A myriad of macroeconomic factors are colliding this year to create a string of uncertainties that have worried energy producers around the world. It is still unclear how Beijing plans to manage China’s first major economic wobble in nearly three decades; meanwhile, subsidy cuts in Gulf countries that have long enjoyed oil wealth are still underway and the US has raised interest rates for the first time in a decade.
Plus, the Saudi Arabian riyal fell to a record low against the US dollar in the one-year forwards market in mid-January and state-owned Saudi Aramco, the world’s largest oil producer, said it is eyeing an initial public offering (IPO) this year. Questions abound over whether region’s economic powerhouse is falling. Europe is still posting minimal economic growth and the majority of the BRIC economies (Brazil, Russia, India and China) are struggling to find their fiscal feet.
All of these macroeconomic factors feed into what underpins the character of the global economy – confidence. The bearish sentiment means many investors that have typically rushed to funnel cash into oil and gas projects are now tentative, including those in the Middle East.
Tightened budgets are one of the reasons behind Royal Dutch Shell’s decision to withdraw from a $10 billion development of the Bab sour gas reserves with Abu Dhabi National Oil Company (ADNOC), while Total is reducing its global workforce by 4,000 and the UAE’s Sharjah-based Dana Gas is cutting its headquarters’ workforce by 40 percent.
Perhaps confidence in the macroeconomic outlook will improve as the year progresses if China’s economy stabilizes, the US’ plans to increase interest rates become clearer and the subsidy cuts in the Gulf help boost coffers.
China’s fiscal transformation
The treasury of the world’s largest economy faces a challenging year and energy producers are not immune, but China’s outlook is not as bleak as global headlines suggest. The devaluation of the country’s currency, the yuan, last August fueled fears that its debt-driven burst onto the global stage over the past decade could crumble and take the bulk of Asia’s energy demand down with it. But the Chinese economy is still expected to grow by roughly seven percent in 2016 – albeit the slowest full-year growth since 1990 – and Beijing’s double-freeze on China’s small stock market in early January primarily affected sentiment rather than actual business.
Beijing’s plans to start switching to more sophisticated market reforms in 2016 could lead to a safer and consumer-based economy – clarity that will benefit economies worldwide. Energy producers in the Middle East are expected to benefit from China’s historical trade links that have endured for more than two millennia, as Beijing ramps up its One Road, One Belt program along the new Silk Road.
Trade between the UAE and China, for instance, is already growing at 16 percent annually and China is now the UAE’s second-largest trade partner: volumes stood at $54.8 billion in 2014. Beijing’s aversion to wade into regional politics will continue to charm trade partners like Oman, the UAE and Iraq, and the historic Sino-Iran trade accord will regain momentum following the lifting of sanctions on Iran in January.
Entering uncharted territory
Saudi Arabia is entering uncharted territory – budget deficits, subsidy cuts and IPOs are not terms usually associated with the Kingdom. Saudi Arabia’s oil-centered economy, where petroleum accounts for 80 percent of its revenues, will spend less this year, rapidly trying to balance the weight of lower oil prices and the escalating costs of the Saudi-led coalition’s first year of operations in the Yemeni war.
Financial pressures mean the Kingdom’s initial subsidy cuts, which saw petrol prices rise by up to 50 percent in late 2015, could be deepened this year. So far, Saudi Arabia’s forecast budget deficit of SAR326 billion ($87 billion) equates to 16 percent of its GDP.
The possibility of an IPO of state-owned oil giant Saudi Aramco is an indication to many of how the cash-strapped Kingdom is looking to raise finances. Some energy professionals counter that Riyadh’s vast foreign exchange reserves will protect the treasury from the worst of the low oil prices this year, saying that Saudi Aramco’s move reflects the country’s confidence and efforts to introduce market reforms. A third explanation is that the tentative IPO illustrates Riyadh’s attempt to ring-fence its market share by inviting international partners into the fold, especially at a time when sanctions are lifted on Iran, the Kingdom’s main competitor in the region.
US interest rates
The much-anticipated increase in US interest rates – the first rise in a decade – will have far-reaching consequences in 2016, raising borrowing costs for both corporates and consumers at a time when low oil prices are triggering budget deficits.
Another hike in interest rates was expected as we went to press, so companies at home and abroad that have not already factored in the change need to adjust quickly to the US’ new fiscal landscape. Emerging market currencies are expected to move as they absorb the shock, especially in economies like Turkey, Malaysia and Brazil. But the Philippines, India and Korea are likely to remain stable.
Low oil prices, combined with rising interest rates, mark the final straw for small and medium US shale oil producers as many look to declare bankruptcy, curbing both shale production and new infrastructure projects until oil prices climb above $50 per barrel again. The US has 5,000 drilled and unused wells that could bring another four million barrels per day (bpd) of new supply to the market at 100 to 200 bpd each – a welcome fiscal boost if oil prices recover later this year.
Africa’s emerging middle class
With many energy hubs in the Middle East and North Africa beset by political strife, Gulf and Asian investors are eyeing the largely stable democracies in the East African Community (EAC). Tanzania, Kenya and Uganda are spearheading East Africa’s economic prowess; growth forecasts for the region are 5.6 percent and 6.7 percent for 2015 and 2016, respectively.
The population of middle-class households in 11 sub-Saharan African countries – including Tanzania, Kenya and Uganda – is expected to more than double from 15 million people to exceed 40 million by
2030, according to Standard Bank’s research. The subsequent economic growth and appetite for oil products from the continent’s own reserves, as well as Gulf and Asian suppliers, is vast.
The EAC hopes to invest roughly $1.5 billion to build 1,454km of intra-regional and domestic pipelines over the next few years. The longest pipeline will be the 784km Kenya-Uganda-Rwanda route, which should significantly bolster fuel trade between the three countries.
Several East African countries are addressing wobbly regulatory frameworks by establishing bidding rounds – a more transparent way to allocate resources. Tanzania hopes to use its
55 trillion cubic feet (tcf) of natural gas reserves to become a liquefied natural gas (LNG) exporter by 2025, while Tullow and Canada’s Africa Oil have identified
600 million barrels of oil reserves in Kenya’s South Lokichar basin.
Economics and geopolitics
Economics and geopolitics are permanent bedfellows and the year ahead sees major changes in both. The political turmoil in the Middle East is unlikely to improve in the short term, with souring relations between Saudi Arabia and Iran adding a fresh dose of uncertainty to a backdrop of war in Syria, Iraq and Yemen.
Wars are costly and the Yemen war in particular is weighing down Saudi Arabia’s economy as it spearheads a coalition into a second year of airstrikes and fighting against the Houthis in Yemen.
Saudi Arabia’s attention is also firmly fixed on Iran’s economy, which has been honed by nearly a decade of sanctions. The country’s inflation rate has dropped from approximately 45 percent in 2013 to ten percent in 2015 and, while Iran lacks the economic might of Riyadh, it is highly ambitious and has already built a network of relationships for potential energy supply contracts that stretch into Europe, the Gulf and Asia.
And, outside of the Gulf, geopolitics is putting a strain on Europe’s economy as an influx of refugees squeezes budgets, especially in countries that are also grappling with rising unemployment.
Dyala Sabbagh is a founding partner of Gulf Intelligence.
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