THE OIL FREE FALL
And its impact on the GCC economies, particularly Qatar.
Hitting several pockets of turbulence, oil prices have crashed by over 60% from $115 in June 2014 to $46 per barrel in the last week of January 2015 – and are likely to plummet further to $40 in the not too distance future.
Saudi Arabia, one of the biggest oil exporters, has made it very clear that it was ready to face the consequences even if the price fell to $20 per barrel in the coming weeks. It is reported that the Kingdom will end up losing QR465.92 billion ($128 billion) revenues if the oil prices are pegged at $50 per barrel for one year.
Several reports have been doing the rounds, after the Organisation of Petroleum Exporting Countries (OPEC) met in November 2014 and refused to cut production. One theory has been that the decision was taken, at the behest of the US and its allies, to “hurt” the oil-centric state economies such as Russia and Iran. But the catch is that these declining prices will affect Saudi more than anyone else, since their economy is so intrinsically dependent on oil. Despite numerous initiatives and billions of dollars spent on efforts to diversify the Saudi economy, oil proceeds continue to account for 90% of export earnings, approximately 80% percent of government revenues and about 40% of GDP.
Russia, which has already been hard-hit due to Western sanctions, has been struggling to insulate its economy from further collapses but the declining oil prices have reduced the value of its exports, putting downward pressure on its currency. Pegging the oil price at $100 per barrel, the Russian Parliament has recently approved a three-year budget (2015-1017) but Moscow may experience deep recession and default on its debts if the oil prices fail to rise in the coming months.
The development also hit Iran's economy, which was limping back to near normalcy. Sanctions over the years have brought down Iran's oil exports considerably and its leaders are blaming fellow OPEC producers of colluding with the West to keep oil prices low.
While Europe is cut up with Russia for its support to Syria and also for precipitating the crisis in Ukraine, the US foreign policy is aimed at exerting pressure on Iran (which is also supporting the Syrian regime led by Bashar Al Assad), to limit its ambitions during the nuclear talks with the West.
Iran needs the oil price to be around $140 per barrel to balance its books and another OPEC member, Venezuela, needs $117 per barrel to avoid the ignominy of defaulting on its debts and also to meet its fiscal commitments.
Besides Iran and Russia, the two GCC countries - Saudi Arabia and Kuwait - are also likely to bear the brunt as oil sales accounted for 90% and 92%, respectively, in the overall budget income for these two countries in 2013.
On the other hand, Iraq too has warned that it has lost 50% of its oil revenues due to the price slump and had no money even to buy weapons to fight the Islamic State. In other words, Iraq has accused the GCCbased OPEC members of aggravating the crisis in the violence-hit Middle East.
The other version is that non- OPEC countries like the US and Canada have stepped up crude oil production to challenge the hegemony of OPEC, and the latter
“We believe that gas has a strong advantage not only as a source of energy but as a source of cleaner energy. And gas demand is likely to be further augmented.”
HE Mohammed bin Saleh Al Sada
Minister for Energy and Industry
hit back by refusing to cut back oil production.
Whatever the case is, the intentions of the four GCC countries – Kuwait, Saudi Arabia, Qatar and the UAE – are the same and they do not want to surrender their market share in the global oil market for years to come.
These four nations are of the view that they can survive the oil price slide as their production cost is less, while the US energy industry cannot compete with them as it cannot afford to produce oil at a high price and sell cheaply.
The good news, however, is that the European Central Bank's quantitative easing plans on January 22, to buy European bonds worth QR4.73 trillion ($1.3 trillion), is expected to push up oil prices in the coming months.
“Oil prices should be around $60 a barrel by the end of this year as demand from Europe increases because of the economic stimulus from the European Central Bank,” HE Sheikh Ahmed bin Jassim Al Thani, the Minister of Economy and Commerce, said during the World Economic Forum summit at Davos in Switzerland last month.
As of now, there are no indications of an oil price rebound due to oversupply from the US and Canada, falling demand in the European Union besides the slowing of the Chinese economy. All these factors are likely to impact the global economy.
The US Energy Information Administration (EIA), which estimates that the price plunge will result in a revenue loss of $257 billion (QR935.48 billion) to OPEC in 2015, says that further revisions to future budget plans may be required by many of its members, particularly Venezuela, Iraq and Ecuador, because of lower oil prices and large uncertainty over future global economic growth and crude oil production levels.
The OPEC's decision prompted the International Energy Agency (IEA) to remark that there was too much oil in the world and not enough buyers. “There are two million barrels per day of crude oil production that don't have a home,” the Vienna-based organisation says.
According to the International Monetary Fund, Saudi Arabia, Kuwait, Qatar and the UAE, whose oil production represents 63% of their total exports, are estimated to have combined reserve assets of around $855 billion (QR3.11 trillion).
Among them, Saudi Arabia has amassed $794.38 billion (QR2.89 trillion) to see it through times of low oil prices. While these huge reserves can shield these countries for a short time, the low oil prices will eat into their fiscal surpluses leaving them high and dry if continued for a long time.
The continuation of Ibrahim Ali Al Naimi as Saudi Arabia's Oil Minister, after the death of King Abdullah on January 23, confirms that the new King Salman bin Abdulaziz Al Saud will not deviate from the policy decisions of his predecessor on oil prices.
Al Naimi told the OPEC meeting last November that it was not in OPEC's interest to cut oil production as it aims at defending market share rather than supporting price. Echoing similar views, PwC (Middle East) Energy, Utilities & Mining Leader Paul Navratil says that the decision of the large-producing countries in OPEC, specifically those with surplus budget reserves, is to "protect market share" rather than solely shoulder the responsibility of reducing output at the gain of the marginal barrel producers.
“The other countries in OPEC, which are not awash in funds, need to maintain production as a means to generate much-needed government income, albeit lower due to the price, and cannot afford to have a double hit of lower volumes and lower prices,” he says.
Navratil also says that the GCC-based OPEC countries are likely to allow the oil price fluctuation to pursue its course of finding equilibrium and most government budgets this year, which have been set using higher oil prices in their estimations, will be utilising their financial reserves to weather this current volatility.
A lesson learnt from earlier oil gluts in 2008-09 is that significant cost savings can be realised by “staying the course” and renegotiating prices with key suppliers who are keen to maintain their own order books, Navratil says.
“We expect the potential savings to be in the order of 20% to 30% in many instances, which is sufficient enough reason for the GCC to continue with its plans to build infrastructure and further diversify their industrial bases and economies - provided we all believe there will be a price recovery in the not too distant future,” he says.
Salam Awawdeh, Partner and Energy & Resources Consulting Leader at Deloitte Middle East, says that the oil producers have no intention to create an oil glut as the business is driven by “hard-headed commercial decision-making” rather than emotion but the decision-makers have become less unified than in the past.
There is an increasing divergence within
“We all have to get used to living in a more and more efficient way. Geopolitics are not de facto an offspring of oil, but like water moving down a hill it finds its way into every crevice.”
Sean Evers Managing Partner Gulf Intelligence
OPEC in decision-making between GCC and non- GCC members due to the individual operating circumstances of each member (market share strategy, types of crude, technical difficulty of extraction, availability of infrastructure, ability to meet quotas, fiscal strength).
“It is no secret that the production cost is much lower for OPEC members in the GCC than others. Non- OPEC decision-making is, however, also less unified due to the emergence of major hydrocarbon producers such as the US, whose operating conditions are certainly different from those of Russia,” he says.
Besides, the pricing ambitions of large commodities trading houses, many of whom hold physical stocks of oil (and increasingly, natural gas) can be different from, if not the opposite of, the hydrocarbon- producing countries.
“If this fragmentation were not enough, we also have the increasing emergence of natural gas as a fossil fuel which is priced separately from oil. For example, here in Qatar, gas is far more strategically important than oil due to Qatar's leadership of the LNG community. Due to this, it is impossible to foresee what the oil price will do and very few people have achieved this foresight,” Awawdeh points out.
The signs of the shrinking footprint of investments in the oil and gas industry were clearly visible with the oil tremors not only being felt by Iran and Russia but also in the GCC region, the US and in other oil producing countries.
Venezuela, which is a member of OPEC, has landed in a financial mess following the oil price plunge and its president Nicolas Maduro sought help from Qatar and other countries to wriggle itself out of the crisis.
The worst fears that investments in the oil and gas sector would be hit were confirmed with Shell and Qatar Petroleum scrapping the QR23.3 billion ($6.4 billion) Al Karaana Project as it was economically unfeasible.
“Qatar Petroleum and Shell have decided not to proceed with the proposed Al Karaana Petrochemicals Project. The decision came after a careful and thorough evaluation of commercial quotations from EPC (engineering, procurement and construction) bidders, which showed high capital costs rendering it commercially unfeasible, particularly in the current economic climate prevailing in the energy industry,” Shell said in a statement in mid-January.
Unconfirmed reports even suggest that the prestigious QR43.68 billion ($12 billion) Sharq Crossing Project in Doha may be delayed by a few years and the reason for this could be the falling oil prices.
Saudi Arabia also is forecast to cut its expenditure by 18% to QR833.56 billion ($229 billion) in 2015 compared with last year, according to reports.
Saudi Basic Industries Corp (Sabic), one of the world's largest petrochemicals groups, reported a 29% plunge in Q4 2014 net income and the company's chief executive, Mohamed Al Mady, says that his company's outlook for 2015 depended on oil prices and was therefore unpredictable. Sabic is among the GCC's largest-listed companies and has earned $1.16 billion (QR5.82 billion) in the three months to December 31.
In the US, the oil industry pulled back from high-cost areas of operation, slashing jobs and spending as the companies cancelled drilling rig contracts in the Gulf Coast. More than 1,500 active drilling rigs have gone out of business by mid-January and the oil rig fall is said to be the biggest since 1991.
The efforts of the Narendra Modi government in India, which was looking to reduce the country's fiscal deficit in the next financial year beginning in April by selling off shares in part in the profit-making Oil and Natural Gas Corporation (ONGC) and in Indian Oil Corporation (IOC) respectively, reportedly fell flat with investors having second thoughts in view of the developments.
Despite these setbacks, Awawdeh sees light at the end of the tunnel.
“As far as controlling the oil price slide, one has to assume that the demand for hydrocarbons will increase in the long term as emerging markets such as India, China and Africa become more developed, and that this demand will outstrip the decline in OECD countries due to environmental awareness and innovation as well as elevated indirect taxation,” he says.
Another effect would be that non-fossil fuels and alternative energy will supplant fossil fuel consumption in those very countries where demand growth is expected to be highest. It is interesting to note that China is aggressively pursuing the development of non-fossil fuel energy sources to tackle well-publicised environmental issues in some of its largest cities.
“Although LNG prices are based on Japanese Crude Consortium driven formula, which is oil indexed, the drop in gas prices has not been as severe as oil prices and therefore, the impact on Qatar is not as high as in countries which depend only on oil.”
Gopal Balasubramaniam Head of Oil and Gas (Middle East and South Asia) and Partner and Head of Audit KPMG, Qatar
they are well-positioned to weather such developments.
The confidence of these countries stems from the fact that the LNG demand is growing at a faster pace compared with that of oil as the IEA, in its report entitled “World Energy Outlook 2014,” says that the global gas demand would be around 5.4 Trillion Cubic Metres (TCM) in 2040.
The IEA report also says that gas draws level with coal as the second-largest fuel in the global energy mix, after oil. The main regions pushing global gas demand higher are China, which will become a larger gas consumer than the European Union around 2030, and the Middle East.
The Minister for Energy and Industry, HE Mohammed bin Saleh Al Sada, admitted in December that the drop in oil prices has affected the price of natural gas as both markets were interconnected.
However, he said that both supply and demand for LNG are increasing. “We believe that gas has a strong advantage not only as a source of energy but as a source of cleaner energy. And gas demand is likely to be further augmented,” the Minister adds.
Keeping in mind the projected demand and the positive outlook for natural gas, countries like Australia are pouring billions of dollars in to developing LNG projects to produce as much as 350 Million Metric Tonnes per Annum (MTPA). If they are completed on time, provided there is no upward revision in project costs, they would more than double the current capacity, which is less than 300 MTPA, by 2025.
The other reason that has been driving the demand for natural gas is the Fukushima nuclear mishap in Japan in 2011, after which Japan has shut down all other nuclear power stations and opted for LNG as fuel for power generation.
Besides Japan, the demand for gas has gone up considerably in Far East countries like Malaysia, Indonesia and Singapore, and Qatar, as the world's biggest LNG exporter, has benefited enormously from its status as a stable, long-term supplier to the high-value Asian market.
Another fact from which Qatar can take comfort is that most of the long-term agreements with the Asian buyers will not expire till 2021 and they are likely to extend the agreements as Qatar is the low-cost LNG supplier at present and is flexible as far as price negotiations are concerned.
This is not the first time Qatar has survived a scare. When the shale gas boom crowded out expected LNG imports to the US, Qatar diverted its supplies to Asia and earned a reputation among its buyers for its reliability considering the uncertainties that may plague the upcoming and planned LNG projects.
On whether Qatar would be impacted, Awawdeh says it depends over what time frame oil price movements are measured, as well as the individual operating circumstances of each OPEC country (types of crude, technical difficulty of extraction, availability of infrastructure, ability to meet quotas, fiscal strength) – Nigeria and Saudi Arabia are quite different.
“If there is a price correction towards the end of this year – which a number of commentators predict – then the effects on some ( but not all) countries will be relatively small. If we are in for a permanently low oil price environment from now on, then it
“Oil prices should increase to an average of $60 a barrel by the end of this year as demand from Europe increases because of the economic stimulus from the European Central Bank.”
HE Sheikh Ahmed bin Jassim Al Thani
Minister of Economy and Commerce
is a question of the survival of the fittest,” he adds.
However, Doha Bank Group CEO Dr R Seetharaman says that the plummeting oil prices will have no impact on Qatar's economy and on the ongoing infrastructure projects in the country.
“The slide in oil prices will not affect or challenge the financial ability of Qatar as its economy has been diversified and investments have been made in various non- hydrocarbon sectors. This is evident from Qatar's economic growth of 5.7% in Q2 of 2014 as robust non-oil activity outweighed a decline in the hydrocarbon sector,” he says.
He also dismisses reports that Qatari banks will be under pressure to finance megaprojects due to falling prices. “Market liquidity is not an issue and we can fund the projects. We can always borrow from international markets and then lend here. As long as Qatar is financially stable, the international markets will be ready to lend to us. I don't foresee any short-term pressure on account of oil price fluctuations,” he adds.
KPMG's Head of Oil and Gas (Middle East and South Asia) and Partner and Head of Audit in Qatar, Gopal Balasubramaniam, says that Qatar is in a unique position amongst the OPEC countries, more so among the GCC economies where oil is the main contributor to their GDP. However, in Qatar, natural gas is the main contributor with LNG production at 77 MTPA. Qatar's LNG is mainly sold on long-term sales and ,purchase agreements along with spot deals.
“Although LNG prices are based on the Japanese Crude Consortium driven formula, which is oil indexed, the drop in gas prices has not been as severe as oil prices and therefore, the impact on Qatar is not as high as in countries which depend only on oil,” Balasubramaniam says.
According to him, for more than a decade, with the exception of a few months in 2008, every oil-producing country had a great run, with oil prices at $70-$80 upwards, so a drop was definitely due - but not this drastic drop. For GCC oil-producing countries, production costs are low and to deal with the price drop, they only need to reduce the surplus they make to avoid losing at the current price or even if it goes down to $10 per barrel.
However, those countries where the cost of producing oil is upwards of $50 per barrel are incurring losses. “I think the OPEC countries want to avoid becoming marginalised, having held the supremacy on crude for so long. So it is a question of waiting to see who can stick it out by producing the same levels, and for how long” Subramaniam says.
Very rare moment
Gulf Intelligence Managing Partner Sean Evers says that the world is witnessing a “very rare moment” where the oil market has been behaving like any other open competitive liberal market, be it bottled water or shampoo.
The prices will continue to slide downwards until there is a crystal clear indication that supply may become tight, and there could be multiple triggers from Known Knowns, and Unknown Unknowns - black swans to good old-fashioned robust global economic growth.
“Or perhaps, contrary to current sound bites, OPEC will in due course, i.e. June, return to its historic role as the swing producer and curtail production,” Evers says.
He says that the US was once the world's largest oil producer, then they almost
“The slide in oil prices will not affect or challenge the financial ability of Qatar as its economy has been diversified and investments have been made in various non-hydrocarbon sectors. This is evident from Qatar’s economic growth of 5.7% in Q2 of 2014 as robust nonoil activity outweighed a decline in the hydrocarbon sector.”
Dr R Seetharaman Group Chief Executive Officer Doha Bank
“It is no secret that the production cost is much lower for OPEC members in the GCC than others. Non-OPEC decision-making is, however, also less unified due to the emergence of major hydrocarbon producers such as the US, whose operating conditions are certainly different from those of Russia.”
Salam Awawdeh Partner and Energy & Resources Consulting Leader Deloitte Middle East “The decision of the largeproducing countries in OPEC, specifically those with surplus budget reserves, is to protect market share rather than solely shoulder the responsibility of reducing output at the gain of the marginal barrel producers.”
Paul Navratil Energy, Utilities & Mining Leader PwC Middle East
dropped out of the top 10, and now they are back again due to innovation and technology, but he will not bet against them one day returning back to their anonymity as a junior oil producer. And the cycle will probably continue over the coming decades with more and more volatility.
“But oil isn't losing any of its gold shiny top-kid-in-the-energy-class luster anytime soon. It is here to stay for probably the remainder of the 21st century. So, like the mother-in-law, we all have to get used to living with her in a more and more efficient way. Geo-politics are not de facto an offspring of oil, but like water moving down a hill it finds its way into every crevice,” he says.
Evers says that at current prices, the oil revenues of the Gulf States could be QR1.45 trillion ($400 billion) less in 2015 than in 2014 and by any measure that is going to sting. “But thinking of it on a personal level - how would it affect you if your salary was suddenly cut in half - you would probably dig into your bank account savings if you had any (Saudi, Qatar, the UAE, Kuwait), but if you don't have any savings ( Venezuela, Nigeria, Iran) then you are going to be in deep pain and making rapid and deep cuts to government expenditure,” he points out.
He also feels that OPEC need not cut production. “Why should they? Acting as the world's oil price controller has seen their global market share rapidly decline over the last decade from 40% to 30% – as the saying goes, don't keep banging your head against the wall and expect a different result. Sometimes you have to try something different to get the result you desire,” Evers adds.
Hong Kong-based Bernstein Research says that the oil industry is facing a challenge in a generation in 2015, although prices are expected to recover and capital expenditure cuts are likely to be smaller in Asia Pacific than elsewhere around the globe.
Bernstein expects oil prices to recover later this year as supply and demand outside OPEC re-balances, but the analysts are not ruling out a near-term fall toward the historical cyclic bottom, which they say is the marginal cash cost of $50 per barrel.
Bernstein estimates a recovery would require non- OPEC supply growth to drop below 1% and global demand growth to recover to more than 1.5%. Although there are signs of re-balancing, with double digit capex cuts and rising SUV sales in North America, evidence of a tightening of supply and demand remain ambiguous, Bernstein adds.
Navratil says that the oil price will find its floor – a combination of supply/demand economics and the momentum created by the active players in the traded global oil market.
“Once this happens, it is widely thought that the oil price will return to a level that is more reflective of the true cost of the marginal barrel. That point will largely be influenced by the amount of production which does not get developed, is mothballed or shut in, and is financially stranded as a result of the current price environment. The more production is affected, the more upwardly skewed the price recovery will be,” he says.
Subramaniam is also of the view that small-time oil producers with high production costs will eventually exit as they cannot continue to incur cash losses, and this will result in a gradual increase in prices
Source: EY assessments of data from multiple sources