Oil Price Blues Force Lower Budgets, Restructuring In the Region

By Colin MacKinnon

The new year was not a happy occasion for oil-producing states. Many of the countries of the region saw their budgets fall into chaos in 1998 and when they looked to the coming year—well, that didn’t look much better.

OPEC oil export revenues for 1998 were an estimated $101 billion. This is down, in constant dollars, one-third from the year before. It is also, again in constant dollars, less than one-fifth the revenues of 1980, which was the high-water-mark year for OPEC oil income. OPEC’s performance in 1998 may turn out to be its worst since 1972.

Though OPEC oil ministers duly met in Vienna last November, they agreed on little except the date for the next meeting (this March). With no agreement on production cuts and with more Iraqi oil likely to come onto the market, the prognosis is low prices well into the future.

The region’s economic despond is due almost wholly to this slump in oil prices, which is now well into its second year and for which no end is in sight.

With oil prices down by a third or more since late 1997, governments are having to scramble—to raise revenues, cut expenditures, and borrow funds to finance their soaring deficits.

This is particularly true of the countries of the Gulf Cooperation Council (Saudi Arabia, Kuwait, Bahrain, Qatar, the UAE, and Oman). Except for Bahrain, which produces little oil, the GCC states derive 30 to 40 percent of their Gross Domestic Product from hydrocarbons. Worse, from the producers’ point of view, GCC governments get 80 to 90 percent of their revenues from the sale of oil, gas, and refined products. (Iran, not a GCC member, is a little less beholden to world oil markets—36 percent of Iranian state revenues come from hydrocarbons.)

The price slump, which stems from low world demand, high production, and two warmer than usual winters, has had severe effects on business. Region-wide, high deficits and borrowing are forcing governments to cut back their spending on projects and to delay paying contractors what they are owed. Further, as countries like Saudi Arabia struggle to maintain market share, they are also discounting oil prices—a further boon for international oil companies and the world’s energy consumers but a bane for producing countries.

As the slump drags on, more than mere commerce is likely to be affected. Governments are feeling pressure to change their fundamental economic policies as well, how they think and how they operate.

And this pressure for change may be more significant in the long run. Governments are having to cut subsidies and introduce user fees for formerly free services. They are also, much against their will, having to consider privatizing state-owned enterprises like power stations and airlines and consider adopting laws that are friendlier toward foreign direct investment. Pressure to rationalize capital markets will grow as well.

Here’s what’s been happening in three key GCC states.

• Saudi Arabia. The Kingdom, OPEC’s largest exporter, produces over 8 million barrels a day of crude—30 percent of OPEC’s total. But Saudi Arabia’s earnings for 1998, estimated at $29 billion, are way down from 1997’s $45.5 billion. The Kingdom’s 1998 budget deficit turned out to be $12.2 billion rather than the $4.8 billion projected in January of last year. The Kingdom’s GDP in 1998 has actually fallen from the year before, probably by as much as 10 percent.

In response, Saudi planners have cut the 1999 budget to $44 billion, down 12 percent from last year’s $50.4 billion. Government revenues in 1999 are projected to be $32 billion, but that figure is based on a petroleum price of $13 a barrel and may well be optimistic. (The price of Saudi crude at the first of the year was under $10 a barrel.)

In May of last year King Fahd reportedly signed a “secret decree” to halt new projects, cut existing contracts by 10 percent, freeze government hiring, and cut government purchases. Then in June the Saudi government for the third time issued so-called “contractors bonds”—that is, instead of paying its suppliers real money, the government gave them low-interest IOUs. Contractors can wait for the bonds to mature or sell the bonds at a discount to their creditors. The latter is the more usual choice since contractors are often deeply in debt themselves.

The government also approved airport departure fees in June, and in September the national airline, Saudia, announced fare increases.

The government may take further steps toward privatization, though such things always go slowly in the Kingdom. Likely sectors include telecommunications and power generation. The Kingdom’s regional power companies are to be consolidated and private participation in the companies will be increased (there have been brown-outs thanks to high usage and not enough supply).

In September foreign oil companies were told they might be allowed to invest in some upstream ventures in the Kingdom.

• Kuwait. Some projections for 1999 put expenditures around $16.2 billion, revenues $13.2 billion, with a deficit of $2 billion. But the deficit for 1998 is an estimated $6.6 billion, and more realistic observers see deficits in this range for a number of years.

In November the Ministry of Finance and Planning published a plan to deal with the revenue shortfall. The ministry wants to cut subsidies on water and electricity, raise customs duties on “non-productive” goods (while lowering them on food and other essentials), and raise fees for government services and use of government property.

In the past Kuwait has excluded international oil companies from the state petroleum sector, but is rethinking that position. Look for the emirate to conclude service agreements with foreign firms, especially in the northern fields near the border with Iraq. BP, Chevron, Shell and Total are reported to be interested in such deals.

Kuwait will also partially privatize the Kuwait Oil Tankers Company and the Petrochemical Industries Company, two subsidiaries of the Kuwaiti Petroleum Corporation.

• The UAE. Expected oil earnings are $9.3 billion in 1998, down from from $13.7 billion in 1997. The UAE economy will contract an estimated 4 percent in 1998 (it grew 1 percent in 1997 and 9.9 percent the year before).

The UAE is also trying to diversify its economy to lower its dependence on oil and gas revenues. The federal government has invested in tourism, aviation, re-export commerce and telecommunications.

Abu Dhabi will get an official stock market to replace an old equity trading system. The market should be approved early this year.

The Abu Dhabi National Oil Company is restructuring its management. ADNOC will consolidate its operations under five new directorates. Industry observers say the restructuring may be the first step in privatizing Abu Dhabi’s major oil assets, beginning with downstream operations.

The UAE even has a Privatization Committee for the Water and Electricity Sector. The committee wants to privatize the state-owned Abu Dhabi Water and Electricity Department. The government will be majority owner in new private ventures, with minority interests held by foreign firms, then will sell its shares to UAE nationals.

The first major step in this direction is expansion of a power and diesel facility at Tawilah. The project will be run by Emirates CMS Power, a joint venture between the U.S.’s CMS Energy, which has 40 percent ownership, and the newly-formed Emirates Power Company, with 60 percent.

Colin MacKinnon is contributing editor to the Washington-based Middle East Executive Reports.