Political risk for oil producers in the Middle East

Governments are set to benefit as unrest in the Middle East pushes oil prices above budget forecasts. Published in MEED, 11 March 2011

Oil prices are once again on the rise as a wave of political instability across the Middle East and North Africa region increases fears about supplies being disrupted.

The revolution in Egypt in January had made international markets nervous, but events in Libya since then have increased the upward pressure far more. For many Middle East governments that is just where they need prices to stay, even if they would prefer the protest movements to disappear quickly.

Almost without exception when drawing up their budgets for this year, the energy-rich countries of the region have increased their estimates for crude oil prices compared with 2010. This is the critical calculation in their budgets, as oil accounts for the vast majority of government revenues in these countries.

Oil budget estimates

While the average budget estimate across the region was $53 a barrel last year, it has now climbed to $64 a barrel and could go higher still once figures are known for Qatar and Abu Dhabi. The most bullish are Bahrain and Iran, which have both drawn up an estimate of $80 a barrel. The lowest price in the Gulf, set by Saudi Arabia, is $56 a barrel, $3 above the 2009 average.

Even in the case of Algeria, which is sticking to the $37 a barrel level it used last year, it is clear the government is banking on oil prices being far higher in reality, given the $50bn budget deficit it envisages running at that price.

On the face of it, with the price of oil so high, the position the region’s producers have taken looks like a reasonable one. The average cost of the Opec basket of crudes was less than $78 a barrel last year, but it is already more than $96 a barrel so far in 2011. Economists’ estimates of the price of oil for the year as a whole are generally in a range of $80-90 a barrel, with some raising estimates for the year to above $100 a barrel. And most say their figures are more likely to be revised upwards than downwards as the year progresses, particularly if the political upheaval in Libya is followed by problems in other countries. At that level, the region’s oil producers look to be in a strong position.

“We’ve seen an increase in oil price estimates take place across the board and the increases have been quite significant,” says Jarmo Kotilaine, chief economist at Jeddah-based National Commercial Bank. “Countries in the region have a reputation of underestimating oil prices. It’s still reasonable to expect that most will book a surplus over the year.”

“There has always been a trend of [governments in the Middle East] being relatively conservative on price and most of them have an oil reference price below $70 a barrel,” says Bill Farren-Price, chief executive officer of UK-based energy consultant Petroleum Policy Intelligence. “I think $70 is a pretty good base. Opec would take action if it fell below that for any period of time.”

Governments have long used a conservative estimate for oil prices, while hoping that actual revenues come in ahead of target to cover their spending plans. For example, over the past decade, the oil price has been on average more than 60 per cent higher than the estimates used in Saudi Arabia’s budgets, according to local investment firm Jadwa Investment.

Riyadh does not give an explicit figure for the oil price it uses for its spending plan, but Jadwa estimates this year’s budget is based on a price of $56 a barrel of Saudi crude, which it says is equivalent to $60 a barrel for the international benchmark West Texas Intermediate crude. At this price, the difference between government revenues and expenditure would leave Riyadh with a shortfall of more than $10bn for the year.

Controlling deficits

That would be a large amount for many countries to have to deal with, although it is only equivalent to about a week’s spending in the kingdom. However, it is unlikely that by the end of the year there will any deficit at all. Jadwa says it expects oil prices to average $78 a barrel for Saudi export crude over the course of 2011. At that level, the government will still be able to book a comfortable surplus, assuming its spending does not spiral out of control.

Most other oil-rich governments look like they will be able to do the same in 2011, even after allowing for the sharp increase in the oil price estimates. The level of $80 a barrel that Bahrain and Iran are both relying on has only been reached five times in the past 150 years, after adjustments for inflation, but other countries have far more room for manoeuvre.

“As usual they’ve been quite conservative with their estimates for oil prices,” says Liz Martins, senior economist at HSBC Middle East in Dubai. “We’re not worried about the downside risks to oil this year. We see all the GCC states in surplus.”

Perhaps the greatest risk for countries hoping to be able to stay in the black is the heavy pressure that governments will come under to boost their spending over the course of the year, particularly if the political trends evident in January and February continue. As most finance ministries were putting their budgets together towards the end of last year, before the wave of protests had got under way, the actual patterns of government spending in 2011 may look rather different to those originally envisaged in their budgets.

Expanding food and fuel subsidies

The unrest has already forced several governments to expand their support for subsidies on basic commodities, such as food and fuel, in a bid to defuse economic tensions before they boil over into regime-changing protest movements. Others have resorted to simple cash gifts.

Kuwait launched a $4bn handout to its citizens in late January, equivalent to about $4,000 a person. The Bahraini government gave BD1,000 ($2,650) to each household in the country in mid-February, in a failed effort to dissuade people from taking to the streets and calling for social, economic or political reforms.

Saudi Arabia has gone furthest, announcing a wide-ranging package of benefits on 23 February on the day King Abdullah bin Abdulaziz al-Saud returned to the country, after a lengthy absence for health reasons. The measures covered everything from financial assistance to Saudis studying overseas, to additional funding for social security and housing programmes, and rises in public sector salaries. The extra spending on housing alone expected to cost the government some SR36bn ($9.6bn), with the total investment estimated at about SR135bn.

Alongside the handouts and subsidies, security spending is also likely to be increased by authorities keen on ensuring they can cope with any political challenges that emerge. These moves will put significant pressure on the fiscal positions of some states, particularly as the cost of importing most basic commodities has also been rising.

“The cost of living concerns are growing,” says Kotilaine. “Some of these commodity price pressures look like they’re becoming quite entrenched.

“The fiscal model of some countries is coming under a little bit of strain. Algeria needs an oil price close to $100 a barrel to break even fiscally. In that, it is not that different to the situation Bahrain is in.”

The pressure is far worse in countries that are net oil importers. Governments in Amman, Rabat and elsewhere do not have the benefit of increased revenues from crude oil sales to offset higher spending, but they may nonetheless feel the need to increase subsidies for fear of seeing even more protestors take to the streets.

Higher state spending in Saudi Arabia

That is not a concern for the region’s oil producing countries, however. Several have been able to use their higher oil price estimates to draw up expansionary budgets as they chase greater economic growth – something that is all the more important in a climate where banks are still reluctant to lend. For example, Saudi Arabia’s expenditure in 2010 totalled SR626bn and it has set a target of SR580bn for this year. Riyadh has tended to overspend in recent years and Jadwa estimates the actual figure for this year will reach SR658bn.

“It’s a trade-off for the Middle East,” says Martins. “You need to have higher spending, but then you also have higher revenues because the oil price is stronger.”

Even if oil prices did tumble, Saudi Arabia would be able to withstand the shock comfortably, even if some of its neighbours are more fiscally vulnerable. The greatest risk for oil exporting countries this year, however, looks to be political rather than economic. If their spending plans fail to create growth and jobs, they could find that their citizens become ever more vocal in their criticisms.