May 31, 2023

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The end of easy money


Oil prices have fallen 55% since September 2014 and the International Monetary Fund has warned GCC governments to curb spending in the face of predicted budget deficits this fiscal year. As global supply dynamics continue to spook investors Melanie Mingas examines the potential impact on the construction and renewable energy industries


If one story has dominated the summer of 2015, it has been that of the tumbling oil price. After four years of steady income, with the price per barrel resilient enough to remain over $100 in the face of complicated and ongoing global economic factors, recent months have seen values tumble, day by day, to lows unseen since 2009. According to the International Monetary Fund (IMF), the decline totals 55% since September 2014.

In a crescendo of negative market forces, last month Standard and Poor’s went as far as to speculate that “gradual weakening in economic conditions” will “adversely” affect the regional banking industry.

Growth of net income and deposits in Gulf-based Islamic banks will slow down, while asset quality is seen to deteriorate, the ratings agency warned.

If the trend continues the GCC could be set to lose $215bn in oil revenues, more than 14% of the six state’s combined GDP, according to calculations by the World Bank.

While the developments are reminiscent of the use of oil prices to bring down the Soviet Union in the 1980s, governments have been quick to dispel such rumours this time, putting developments down to simple supply and demand in addition to heighted US production and a rise in fracking. However the impact on the fiscal health of the GCC could cause significant waves.

The above-water appearance has been one of poise and composure, but there is no doubt some fast peddling going on below the surface.

The ability of each GCC state to bankroll planned projects is pegged on oil remaining at a certain price per barrel (see fiscal breakeven price graphic). The long term effect should prices fall below, few are certain of.  Yet Oliver Klaus, Dubai bureau chief at Energy Intelligence, warns that of all the industries active in the GCC the construction industry could feel the effects first.

“Middle East oil producers have not delayed many projects thus far, but the recent drop in oil prices may make them rethink the timing or the feasibility of some of their plans. It could raise question marks about enhanced oil recovery projects in Oman and Qatar, or heavy crude developments in the Neutral Zone shared between Saudi Arabia and Kuwait.”

He adds: “In general, industries that rely to a large extent on government spending will be most affected as revenue from crude sales is being eroded. The construction sectors in the GCC are among those relying heavily on government projects and would be among the first ones to feel the consequences of reduced state spending.”

The concerns are far from new. As long ago – in economic terms at least – as Q1 this year analysts were sounding warning alarms.

Now, as Q3 dawns, those concerns are far from fading and all the signs of a tectonic shift in spending power are present.

With so many huge projects planned, could we be looking down the barrel of a greater crisis?

Klaus responds: “Ongoing delays in oil companies’ investment decisions and cancellations of new oil and gas projects, amid sustained low crude prices, could have a knock-on effect on new capacity additions in coming years and lead to a supply crunch.”

A new way of life

There is no solid plan forthcoming, should the downward spiral continue, as to how the GCC will diversify its economy. It can be buoyed with foreign assets and currency reserves, but not forever and for now, at least according to Kuwaiti Oil Minister Ali Saleh Al Omair, hopes are pegged on a boost in the growth of the global economy.

In July, Al Omair was quoted in Al Qabas newspaper saying: “There is satisfaction among member states with indications of better growth of the world economy.”

“We do not look at the amount of production, but what concerns us primarily is the rate of growth of the world economy, which will bring the required balance to keep prices at the desired level.”

Should that fail, regional economies are prepared for “several years” of reduced hydrocarbon income.

The issue isn’t contained to the Middle East. Surmising the view from outside, The New York Times reported last month that Venezuela, Iran, Nigeria, Ecuador, Brazil and Russia will suffer economic and perhaps even political turbulence, while Gulf States are likely to invest less money around the world, and may cut aid.

The saving grace for the regional construction industry could be that prices for other commodities have also declined, though not by as much as oil prices. The IMF reports that metals are expected to be 13% lower in 2015–19 than was projected in the October 2014. Baseline forecasts for average gas prices remain broadly unchanged; even if, some gas exporters such as Qatar, are facing lower gas prices because their contracts are indexed to oil prices.

One thing can be agreed upon – the days of “easy money” are numbered.

According to the IMF’s breakeven price calculations, Bahrain and Oman face the largest threat.

Bahrain, the most severely affected, is contemplating a request for budget support from its Gulf allies. Oman has released a 2015 budget that includes no spending cuts or additional revenues, but may resort to both in the year ahead.

While the Economist Intelligence Unit estimates that Oman’s fiscal breakeven oil price climbed from $84.5/barrel in 2011 to $110.6/b in 2014, the Sultanate’s fiscal budget, set in January, projected a deficit of 8% of GDP with spending set to rise by 5% compared to 2014.

The project pipeline comprises the dualisation of Adam to Thamrait road; ongoing works at Duqm Port; a new residential city inn Liwa; wastewater plants and a number of hotels.

In Bahrain, where construction contributes 10.7% to GDP, planned projects include the Gulf rail line development; a public transport network due in 2030; Bahrain International Airport Expansion; the construction of infrastructure for three planned cities; and investment in power and water projects.

If the wealthiest GCC states are unable to step in and prop up their smaller neighbours, some tough decisions may have to be made about the feasibility of entire pipelines of mega projects, unless funds can be generated from elsewhere.

Klaus advises: “GCC governments have a few options at their disposal including drawing on their reserves, issuing debt, selling assets and cutting back on spending. The immediate moves are likely to be tapping their substantial reserves as Saudi Arabia has been doing over the last few months for example, and issuing conventional or Islamic bonds. Again, Saudi Arabia has done so already and others, like Kuwait, are expected to follow.

“At this point, it seems rather unlikely that governments would resort to the sale of assets as it’s going to be more difficult in today’s environment to secure the sale price they’d want to achieve. Governments also appear to remain committed for now to sustain spending as a means of stimulating their economies and creating jobs for their local populations. Another option governments may seriously consider now is cutting back on certain subsidies, in particular around electricity and water, as the UAE has done,” he adds.

In the 2015 Deloitte Powers of Construction report, governments are urged not to cut back on project spending, specifically airport projects, which will be vital to economic diversification in the long term.

“Against this backdrop of commercial pressures and greater public scrutiny on delivering value for money, there is an increased priority for capital projects to be delivered efficiently and by fit-for-purpose organisations. Setting up the delivery strategy and organisation at the start of the project is, of course, critical to success, and this is something that Deloitte has been supporting a number of global and regional airports to achieve,” the report read.

The role of renewables

While the construction industry could see some mega-projects halted until further notice, the renewable energy industry is set to gain.

Bucking the austerity drive, Kuwait announced it is to spend $100bn on energy projects over coming years, but a closer look at the announcement showed much of the money would be used to pursue the country’s ambition to source 15% of all power from renewables under its 2030 development plan.

The numbers behind the plan leave little room to manoeuvre. Kuwait has one of the highest energy consumption rates per capita in the world, with the average Kuwaiti using 22 times more resources than the country provides per person.

It is widely believed Kuwait will need 20% of its oil production capacity just for energy generation within four years, a consumption rate deemed unsustainable given that two thirds of the country’s GDP is dependent on the oil industry.

The impact on other planned infrastructure spending has yet to be analysed.

It cannot be denied that the recent drop in oil prices does highlight the need for diversification for the oil exporting economies, especially the ones in the GCC, says Abhay Bhargava, regional head of Energy and Environment Practice MENA at Frost & Sullivan.

“The GCC countries cannot base their power generation on one single foundation of conventional fuels, as this will lead to overdependence, resulting in high risk. Additionally, there is wastage of crude by using it for power generation, while it could be diverted into the petrochemicals and refining industries, leading to development of higher value-add downstream products that can result in greater benefit for the economies,” Bhargava was quoted as saying earlier this year.

“Based on these parameters, it is critical for the GCC countries to reconsider their energy mix. All these countries are also facing power-related issues since, they either buy or rent Gensets in order to supplement their energy needs. Thus, there is deficiency, and the choice will be to invest in solar or conventional power,” he said, adding that today there is an increased willingness to look at diversifying into renewables in the region as capital costs are going down.

It is important to note that recent oil price volatility has not been the trigger for renewable projects, however it could be the final push required to drive meaningful momentum in the renewables sector.

“Efforts to build an efficient infrastructure to support renewable energy have been undertaken for several years now. No doubt, increasing demand for energy – led by the demand from a growing population – will continue to shift the dialogue towards green energy. In fact, we are also seeing a strong focus on promoting retrofitting existing buildings with the goal of making them energy efficient,” says Saeed Al Abbar, chairperson of Emirates Green Building Council, which recently issues the ‘Technical Guidelines for Retrofitting Existing Buildings’, aimed to serve as a guide for UAE industry professionals and building end-users.

“We see positive and tangible change on ground in the UAE’s shift towards renewable energy – and this will only gain momentum in the coming years,” he adds.

The bottom line is, that as economic push and pull factors continue to re-draw the boundaries of government ambition, business dynamics will have to respond – and in future the government’s role will evolve from that of budget holder to policy developer, supporting the private sector in helping to achieve ambitious growth plans through robust PPP frameworks and transparency in the tender process.


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