Plummeting oil prices may drive diversification in the GCC

Published May 4th, 2015 - 06:28 GMT
Al Bawaba
Al Bawaba

Low crude production costs and fiscal breakeven prices will support the GCC in a period of low oil prices increasing the pressure to diversify away from the hydrocarbon sector, a report said.

Because of the region’s accumulated reserves and low debt levels, the GCC will continue to spend at the current rate, but an extended period of low oil prices will fuel greater urgency to execute diversification plans and introduce reforms, in particular the reduction on subsidy bills, explained the analysis released by Asiya Investments, a subsidiary of Kuwait-based Asiya Capital Investments Company.

Oil prices are now at their lowest level in a decade, roughly 50 per cent below last year’s peak of $115. Oil-exporting countries are facing significant headwinds, but the strength of the headwinds varies substantially among them. The cost of producing a barrel of oil diverges significantly between countries. The main reason for the difference resides in the extraction method.

According to Morgan Stanley, oil prices must be above $65 per barrel for the average North American shale company to be profitable. Extracting oil from sands, a common method in Canada and the Arctic, is even more expensive, with an average price of $70 and $75 per barrel respectively. In stark comparison, the average cost of onshore, close to the surface Gulf oil is only $27 per barrel.

“Despite years of failed plans to diversify away from the energy sector, growth in Middle East oil-exporters remains strongly linked to oil prices. Oil exports constitute the main source of revenue, which translates into subsidies and infrastructure projects,” said Camille Accad, economist at Asiya Investments.

The current period of weakness has plunged price levels below most countries’ fiscal breakeven prices, the level needed to generate a fiscal surplus. That threshold varies greatly in the Mena region.

“The region that presents lower fiscal breakeven prices is, not surprisingly, the Gulf Cooperation Council (GCC),” Accad said.

“Given that many of these countries have also accumulated sizeable financial reserves, it follows that the region is relatively well equipped to withstand low prices. The only country in Mena that can still generate a fiscal surplus with current oil prices is Kuwait, which posts a breakeven price of $50 for 2015, as estimated by the International Monetary Fund (IMF).”

“Qatar and the UAE’s economies are more diversified than Kuwait’s, but larger fiscal spending have resulted in breakeven prices of around $70 per barrel.

“Saudi Arabia’s breakeven price is around $85 per barrel. Even though it produces more than three times as much oil as Kuwait, its large spending on infrastructure and diversification projects makes the fiscal balance more sensitive to changes in oil prices,” she added.

The most vulnerable countries in the region are Bahrain and Oman, whose breakeven prices stand at around $100 per barrel. In Bahrain, with a mere 50,000 barrels per day production rate – sixty times smaller than Kuwait’s three million barrels – subsidies and welfare require around 50 per cent of the government’s total spending. In the case of Oman, 75 per cent of its revenue comes from proceeds of 950,000 barrels sold per day.

“Outside the Gulf and Iraq, Mena’s oil exporters, such as Yemen, Libya, Algeria and Iran, will suffer as their fiscal breakeven prices are around double the current price of oil, and with much lower reserves available, may result in political instability,” said Accad.

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