massive subsidies with cash transfers. But it came with political undertones, and was undone by the massive sanctions-induced devaluation and parliamentary opposition to the previous president, Mahmoud Ahmadinejad. Still, it provides a viable template for Iran's Gulf neighbours.
Dubai, helped by a predominantly expatriate population, has also managed to reach cost-reflective tariffs for electricity and water, though petrol remains cheap. Saudi Arabia, by contrast, is one of the world's most oil-intensive economies, burning more than 1 million b/d of crude for electricity during the summer. Its ambitious solar and nuclear power programmes can only be half of the solution, without dramatic improvements in energy efficiency.
The Holy Grail remains a diversified economy with a broad revenue base. Dubai's achievement still depends on attracting oil earnings from its neighbours, and rivals from Abu Dhabi to Doha have found its model hard to replicate. Energy-intensive industries such as petrochemicals and aluminium are profitable, but do not create much employment and rely on increasingly scarce supplies of cheap gas.
Much of the GCC has advantages of geography, good security, readily-available capital and excellent infrastructure. Iran and Iraq have the first of these, plus demographics and industrial and agricultural potential. But successful diversification requires radical changes to the state-dominated industrial model; creating an autonomous, indigenous private sector and encouraging a real culture of entrepreneurship; rebalancing incentives away from the pampered public sector; dramatically improving education and reshaping it for the modern world.
Any government - even the paragon of successful oil states, Norway - faces strong pressures for social benefits, rising salaries and white elephant investments during an oil boom. But the Gulf countries have to confront some of the structural challenges that make them particularly vulnerable. Iraq, not even at the earliest stage of oil-fuelled affluence, is already repeating the same mistakes. Iran, by contrast, is being forced by sanctions into a more diversified economy and tax base. Yet the region's oil exporters have between them only pieces of a comprehensive solution, even as competitors, inflation and demographics eat away at the fair oil price of $100 per barrel.