Oil prices have slowly recovered from last’s year shock caused by the Saudi-Russian price war and the economic impact of the COVID-19 pandemic. Yet, some analysts – encouraged by extended OPEC+ production cuts and a surge in demand – have already been speculating about a new price spike and oil boom, that may well be the last one.
While these forecasts would be welcomed news for the Gulf countries, since it would give them one more chance to finally shift their economies away from oil, it is rather debatable whether this optimism rests on solid foundations.
Indeed, the factors on the ground suggest otherwise, when taking into account the anticipated third wave of COVID-19 cases in the Organization for Economic Cooperation and Development (OECD) countries, and the immense financial impact the virus has had on Latin America and other places. The reasons for the optimism are quite baseless, according to Cyril Widdershoven.
Widdershoven, a veteran global energy market expert and founder of Verocy, is convinced that this month prices will be hit again, not because of extended or renewed lockdowns in the main markets, but also because of a possible realization that facts are more stubborn than wishful thinking. “So, when talking about the [final] oil boom, analysts are looking for something that doesn’t exist yet,” he told Inside Arabia.
And even if the oil boom does happen, it may not be the last one says Tom Kenison, Upstream Oil Analyst at energy consultancy Facts Global Energy (FGE). This is evident, in his opinion, when assessing the volume of recoverable reserves still awaiting development across the Middle East, supported by the low cost of production which attracts investors. “There is still plenty of upside potential for producing nations, NOCs [National Oil Companies], and IOCs [International Oil Companies] within the Middle East,” he told Inside Arabia.
Yet, Widdershoven estimates that potential price increases could be expected in 2022, when vaccines should be having a real impact in lowering the spread of COVID-19, allowing for the first actual signs of economic growth. Still, he thinks the negative effects of the trillions of US dollars used to stimulate the economies amid the pandemic will need to be seen first. Nevertheless, by easing support, or by demanding higher taxes, growth will be lower, while unemployment levels will increase, according to Widdershoven.
The current grave economic prospects once again clearly show how vulnerable GCC economies are, and how urgent it is for them to diversify.
The current grave economic prospects once again clearly show how vulnerable Gulf Cooperation Council (GCC) economies are, and how urgent it is for them to diversify as quickly as possible and find new sources of revenue. Despite increased efforts to shift away from oil, experts suggest that Gulf oil exporters will try to maintain a leading position in the energy markets, while investing in other energy projects apart from oil in pursuit of their energy diversification goals. Further development of liquified natural gas (LNG) potentials, petrochemical facilities, and investments into renewable sources and green hydrogen technology are some of the strategic goals that Gulf countries, notably Saudi Arabia, are expected to follow in the future.
Saudi Arabia, for example, is seriously targeting green hydrogen as one of the priorities for the energy sector’s diversification under its Vision 2030 strategy, through leveraging cheap solar and wind power to produce this “fuel of the future” with zero emissions. The kingdom is planning the construction of a massive green hydrogen facility that will be an essential part of Saudi Arabia‘s NEOM “smart city” project. It is believed that with cheaper renewable energy sources, it is just a matter of time before this source of energy will be widely applied.
Of course, any further investments will require relatively stable and reasonably high oil prices. But even if oil prices increase sometime next year, observers suggest that producers should not get carried away, as even at US$70 a barrel, prices do not meet fiscal break-even thresholds for most Arab Gulf states.
However, Widdershoven strongly disagrees with this generally accepted overview circulating in the media, arguing that most oil producers are more flexible in their approach than the excel sheets used by financial analysts. For most oil producers, he explained, the break-even is much lower, if they adjust their rentier state financial approach. By removing subsidies, lowering payouts to government employees, or rationalizing expenditures, break-even is much lower.
Moreover, there is a huge group of flexible foreign employees, aka expats. This work force could be used to bring down expenditure, remove budget deficits, and result in a lower break-even. Widdershoven recalls that most of the residents in the Gulf are foreign workers, and to provide a better life for Arab citizens, much less cash is needed. He, therefore, suggests that Arabization should be the prime target, and will bring the much-needed equilibrium.
Any further price stability or a future oil boom would require prolonged commitment from OPEC+ to stick with the current oil supply constraints deal.
Any further price stability or a future oil boom would also require prolonged commitment from OPEC+ to stick with the current oil supply constraints deal. This means that Saudi Arabia will continue to carry the lion’s share of the productions cuts, as Riyadh unilaterally chose to withdraw another 1 million barrels of oil per day (BOPD) from global markets beyond its OPEC+ commitments.
In Kenison’s view, compliance with the deal has generally been significantly better than expected but the longer the cuts persist, the higher the risk of compliance fatigue. He explains that higher prices typically result in reduced compliance, but if compliance is a potential concern, then so is the possibility of a surge in supply from OPEC+ countries that are exempt from cuts. For example, Libya is already back up at 1.3 mmb/d, while Iranian volumes have slumped by more than 1.5 mmb/d under tight US sanctions. Therefore, Kenison expects Saudi Arabia will continue to take on the majority of voluntary production cuts, at least until the second half of 2021.
Widdershoven holds a different view. He believes that it is not feasible anymore for Riyadh to take on such a large portion of the cuts, while other member countries are foot dragging. Saudi Arabia and its Aramco oil company also understand that most OPEC and OPEC+ countries are increasing their production capacity to get a higher market share. “If no real action is taken, the Saudi market share is under threat, and it would be hard to regain it as we all know. It is a catch-22 situation at present, but don’t count on a long continuation of Saudi Arabia’s consideration of others,” he said.
With increasing production capacity across numerous Middle East countries, Gulf countries will continue to export crude to focus on their shares in the Asian market – particularly China, independent of how US production trends. However, putting all the eggs in China’s basket is a great gamble, according to Widdershoven, as Beijing is not looking to support others, only its own strategic goals. Therefore, he believes it would be far wiser to disperse the risks by including the old markets, such as the EU, or new emerging giant India.
It is important to remember that the potential oil boom is yet to arrive, and the main risk to it happening is that supplies will be hit by lack of investment. In such a scenario, the revenues will also be affected, so analysts predict that Gulf countries will be much more cautious when offering foreign aid as well as when it comes to projecting hard power and interventions abroad.