Middle East

Capitalizing On Debt: Middle East Bonds

By almost any measure, Saudi Arabia’s bond issue on October 19, 2016 was a success. While analysts had been predicting an issu­ance of between $10bn and $15bn, the final amount was $17.5bn, setting a new record for the largest ever emerging markets sovereign bond—the previ­ous record had been set by Argentina in April 2016, when it sold $16.5bn.

Rig count moves in line with oil strategy

Published in MEED, 25 October 2016

The Middle East has bucked a global trend for declining oil rig counts, spurred on by Saudi Arabia’s pursuit of market share

In most corners of the oil and gas industry there is a strong, and unsurprising, correlation between energy prices and the number of drilling rigs in use.

When prices were above $100 a barrel, as they were for most of the period from 2011 to 2014, the number of rigs in operation around the world was also high, reaching a peak in February 2012 of 3,900 rigs, according to US oil field services company Baker Hughes. But since the oil price began to spiral downwards in late 2014, so too have the number of drilling platforms. As of September this year, there were 1,584 rigs in operation around the world, some 59 per cent lower than the peak in the space of just four and a half years.

The Middle East, however, has bucked that global trend. When oil prices began to falter in 2014, the number of rigs in use in the region held fairly steady at just over 400. This year their number has slipped back a little, falling to 379 in August before recovering slightly in September to 386. That relative stability has meant the proportion of the world’s rigs that are now in the Middle East has risen from 10 per cent in 2012 to 24 per cent this year.

The unusual trend in the region stems, in large part, from the decision by Saudi Arabia to maintain high output levels even as prices were falling. Riyadh’s aim was to maintain its share of the global market and force other, high-cost producers – principally in the US – out of the market by making it uneconomical for them to continue drilling.

The policy has had only limited success. The US rig count fell dramatically as prices went south, from just over 1,900 rigs in late 2014 to a low of 408 rigs in May this year. Since then, however, the number has been creeping up again, reaching 481 rigs in August and 509 in September, as the oil price has shown some signs of life. Even more importantly, US production levels have remained relatively high – output peaked at 9.6 million barrels a day (b/d) in June 2015, but it was still running at 8.5 million b/d in late September this year, proving that US producers have been far more resilient than many analysts in Riyadh and elsewhere had expected.

Part of the reason for that resilience is that producers in the US have been cutting costs and focusing on lower-risk assets. This too is a global trend. “The new economics of exploration mean that rather than pursuing high-cost, high-risk exploration strategies, the majors have become more conscious of costs,” says Andrew Latham, vice-president of exploration research at UK consultancy Wood Mackenzie. “Smaller budgets have required them to choose only their best prospects for drilling, including more wells close to existing fields.”

Perhaps the biggest problem for the Saudi strategy is that any sign of a rise in the oil price tends to prompt US producers to invest and expand. As Saudi bank Jadwa Investment noted in a September 2016 report, the number of US oil rigs was steadily rising over the course of the summer months. “Oil prices around the $50 a barrel mark are encouraging US producers to add oil rigs,” it said.

Saudi Arabia needs oil prices to be higher if it is to have any chance of bringing its large budget deficit under control, but for that to happen it will also have to accept that it will no longer be the dominant actor in the market. The production cut announced at an Opec meeting in Algiers on 28 September, designed to prop up the price of oil, appears to be a recognition of this reality.

Nonetheless, Saudi Arabia remains the dominant figure in the regional industry. It has, by far, the highest number of rigs in operation and, while other countries have been holding their fleets steady (or seen them decline in the case of Iraq and Egypt), the kingdom has been expanding. From about 80 rigs through most of 2013, Saudi Arabia has increased the number to 124 as of September this year. That is almost twice the figure of the next largest operator, Oman, which has 64 rigs in use. Following them are Algeria with 53 rigs, Abu Dhabi with 49 and Kuwait with 48.

The majority of rigs in the Middle East today are onshore, accounting for about 87 per cent of the total. However, the picture varies considerably from country to country. In Abu Dhabi only 55 per cent of rigs are onshore, while in Algeria, Iraq, Kuwait and Oman, all of them are. In Saudi Arabia, the vast majority, 88 per cent, are on dry land.

As has been the case for many years, roughly three-quarters of the region’s rigs are used to pump oil rather than gas. The two countries where gas rigs account for a more sizeable minority are Algeria, where it is 34 per cent of the total, and Saudi Arabia (43 per cent).

The fall in global rig counts over the past two years means there is now significant oversupply in the market, which is leading to a sharp fall in costs, according to analysts. “Rig utilisation, vessel utilisation has plummeted and day-rates have fallen in some cases by more than 60 per cent,” says Steve Robertson, director of the research centre at UK energy consultancy Douglas-Westwood. “Oversupply will take some time to work its way out of the system as older units are scrapped.”

The future trajectory of the market depends, as ever, on factors such as oil prices and the balance between supply and demand, but some at least are predicting that activity and investment levels should start to pick up in the coming years. Douglas-Westwood forecasts that global expenditure on onshore oil field equipment is set to rise by 8 per cent a year between now and 2020, from $61bn in 2016 to $83bn in 2020. Most of the activity will be focused on onshore sites, with investment in more expensive offshore operations likely to decline from $67bn this year to $43bn by 2020. For Middle East producers, that could mean that competition will be getting tougher in the years to come.

Region’s growth in military spending slows

Published in MEED, 21 February 2016

GCC military budgets are under pressure, but fears over a resurgent Iran may prompt higher spending

The wars around the Middle East are causing unprecedented suffering for the people of Syria, Yemen and Libya. They are also testing the abilities of the region’s armed forces like never before.

After years of pouring billions of dollars into their military machines during the oil boom, governments in the Gulf and elsewhere are now starting to discover whether all that money was well spent.

A Saudi-led coalition is fighting against Houthi rebels in Yemen from the air and GCC troops have been deployed on the ground, leading to a significant number of deaths of service personnel.

At the same time, many of the GCC states have been involved in the Syrian war too. For now that has been restricted to helping the US-led air campaign and providing funds and weaponry for rebel groups, but there has been speculation that Riyadh might place troops onto the ground there too.

All this is coming at a time when military budgets are coming under pressure from the sharp drop in government revenues as a result of low oil prices. While there has been plenty of discussion about cutbacks to capital spending programmes in Saudi Arabia and the lifting of fuel subsidies in the UAE, less has been reported about the impact that the tighter fiscal environment is having on their armed forces. Yet the signs are that here too governments are taking a more cautious approach.

By some measures, the amount being committed to military spending is still increasing. According to the International Institute for Strategic Studies (IISS), a London-based think-tank, defence budgets across the Middle East accounted for 6.5 per cent of regional gross domestic product (GDP) in 2015. That marks a slight rise on the 6 per cent figure for the year before, although the difference is at least partly explained by military budgets holding steady at a time of declining GDP for oil exporters.

Overall, the growth rate of spending decelerated last year, in spite of the costs involved in the operations in Syria, Yemen and elsewhere. IISS says that regional defence spending rose by 1.2 per cent in 2015, after taking into account inflation and exchange rate changes.

In dollar terms the amount actually fell, from $212bn in 2014 to $205bn last year, as a result of the fall in value of some of the region’s currencies against the dollar. Figures come with a significant health warning, though, given the secrecy surrounding military budgets in most countries.

The Middle East is getting harder to assess and to estimate the spending,” says Giri Rajendran, research associate for defence and economics at IISS. “There are more countries in turmoil which means budgetary documentation is getting poorer. Our estimate is that, from the Arab Spring in 2011 until 2014 spending was increasing at about 10 per cent per annum. Last year in 2015 we think it decelerated quite considerably to 1 or 2 per cent [growth].”

Overall spending in the region is still dominated by Saudi Arabia, which has the third largest defence budget in the world, behind only the US and China.

Riyadh’s $81.9bn outlay is now equivalent to 13 per cent of the country’s GDP and makes up 42 per cent of the total military spend across the entire Middle East and North Africa (Mena) region.

The next largest military spending programme is Iraq’s, at $21.1bn, followed by Israel with $18.6bn and Algeria with $10.8bn. Among the remaining GCC states, the biggest spenders are the UAE and Oman.

One country which is likely to be eyeing an increase in military spending in the years ahead is Iran. Secondary economic sanctions imposed on the country as a result of its nuclear programme were lifted in January, in the wake of the implementation of the Joint Comprehensive Plan of Action (JCPOA) with the EU, US, Russia and others.

Some sanctions remain, however, notably on the sale of military weapons. These will remain in place for a further five years in the case of conventional arms and for eight years in the case of ballistic missiles and related technology.

Nonetheless, the clock is counting down and Tehran can at least look ahead to a time when it will be able to start modernising its creaking air force, navy and army, which have been struggling with obsolete equipment for many years.

“A considerable proportion of Iran’s inventory is so old that it can be considered obsolete,” says John Chipman, director general of IISS.

“Most of Iran’s front-line combat airpower dates back to the 1970s and [is] kept in service by a combination of local maintenance skills and parts bought on the grey market. The same goes for land and naval forces, with the T-54/55 and Chieftain main battle tanks, and the Alvand-class corvettes among those showing their age.”

Despite the limitations of its outdated equipment, Iran continues to be actively involved in projecting its political and military power around the region, most notably in Syria and Iraq. Saudi Arabia has also been flexing its military muscle, although it has relatively little to show for its year-long operation in Yemen, with no decisive weakening of the Houthi forces it is battling against.

The danger is that, as Iran starts to invest in its armed forces once again, the GCC states will feel compelled to act, potentially setting off an arms race in the Gulf, with the US and Europe supplying their GCC allies and Russia and China selling their skills and technology to Iran.

It could also prompt the GCC states to finally start cooperating more closely with each other, as the US has long been urging them to do.

“Previously, Gulf states assumed that they would retain a qualitative edge over Iran. If Iran re-arms, this assumption may no longer hold,” says Chipman.

“While the US has exhorted Gulf states to better coordinate these capabilities, the US still remains at the hub of regional missile defence. If Iran re-arms, this may spur greater cooperation among GCC states, building on the military ties now seen in Yemen.”

Military spending may have decelerated over the past year, but it seems that the trend could well be a short-lived one.

A region lacking in banking access

Published in MEED, 28 September 2015

The countries of the Middle East and North Africa would benefit from far more extensive branch networks.

It can be difficult to find a bank branch in some parts of the Middle East and North Africa region. In countries such as Algeria, Egypt and Mauritania, there are just five commercial bank branches for every 100,000 people. The situation is even worse in places like Sudan and Syria, where there are just three and four branches respectively. In contrast, the network of bank branches is five or six times more extensive in the likes of Lebanon, Iran and Morocco.

The disparity around the region offers an indication of the weakness of some economies and their lack of diversity and resilience. The fewer the bank branches there are in a country, the less likely it is that the people there will hold bank accounts.

In Iran, for example, where there are 28 branches for every 100,000 people, 92 per cent of adults have an account at a financial institution. In Sudan, where there are just three branches for every 100,000 people, the proportion of adults holding a bank account is just 15 per cent.

Low rates of bank account ownership are in turn likely to be a contributing factor to poverty. Financial inclusion is seen as critical to raising people up the economic scale, as it enables them to put money aside for schooling, home improvements or emergencies, and it allows them to borrow money to make investments too.

On this basis, the low number of bank branches in many Mena countries can be seen as holding back the general prosperity of many parts of the region. In Algeria, with its low penetration rate of bank branches, there are 332 depositors and 44 borrowers for every 1,000 adults. In Lebanon, which is well served by banks, there are 832 depositors and 299 borrowers for every 1,000 adults.

Taken as a whole, the Middle East is one of the worst regions in the world when it comes to the reach of its banking system. There are 13 bank branches for every 100,000 people in the region, and the figure for the Arab world is slightly worse, at 11 branches. These figures are not quite the worst in the world – in sub-Saharan Africa there are just four branches for every 100,000 locals. However, on another important measure, the Mena region does lag behind its African neighbours.

According to the Global Findex database produced by the Washington-based World Bank, only 14 per cent of adults across the Mena region have an account at a financial institution, and only 7 per cent of those in the poorest 40 per cent of households do. That means more than 85 million adults in the region remain ‘unbanked’. The situation is worse for women, with only 9 per cent of them having an account.

By these measures, the Middle East is the most underbanked region in the world, with less than half the rate of bank accounts in the next worst region, sub-Saharan Africa.

Enabling women

“When a woman has an account and a safe place to save outside the home, she also has greater control over finances and household incomes,” said Sri Mulyani Indrawati, managing director of the World Bank, at the launch of the Findex report in April. “With access to formal savings and credit, women participate more in the economy. They can set aside funds for emergencies, for schooling, or for starting a business. This is an important stepping stone out of poverty and towards more equality.”

The worst performing country in the region is Yemen, where only 6 per cent of adults have an account at a financial institution, with the figure for women at just 2 per cent. Others that are notably weak in this regard include Sudan, Iraq and Egypt, all of which have bank account penetration rates of 15 per cent or less.

The positive news is that most countries have seen their banking coverage improve over the past decade, although some of the gains have been lost in recent years. In 2004, there were 11 bank branches per 100,000 people across the region as a whole. That increased to 14 by 2008, but since 2011, it has dropped back to 13 branches.

That matches a pattern seen in some other parts of the world, such as East Asia and the Pacific, and the EU. In Latin America and in sub-Saharan Africa, however, the number has continued to rise, as it has for the world as a whole. Globally, the number of bank branches for every 100,000 people has steadily increased from nine in 2004 to 11 in 2005 and to 12 in 2013, the most recent year for which figures are available.

The situation has remained fairly stable for most countries within the Middle East over the past decade, with Lebanon and Iran the clear leaders in terms of the extent of their branch networks, followed by the likes of Morocco, Oman, Jordan and Tunisia. The most notable growth has come in Morocco. It had just 10 branches for every 100,000 people in 2004, which placed it below the regional average. Now Morocco has the third-most extensive network in the region.

Going in the opposite direction, Qatar has slipped back from 24 branches per 100,000 people in 2004 to 13 by 2013. That is partly a reflection of the rapid growth in the country’s population as migrant workers have come in to help with the huge construction efforts under way in preparation for the 2022 Fifa World Cup. The only other countries to have seen their bank branch coverage decline over this period were the UAE, Oman and Lebanon, although none suffered such a dramatic fall.

Of course, the extent of a bank branch network does not necessarily denote strength. Although they have limited networks relative to their populations, banks in Oman and Qatar have non-performing loan ratios of 2 per cent or less, which are well below the regional average of 4.6 per cent and suggest they are performing well.

However, the Gulf banks are liable to find life more difficult in the near future if oil prices remain low. A reduction in state revenues is likely to lead to a fall in government deposits, which currently make up anything between 12 and 38 per cent of all deposits in the GCC banking systems. Lower government expenditure along with the impact on economic growth rates more generally is also likely to mean slower loan growth, higher numbers of problem loans and lower profit levels.

In some other parts of the region, the banking sector is already dealing with very serious difficulties, including years of wars and political instability. For example, according to one official at the Central Bank of Yemen, about a third of bank branches in the country are closed due to the fighting in that country.

Initiatives such as microfinance and mobile banking solutions are starting to fill the gap for the poorer sections of the population, and can be easier to operate during times of conflict. The most recent move in this direction came from the Central Bank of Yemen, which introduced mobile banking regulations in December last year. Although the progress in launching services since then has been fitful, it could in time provide a useful alternative for Yemenis wanting to save or borrow money

Poor uptake

Despite the potential benefits, however, the region as a whole has not seen the uptake in microfinance and mobile banking that it might have, something that observers blame on the overly cautious nature of regulators.

“There are problems on many levels,” says one industry analyst. “The banks are not really interested in serving poor people; they’re serving the rich. And the regulators are focused on banks, and banks alone.

“Microfinance institutions exist but they can’t take deposits in most cases. Institutions that only lend money to poor people will eventually find their growth limited if they can’t find ways to raise their own deposits. The regulators are also very conservative with allowing other non-bank players, for example telecoms firms. I’d like to see what would happen to the financial inclusion landscape if they allowed telecoms operators to play. Personally, I think you’d see an explosion of services.”

In some other parts of the world, mobile phone technology has been the driver of rapid change in the financial landscape, with millions of people who never had a bank account now signing up for mobile money accounts. That has proven to be cost effective for financial providers when it comes to dealing with small transactions. Without the high cost of bank branch networks, they can afford to provide a service to people who would otherwise be locked out of the financial system.

In the longer term, technology might also reduce the need for bank branches for other customers, with online banking increasingly prevalent. But while the people of the Middle East wait for all that to happen, they would undoubtedly benefit from far more extensive branch networks.