By VL Srinivasan
The revenue losses incurred by the GCC nations due to low crude oil prices since 2014 was close to $300 billion (QR1.92 trillion), so it goes without saying that they heaved a sigh of relief when the prices rose, touching a four-year high of $79 per barrel around mid-May this year. Oil exporters are under pressure now to step up production to bring oil prices down.
Some of the reasons for the increase in the oil prices include a spurt in demand, decision of the Organisation of Petroleum Exporting Countries (OPEC) to extend oil production cuts by the end of this year, decline in supplies from Venezuela, the US decision to exit from the Iran nuclear deal, and rising tensions in the Middle East. Though the US has increased its oil production, it could not offset the short supplies from Venezuela, and with Iran’s oil also unlikely to reach the global markets, the OPEC needs to increase the output by at least one million barrels per day to prevent oil prices from shooting up further.
Even the US has informally urged OPEC to step up production, and Saudi Arabia along with non-OPEC member Russia responded positively, but Iran described the US request as “crazy and astonishing”.
The US decision means sanctions will be re-imposed on Iran, which would come into force after a 180-day wind-down period ending November 4. Despite the European Union (EU) seeking US exemption for its firms from purview of the ban, many EU companies have started withdrawing from their operations in Iran.
It may be recalled that Iran has ramped up oil production by one million barrels per day, from 2.9 million barrels per day in early 2016. When the ban was lifted around the same time, it rose to 3.8 million barrels per day in April 2018.
Market watchers aound the world opine that US President Donald Trump’s decision on the Iran nuclear deal is expected to support higher oil prices. However, if oil prices continue to increase, it will force the energy-hungry nations to look at other sources, including LNG, to meet their energy demand.
Francisco Quintana, Head of Strategy at Foresight Advisors, says: “The upcoming two years of high prices constitute a good opportunity for gas exporters to lure customers into switching from oil into gas.”
Still confusion prevails on how the oil prices behave as analysts are estimating how much Iranian crude will be restricted by the US decision, and also if all nations fall in line with regard to the sanctions. It is likely that some nations in Africa, China and in the EU will ignore the sanctions and continue buying Iranian crude and do business with the Persian Gulf nation.
GCC growth rate to accelerate
Awash with funds due to high oil prices till 2014, the GCC witnessed an impressive growth rate when the oil prices hovered around $110 per barrel, but when prices started falling and came down to below $30 per barrel, the growth stagnated. However, with the scenario changing, many feel that these nations are back in business.
Francisco says that the rebound in oil prices will accelerate growth, and the real GDP for the entire GCC region is expected to roughly double to around 2%, though it is a notoriously poor measure of activity for them, given that it removes the impact of prices.
“In major exporting countries like Kuwait or Qatar, it’s basically counting the volume of exports. But price has a huge importance. Nominal and non-oil GDP will accelerate much faster, and governments will dust investment plans. One can expect to see a rapidly expanding pipeline of projects. In this whole picture, real estate will disappoint because the impact of high oil prices will be offset by oversupply in Qatar, Saudi Arabia and the UAE and rising interest rates,” he says.
According to him, with higher oil prices, the governments will defer implementing reforms for some time. Even though the Arab Spring is long gone, the risk of triggering social unrest by cutting subsidies or salaries remains a source of concern for GCC governments. The turmoil experienced in Jordan in the last few weeks is a good example. As such, most of the reforms pushed by the International Monetary Fund and approved in 2015 and 2016 during the period of low oil prices will be put on hold.
“Kuwait has already announced that it will delay implementation of the VAT, which was to begin in early 2019, by two years. Dubai and Abu Dhabi announced stimulus programmes last fortnight that will reduce taxes for many sectors. High oil prices will delay the adoption of many of the reforms that are needed, and were finally getting traction, to ensure the sustainability of the region,” Francisco points out.
Echoing similar feelings, International oil economist Dr Mamdouh G Salameh says that rising oil prices should enable the GCC countries first to offset the revenue losses they have suffered due to low oil prices. They could also enable them to balance their budgets and diversify their economies.
Present oil revenues will also enable GCC to expand their oil and gas production capacities. The UAE is already planning to raise its oil production to 3.5 million barrels a day (MBD) with emphasis on producing light crude oil which normally fetches a higher price, thus enabling it not only to satisfy the needs of its refineries for blending but also to compete with US shale oil.
He said Saudi Aramco was planning to spend QR1.21 trillion ($334 billion) across the oil and gas value chain by 2025, and Kuwait is expected to spend QR418.6 billion ($115 billion) on energy projects over the next five years to help boost the crude production capacity to 4 MBD by 2020.
Qatar is also planning to boost the liquefied natural gas (LNG) production capacity from its giant North Field by 30%, from 77 million tons currently to 100 million tons per year in the next seven years.
“Oil will remain the backbone of the GCC economies for the foreseeable future. However, natural gas production and exports are emerging as an important and additional source of income for countries of the Middle East,” Dr Salameh says.
Dr Nasser Saidi, President of the Dubai-based Nasser Saidi Associates, too says the latest developments will definitely ease the fiscal pains in the GCC which have in the recent past seen removal of subsides in a phased manner as well as the introduction of VAT and excise taxes.
While higher oil prices and thereby higher oil revenues will help soften the effects of fiscal austerity, it still remains lower than breakeven prices projected for most GCC nations. It therefore remains critical that further structural reforms be undertaken for greater economic diversification.
There have been some positive reforms in the labour market, announcements of residency (in the UAE, Qatar and Bahrain) as well as opening up sectors for 100% foreign ownership. There will be spillover effects into the non-oil sector also, alongside improvements in business and consumer confidence (already visible with the uptick in indicators like PMIs, GCC projects, slow pickup in credit growth etc). The UAE government recently also announced several measures to reduce business costs, which will also have a positive impact on non-oil growth, says Dr Saidi.
Qatar stands to gain
In its latest commentary, the Qatar National Bank (QNB) said the monthly inidicators on trade and industrial prices showed that the country’s economy was benefitting from higher global hydrocarbon prices further minimising the impact arising out of the diplomatic rift with its neighbouring countries.
Higher crude oil prices were helping drive the improvement, adding around QR one billion on a year-on-year basis but, looking at the geographical split, suggests that booming LNG demand to Asia is the key driver, QNB said.
Exports to Japan, the world’s largest LNG importer, were particularly strong in April, up nearly QR2 billion versus last April. Japan’s export share accordingly jumped to 20%, up from 17% in March and 15% a year ago.
While Japan’s LNG imports grew by 2.3%, China’s imports soared by 49% in 2017, allowing it to leapfrog South Korea (which registered an increase of 10.8%) as the world’s second largest LNG importer.
Exports to India were less in April but the Indian government has committed to lift LNG to 15% of the country’s energy mix (from under 7% currently) by 2020, and with more LNG import terminals coming up, the demand is expected to increase in the next few years, and these developments certainly bring comfort to Qatar.
The global LNG imports reached 289.8 million tons (MT) in 2017, registering a growth of 9.9% (26.2 MT) compared with 2016, which is the highest growth rate since 2010. No new country has joined the list of 19 LNG producing countries in 2017, but Malta became the 40th country to import LNG in the same year.
Global credit rating agency Fitch Ratings says recovering from political disputes, a $10 per barrel increase in the price of oil could add about 4% to GDP from Qatar.
“Qatar has successfully managed the fallout from last year’s rupture of trade, financial and diplomatic relations with the quartet consisting of the United Arab Emirates, Saudi Arabia, Bahrain and Egypt,” the agency said in a report.
Moving from a fiscal deficit, accounts for Qatar could move into a surplus by next year. There’s been no escalation in the regional disputes and Qatar’s economy should improve on the back of higher crude oil prices.
“Our forecasts for the government budget are based on a baseline Brent oil price assumption of $57.5 per barrel. We estimate that a $10 increase in oil prices could lead to an improvement in the fiscal balance of around 4% of GDP relative to our forecast, all other things being equal,” the reports says.
Oil price indexation
The Gas Exporting Countries Forum (GECF) feels that LNG prices need to be linked to oil prices to keep the revenue predictable for producers, particularly since some QR29.12 trillion (US$8 trillion) worth of investment in the sector is needed by 2040.
In an interview with Bloomberg Markets, newly-appointed head of GECF, Yury Sentyurin, says: “LNG consumers should understand the peculiarities which producers face. Security of investment and supply can only be on the basis of long-term contracts closely connected to oil prices so we could plan further investments into crucial infrastructure.”
The continued expansion of supply is needed to meet demand, which is forecast to grow at an average of 1.6% per year until 2040. Asserting that a deep-rooted linkage between prices of oil and gas exist, Dr Salameh says this has not only kept revenues predictable and supplies steady but also eliminated both volatility in the market and the ability of one player to influence prices and any incentives to do so.
Gas-indexation to spot prices will not necessarily result in lower prices, but will definitely create problems of price volatility, which will have as a consequence the inclusion of a large risk premium in gas prices at the expense of consumers.
“Gas production costs are in fact linked to oil field development costs, and the aim of the oil and gas companies’ strategies are to develop the one or the other type of field. If average gas prices and producers’ revenues are not lucrative enough, they would prefer to invest in developing new oil fields than new gas fields,” he said.
Thus the replacement of oil-indexed price with a gas-indexed price would have the unfortunate effects of introducing higher risks than it is presently with oil indexation. Long-term, oil-indexed contracts will remain the cornerstone of security of supply for the import-dependent countries, Dr Salameh opines.
Dr Nasser Saidi, President of the Dubai-based Nasser Saidi Associates, says that though the markets for crude oil and gasoline are closely linked, it was not automatic as the prices of both products moved in tandem till 2008, and there has been some divergence ever since.
Since natural gas is often a by-product of drilling for crude oil, an increase in crude oil prices may likely lead to an increase in associated gas production, which in turn might exert downward pressure on natural gas prices.
He says that oil continued to remain a global commodity versus the dominance of natural gas in regional pockets (which is influenced by factors like infrastructure, storage, inventories etc). The natural gas price shocks post-2008 were attributed to commodity-specific events (e.g. weather related events like hurricanes) or bottlenecks at refineries, while oil price changes are affected by geo-political changes and global tensions.
“For Qatar, which supplies almost 25% of the world’s LNG demands, there remains a strong demand from Asian economies (especially China) and Europe. Qatar has already announced expansion plans to increase its LNG export capacity to 100 million MTPA by 2024 as against the present output of 77 MTPA,” says Dr Saidi, who was former Minister of Economy and Trade and Minister of Industry of Lebanon.
QP predicts growth in demand
Predicting the growth in demand for LNG, the government-owned entity Qatar Petroleum (QP) had last year announced increasing the LNG production from 77 MT to 100 MT per annum (MTPA) by boosting production in its vast North Field gas reserves, said to be the biggest in the world, within seven years.
QP CEO Saad Sherida Al Kaabi says the demand for liquefied gas was growing faster than that for oil. “LNG supplies are abundant now, and there are many projects under development, but the expected growth in demand is very large.”
“All the studies show that between 2021 and 2024 there will be a shortage of gas because of higher demand. Therefore, the launch of our project will be between 2022 and 2024, which is the period when there will be market demand,” he says.
Expanding its global footprint, QP has also signed an agreement with ExxonMobil to acquire a 30% stake in two of Exxon’s affiliates in Argentina – ExxonMobil Exploration Argentina S.R.L. and Mobil Argentina S.A. – which holds rights with other partners for seven blocks – giving QP access to oil and gas shale assets in the Latin American country.
“This agreement goes hand in hand with the planned expansion of our local production from the North Field, which will further boost Qatar’s leading global position by raising its LNG production from 77 million to 100 million tons per year,” the CEO adds.
Will prices decline again?
Though Saudi Arabia and Russia were keen to step up production levels after the request from the US, other oil exporting countries such as Iraq and Venezuela are opposing the move for various reasons, including a glut in the market.
Francisco says that even if Saudi Arabia and Russia were likely to expand production, there will not be any significant declines in prices as a result.
The three factors that are creating supply constraints will remain in place for the next year: first, the collapse in production in Venezuela; second, the new sanctions on Iran (IEA just estimated last week that these two factors will reduce exports by 1.5MBD by year-end, while OPEC is only planning to expand output by 1MBD); and third, the shortage of pipelines in the US to bring oil to its ports.
“As these issues will take at least a year to be addressed, we expect prices to end the year at around $72 per barrel. We also expect the market to be balanced in 2019 and prices to decline in late 2019 and 2020 on account of softening demand,” he says.
But Saidi believes that oil prices will settle around the $55-$65 per barrel mark in the medium-term and there are various supply and demand side factors that affect the oil prices, including factors like production of shale oil, competitive renewable energy, energy efficiency policies, meeting commitments of COP-21 and beyond, etc.
However, Dr Salameh is very optimistic.
Oil prices underpinned by a global economy projected to grow by 3.9% in both 2018 and 2019, a fast-growing global oil demand adding 2 MBD to global demand this year, surging Chinese oil imports and a virtually re-balanced oil market could see oil prices surging beyond $80 a barrel this year, rising to $80-$85 next year, and hitting $100 by 2020.
“Iran may not lose a single barrel of its oil exports as a result of the US forthcoming sanctions for two reasons. One is that the European Union (EU) has already indicated that it will stay in the Iran nuclear deal and will not comply with US sanctions and will, therefore, continue to import Iranian oil. The second reason is that Iran will be using the petro-Yuan for its oil exports to China, the Euro for its exports to the EU and barter trade with Turkey, Russia and India virtually neutralising the impact of the US sanctions,” he says.
Were Saudi Arabia to accede to President Trump’s request, it will be risking unravelling the OPEC deal that has brought an end to the glut in the global oil market and pushed prices to $80 and also inflicting huge damage again on the Saudi economy, which is already bleeding blood and money in the war in Yemen.
Instead, OPEC members should aim at maximising the return on their finite assets to the highest level that the global economy could tolerate. “Judging by the robust fundamentals of the global oil market, I believe that the oil price has a long way to rise before the global economy reaches its threshold of tolerance,” adds Dr Salameh.