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Khatija Haque - Head of Research & Chief Economist
Published Date: 12 July 2021
The failure of Opec+ to agree on a production increase from August at its most recent meeting this month saw oil prices to rise to their highest level in more than two years. Historically, higher oil prices have been welcomed by GCC oil producers as they have allowed governments to increase spending and drive economic growth in the region’s non-oil sectors while also boosting the assets of sovereign wealth funds, which have been invested for future generations.
While higher oil prices have already contributed to higher-than-expected government revenue in the GCC this year, Emirates NBD expects governments in the region to prioritise the reduction of deficits rather than increasing government spending.
Moreover, the benefit to regional budgets depends not only on the price of a barrel of oil but also on how much crude oil is being pumped and sold at that price. Our analysis of regional budget break-even oil prices suggests that only the UAE would record a budget surplus with oil prices at USD75/b this year while Saudi Arabia’s budget would be close to balanced – a significant improvement on last year’s 11.2 per cent budget deficit but one that still offers limited scope to increase spending. The deficits of other GCC countries are expected to narrow significantly from 2020 but would still require additional financing to meet their existing spending commitments.
Certainly, if Opec+ does not reach an agreement on increasing oil production in the coming weeks, oil prices could rise even further. While this would provide an additional boost to budget revenue, we do not expect this to translate into significantly higher spending in the region, particularly as most countries have committed to medium-term fiscal reforms to reduce their reliance on oil revenue and limit expenditure growth. Consequently, we do not expect faster non-oil sector growth on the back of sharply higher government spending over the next couple of years. Indeed, higher oil prices may delay some of the necessary fiscal reforms that need to be undertaken to put some of the GCC budgets on a more sustainable footing in the long term.
Moreover, if Opec+ does not agree to gradually increase oil production in the second half of this year, this will probably be negative for headline gross domestic product growth in 2021. Even with a gradual increase in crude oil production in the second half of the year, oil sector output is expected to be lower than it was in 2020. If there is no increase in production from August, then the contraction in the oil sector of GCC oil-producing countries could be deeper than we currently expect. The price of higher oil revenue for GCC countries is then slower GDP growth.
For the rest of the world too, there is a cost. Higher oil prices would feed through to higher inflation, which is already surging in many countries as service sectors reopen, supply chains remain disrupted and shipping costs rise. While the major central banks – the US Federal Reserve, the European Central Bank and the Bank of England – have indicated they will look through what they consider “transitory” inflation for now, some emerging market and European central banks have already responded to higher inflationary pressures by raising interest rates, which could slow economic growth in these markets even as they have yet to recover from the Covid-19 pandemic.
Emirates NBD’s base-case scenario is that Opec+ will come to an agreement that will allow for some increase in oil production from August. This should support oil prices in the current range of USD70 to USD75/b. There are two alternatives that, in our view, have a lower probability. The first is that no agreement is reached and oil production remains unchanged in the coming months and the second is that individual Opec+ members increase production outside of a broad Opec+ agreement.
In the first no-increase scenario, oil prices could rise sharply from where they are now, boosting oil producers’ budget revenue but at the cost of regional and, potentially, global growth. In the second scenario, where oil producers increase production outside an Opec+ agreement, oil prices could fall sharply from current levels. However, with demand recovering, we are unlikely to see a repeat of the April 2020 price collapse. Oil prices could fall to between USD55 and USD65/b in this scenario. Higher oil production would support regional GDP growth while lower oil prices would support global economic growth, even if budget deficits in the GCC would be slightly wider in this scenario than the others.