Utilising the oil windfall

Fiscal outlook transforms

The surge in oil and gas prices since the invasion of Ukraine in February has had a radical impact on the fiscal outlook for oil-exporting countries in the region—the GCC, Iraq and Libya. Most of these countries are now forecast to achieve fiscal surpluses this year, in some cases very large ones. Of course, for the oil importers (Egypt, Jordan, Lebanon and Palestine), the higher prices are a major source of strain on both their fiscal and current accounts, on top of rising food import prices.

Will the third oil boom last?

The current price surge is the third major oil price boom of the 21st century and to understand what it might mean, and how it is shaping fiscal policy, it is worth reviewing previous experiences. The first boom was part of a broad commodities supercycle driven by the rise of China that saw a steady rise in the price in 2002-6, a brief pullback and then a near tripling in Brent crude over 18 months to a record above $140 per barrel in July 2008. The global financial crisis then drove prices back down by three-quarters by late 2008. There was a steady rebound in 2009-10 as the global economy recovered, moving back into boom territory above $100 per barrel for most of 2011-14, a golden age for oil exporters. Prices declined once again, this time from late 2014-16 due to the unexpected rise in US shale production and Saudi Arabia increasing production to place pressure on the shale firms - crashing prices by about three-quarters by early 2016. The subsequent rebound, catalyzed by the start of OPEC+ cuts in 2017, ran out of steam in autumn 2018, when oil peaked at a modest $85 per barrel, as compliance with OPEC+ quotas wavered.

In early 2020, oil was already trading well below the fiscal breakeven of most countries in the region. Covid then drove it down to just $14 per barrel, its lowest since 1999 in nominal terms, and an all-time low in inflation-adjusted terms. Prices recovered to 2018 highs by 2022 and then the third boom got underway, driven by a variety of factors including the global demand recovery as Covid restrictions eased, supply problems in several major producers and finally worries about Russian supply.

The key question for Middle East oil exporters is whether this third boom will be prolonged, as in 2011-14, or followed by a sharp decline, as in 2008, perhaps due to factors such as a breakdown in OPEC+ and a lifting of sanctions on Iran and Venezuela. Future oil prices are highly uncertain. The oil assumptions used in the IMF’s World Economic Outlook, which is derived from the forwards market, were revised upwards by 47% to $88 per barrel on average in 2022-26, between its October 2021 and April 2022 reports. Some banks are predicting several years of prices remaining well above $100 per barrel, with even higher scenarios contemplated if sanctions further curtail Russian output.

However, others are more cautious, for example, Standard & Poor’s has maintained a forecast of $55 per barrel from 2024. These views are all being scrutinized in the Middle East as countries determine how they will use the current windfall. Added to the mix are concerns about what comes next, as the energy transition could be accelerated by Europe’s newfound energy security concerns.

An end to pro-cyclical spending?

Governments in the region have often demonstrated pro-cyclical fiscal policy, hiking spending when oil revenue is high and cutting back during crashes, which often coincide with periods of pressure on the non-oil economy. This is despite advice from the IMF and others to limit inflationary spending splurges and provide counter-cyclical support during downturns. Looking at data in the GCC for recent cycles (trends in Iraq and Libya are complicated by their conflicts), spending rose at an average rate of 19% a year in 2002-8, peaking with oil in 2008 at 30% year-on-year. Growth slowed during the 2009 crash but picked up again in 2011, tracking oil prices until the oil crash in 2014-16 when spending fell below the 2012 level. Spending has risen more, barring a small dip in 2020.

There is an expectation that this time things will be different, given the fiscal discipline that developed following the 2014-16 oil crash. The IMF’s latest April 2022 forecasts still only see a 5% spending increase in 2022, mainly driven by Qatar and UAE, and it expects Saudi Arabia to actually cut spending by -3% (against a planned 8% spending cut as announced in the Saudi budget). So far, only Saudi Arabia and Oman have published Q1 outturns, both showing modest 4% year-on-year increases in expenditure. Oman has announced additional capex and social support, but these will only boost spending by about 3% above the budgeted level.

As the year progresses we will get a better assessment of how expenditure is trending, particularly from Oman and Kuwait which publish monthly spending data, quarterly data from Saudi Arabia, Qatar and the UAE, and mid-year data from Bahrain. If there is indeed restraint this is probably because of the development of medium-term fiscal plans across much of the region. Saudi Arabia, Bahrain and Oman had all published plans targeting fiscal balances, including setting strict expenditure envelopes.

Debt, reserves and investment

If spending is indeed controlled, the region will have a major windfall to direct to other purposes. Excluding Bahrain, which may still run a deficit including off-budget spending, the IMF expects an aggregate surplus of $154bn for the other five Gulf states in 2022 and a further $624bn in 2023-27.

Oman and Saudi Arabia have given the clearest indications of how they intend to use the funds. Oman’s Sultan Haitham has personally directed his government to reduce debt, which peaked at $55bn of GDP last year, but the IMF sees it declining quickly to just $22bn in 2027. It has begun debt repayments, including a $3.6bn Chinese syndicated loan that had previously been expected to be rolled over.

Saudi Arabia’s national debt management plan, issued at the start of the year, had envisaged rolling over maturing debt, but it did not refinance a $4.5bn sukuk that matured in March. Speaking at Davos recently, the Saudi finance minister, H.E. Mohammed Al-Jadaan, said that the priority was on rebuilding reserves—the government reserve account hit a 15-year low of $85bn in April 2022, a quarter of its 2014 peak. He said that a fiscal sustainability policy is currently being crafted that will set a “double-digit” floor for reserves as a share of GDP (they are currently about 9% of GDP). Remaining funds will then flow to the Public Investment Fund and the National Development Fund to finance local development projects.

Some Saudi funds will likely also go to PIF’s foreign investments, particularly to take advantage of the current market dip (in 2020 it received a $40bn transfer to invest mainly in US stocks). Qatar, UAE and Kuwait haven’t announced formal policies for the windfall, but it is likely that the bulk, totalling $90bn this year, will go into foreign investments, after redeeming maturing international debt.