Higher oil prices appear unlikely to change government spending plans in GCC

The failure of Opec+ to agree on a production increase from August at its most recent meeting this month forced oil prices to rise to their highest level in more than two years. Historically, higher prices have been welcomed by GCC producers as they have allowed governments to increase spending and drive economic growth in the region’s non-oil sectors while also boosting sovereign wealth funds.

While higher prices have already contributed to better-than-expected GCC government revenue this year, Emirates NBD expects the prioritity will be the reduction of deficits rather than raising spending.

The benefit to regional budgets depends not only on the price of a barrel of oil but also on how much crude oil is being pumped and sold at that price.

Our analysis of regional budget break-even oil prices suggests that only the UAE would record a budget surplus with oil prices at $75 per barrel. Saudi Arabia’s budget would be close to balanced – a significant improvement on last year’s 11.2 per cent deficit.

The deficits of other GCC countries are expected to narrow from 2020 but would still require additional financing to meet their existing spending commitments.

Certainly, if Opec+ does not reach an agreement on increasing production, oil prices could rise even further. While this would provide an additional boost to budget revenue, we do not expect this to translate into significantly higher spending, particularly as most countries have committed to medium-term fiscal reforms.

Higher oil prices may delay some of these reforms tht are intended to put some GCC budgets on a more sustainable footing in the long term.

If Opec+ does not agree to gradually increase production in the second half of this year, this will probably be negative for headline gross domestic product growth.

Even with a gradual increase in crude oil production in the second half of the year, output is expected to be lower than it was in 2020. If there is no increase in production from August, then the contraction in the GCC oil sector could be deeper than we expect. The price of higher oil revenue for GCC countries is then slower GDP growth.

For the rest of the world too, there is a cost. Higher prices would feed through to higher inflation, which is already surging in many countries as service sectors reopen, supply chains remain disrupted and shipping costs rise.

While the major central banks – the US Federal Reserve, the European Central Bank and the Bank of England – have indicated they will look through what they consider “transitory” inflation for now, some emerging market and European central banks have already responded to higher inflationary pressures by raising interest rates, which could slow economic growth.

Emirates NBD’s base-case scenario is that Opec+ will come to an agreement that will allow for some increase in production from August. This should support prices in the range of $70 to $75.

There are two alternatives that, in our view, have a lower probability. The first is that no agreement is reached and oil production remains unchanged. The second is that individual Opec+ members increase production outside a broad agreement.

In the first scenario, prices could rise sharply, boosting producers’ budget revenue but at the cost of regional and, potentially, global growth.

In the second scenario, prices could fall sharply. However, with demand recovering, we are unlikely to see a repeat of the April 2020 price collapse.

Prices could fall to between $55 and $65 per barrel in this scenario. Higher production would support regional GDP growth while lower prices would support global economic growth, even if budget deficits in the GCC would be slightly wider than the others.

Higher production would support regional GDP growth while lower prices would support global economic growth