Hope for the best but prepare for the worst

HILE traveling in Saudi Arabia lately, I have encountered occasional shortages of gasoline at petrol stations. For outsiders, it is hard to imagine gasoline shortages in Saudi Arabia, the largest oil exporter in the world. When those shortages occur in the Eastern Province, Saudi Arabia’s main oil producing region, it is doubly ironic. In some cases, you could see cars abandoned alongside the road after they and petrol stations had run out of gas.

Shortages do not usually last a long time, and probably should be expected in a vast country like Saudi Arabia, where it may be difficult to keep enough supplies at hand in remote gas station. When shortages lasted longer, Saudi Arabia resorted to importing gasoline, another irony.

When you face this problem in the middle of nowhere, at night, it focuses your mind on the complexities of oil supply and the possibility that one day in the future we may not have any. Oil may turn out to be just a fleeting phenomenon in the long history of Arabia, when for the most part people traveled across its great deserts without cars.

Rationally, of course, we know that exhausting Saudi Arabia’s vast oil reserves could take several decades. Given the level of proven reserves and the amount of oil pumped daily, it could last theoretically for another six decades.

It is true that new reserves may be discovered, but you cannot rely on that possibility. It is also true that there are many marginal wells and underground fields that could be tapped if the price is right, or if a technological breakthrough could take place. Eventually, even marginal wells and shale oil will run dry. We along with rest of the world will move on to other sources of energy.

Equally devastating is when oil prices drop significantly, due to new discoveries, technological breakthroughs or developing alternative energy sources. While for the rest of the world oil is just another source of energy, and as such lower prices are welcome, for us it is a lifeline. The rest of the world talks about “end of oil” as a positive prospect, but here it is the end of life. Oil here is the engine of our economic growth. Not just oil extraction and refining, but the manufacture of petrochemicals also relies on it.

Oil is also the main source of export earnings. In the past six years (2008-2013), oil exports accounted for 85 to 89 percent of total export earnings. Most alarming is the fact that oil is by far the main source of government revenue; in the past six years, oil revenue represented between 90 and 93 percent of government revenue. In other words, our free health care, education and welfare systems, which we take for granted, are financed by those oil revenues. So are roads, airports and other infrastruc- ture. Funding for internal and external security and foreign aid depends to a large extent on oil revenue.

In short, our lifestyle and future well-being are closely intertwined with the health and vagaries of oil markets. Since the future is fraught with uncertainties, we need to accelerate plans for alternative sources of revenue.

The recent drop in oil prices, about 25 percent since June 2014, highlighted the prospects for diminishing government revenues due to price fluctuations. Last week, the IMF released a new report expecting GCC countries to lose as much as $175 billion dollars if oil prices reached $75 a barrel and stayed there for a while. It believes that these losses could shave 8 basis points (almost one percentage point) off expected economic growth rates in GCC countries. Previously, it had expected GCC economic growth to reach 4.5 percent in 2015, but is now revising that estimate downwards.

That loss would significantly affect current account balances and reduce expected combined budget surpluses from $275 to $100. Based on these pessimistic scenarios, which are in dispute, the IMF has now revised its expectations for the trajectory of government deficits in Saudi Arabia. Previously, it did not expect deficits before 2018 or 2019. Now, it thinks they are likely in 2015, if oil prices continued their downward slide and public spending continued at current levels. Some GCC countries can continue spending at current levels for a while, because they have a financial buffer provided by previous budget surpluses. However, such approach could not be sustained for long, especially in countries where monetary reserves are low.

OPEC believes that recent price drops are temporary, which is most likely, with no long-term ill effects. But some Wall Street banks expect the worst; last week, Goldman Sachs revised its forecasts downwards and now expects a target of $85 for Brent price in the first quarter of 2015, and $75 in the rest of 2015. OPEC officials are especially keen to calm the markets. The organization’s secretary-general said last week, at an oil conference in London, that oil supply and demand would return to equilibrium, adding, “We don’t see really fundamental changes in the supply side or the demand side…Unfortunately, everybody is panicking. The press is panicking, consumers are panicking.”

That equilibrium, he referred to, may exist for medium run. But for the short run, we have seen how prices fell by 25 percent since June. The long run is uncertain. As such we should be concerned, not just about prices, but how to make supplies last until we develop other sources of income, economic base, and export earnings.

While we hope for the best, prudence requires us to prepare for the worst. However, it is important not to panic. I argued in my last week’s column that we still have some options to deal with the problem. However, we may not have that luxury in the future.

I argued against across-the-board budget cuts, but for targeted cuts that reduce waste, especially in the energy sector, which eats up a big portion of public spending.