Rising oil prices help cushion impact of recession on GCC

• Text size
•  
•  

JEDDAH: At the start of 2009 the economies of the Gulf Cooperation Council (GCC), especially its large oil producers, faced a daunting year. Oil prices had fallen precipitously from a high of $145 a barrel in mid-2008 to around $35-$40 a barrel, and the outlook was bleak as the world faced its worst recession since the great depression. In addition, in an effort to shore up prices OPEC (Organization of the Petroleum Exporting Countries) had agreed record production cuts of 4.2 million bpd, further dampening growth and revenue prospects for those GCC members subject to quotas (Saudi, Kuwait, UAE, Qatar), according to Samba Financial Group's special report about "2010 Oil Market Outlook and Implications for GCC Economies" released on Tuesday.

In the event, oil prices surprised on the upside, staging a strong recovery during the second half of the year. Prices traded in the $70-75 a barrel range for most of the latter part of the year, breaching $80 a barrel in October and then again in December, and raising the annual average 2009 price to $62 a barrel for WTI. While still down about 38 percent on the 2008 average, the rebound in oil prices during the year has helped cushion the impact of the global recession on the GCC and a reduction in external capital flows. The resultant stronger than expected oil revenues helped finance counter cyclical policies, government support for the region's financial sectors, and revive investor and consumer confidence. While sharply lower, fiscal and current account balances are largely estimated to have stayed in surplus, allowing some replenishment of external assets initially drawn down when the global crisis first hit. However, despite the positive, albeit slower, growth momentum in non-oil sectors, overall GCC real GDP (gross domestic product) growth was dragged down by the reduction in oil production, essentially stagnating at 0.8 percent in 2009, after 7.2 percent growth in 2008. Total nominal GDP of the GCC fell by 20 percent to an estimated $841 billion, principally reflecting the drop in oil and gas prices and hence revenues, the report said.

Developments during 2009 have served as a reminder that, while the GCC states are in the midst of an impressive economic transformation which is fueling strong non-oil growth, their economies remain heavily dependent on oil and gas sectors. These continue to account for over a third of economic output, and more than three quarters of budget revenues and export earnings. Oil revenues are a vital source of finance for the economic transformations underway, and underpin the public sectors' large infrastructure developments. They are also a major driver of liquidity, and oil price fluctuations have a large influence on consumer and investor confidence. The extent to which the GCC can sustainably build on the economic recovery momentum currently under way will thus be substantially influenced by developments in the global oil markets.

Market fundamentals

While oil prices have recovered impressively from their last year low, the fundamentals of the oil market start 2010 in a somewhat fragile state. Oil prices have risen at a time when global demand has fallen and both crude and product stocks have increased, posing some questions as to the durability of the rally. Markets appear to be pricing in a demand recovery that will be sufficient to draw down stocks and restore balance to the fundamentals. However, while oil demand in some key markets such as China and India is already picking up, this anticipated global recovery is not yet assured, and prospects remain sensitive to broader economic developments.

Oil demand

Global oil consumption fell by an estimated 1.5 million bpd, or 1.6 percent in 2009. The International Energy Agency (IEA), estimates global demand fell to 84.9 million bpd, following a 0.3 percent drop in 2008. The majority of the drop occurred in the OECD economies which were particularly hard hit by recession, and some demand destruction from the surge in oil prices during 2008. In particular, demand in the largest consumer, the US, is estimated to have declined by over one million bpd during 2008-09. No region fully escaped the impact of the global recession, although strong fiscal stimulus packages, especially in China and India, helped maintain demand growth in Asia and the Middle East during 2009.

Stock levels high

According to estimates from the IEA crude and product stock levels remain high, with OECD industry stocks put at 2,747 million barrels in November, equivalent to 59.1 days of forward demand. This is well above the 52 days OPEC has traditionally sought to maintain, and would normally exert a strong downward pull on prices. In addition, floating crude stocks are estimated at around 60 million barrels, while oil products in floating storage have risen to over 80 million barrels. Some estimates put the figure even higher at over 100 million barrels. The massive volume of middle distillates in storage are a particular concern to OPEC as it has less control over product markets.

In the absence of robust demand growth refiners will need to cut back runs to drawdown these stocks, thus reducing the demand for crude.

While OECD commercial inventories data should show a decline in fourth quarter 2009 -- the first quarter on quarter drop in two years -- it seems clear that there will still be a substantial supply overhang in early 2010.

Financial 'investors'

Considerable debate remains over the impact of financial sector "investors" on oil prices. Analysis of recently released disaggregated oil trading data from the US Commodities Futures Trading Commission (CFTC) is not conclusive, but has been used by some to argue that such activity has a major bearing on price developments, especially the spike in mid-2008. Certainly there appears to be a consensus that prices during 2009 have been considerably buoyed by investment in the oil futures markets.

Saudi Minister of Petroleum and Mineral Resources Ali Al-Naimi has gone as far as to state that there has been a fundamental change in the market, and that oil is now a macro trade with economic growth and the relative strength of the US dollar driving prices.

Under such conditions inventory levels are not affecting the price of oil as they did in the past. Given traders' willingness to hold product stocks some OPEC delegates have stated that a return to "normal" stock levels of around 52 days of forward cover would be too tight for current markets.

Data from the CFTC shows that non-commercial traders have poured back into oil futures -- with net-long open interest on the Nymex reaching an all-time high in October 2009. Investor interest in oil has also served to deepen the contango in oil prices (where prompt oil is at a discount to later deliveries), making storage more profitable and helping keep excess supply off the market. The hope of OPEC and investors betting on higher prices, is that prices will remain buoyed by market sentiment (predicated in large part on a weak dollar and perceptions of a robust global recovery) long enough for demand to recover sufficiently to draw down stocks and restore some balance to supply and demand.

In addition, Custodian of the Two Holy Mosques King Abdullah's statement in early 2009 that he thought $75 a barrel was a fair price for oil, appears to have provided a psychological anchor for the market during these unsettled times. It has come to be viewed as OPEC's informal target price, and is also now generally seen as a level necessary to secure sufficient investment in new oil production needed to prevent a supply crunch in the medium term.

OPEC quota cuts

A key factor behind the surprising strength in oil prices during 2009 has been the response by OPEC which announced a record 4.2 million bpd in quota cuts from its September 2008 production levels (Iraq is currently excluded from production quotas). OPEC's compliance with these cuts was initially remarkably strong, peaking at 80 percent in March last year. Saudi Arabia has been the linchpin of OPEC's response and has shouldered the bulk of the production cuts, even producing at below its 8 million bpd quota for a three-month period. However, by late 2009 compliance rates had slipped below 60 percent as stronger prices promoted some relaxation. Nonetheless, OPEC's actions did remove close to 3 million bpd of crude from the market during 2009, helping provide support in the face of collapsing demand.

Non-OPEC supply

While OPEC was successful in curbing its output, this was somewhat offset by a surprising increase in non-OPEC supply. Declining oil fields in the Gulf of Mexico and the North Sea were expected to keep non-OPEC supply stagnant at best, after two years of 1 million bpd plus declines in 2007 and 2008. However, output in fact rose strongly boosted by a surge in Russian production to 10 million bpd. Moreover, Brazil and Kazakhstan are in the process of ramping up production and are already producing near 2 million bpd and 1.3 million bpd, respectively. On top of this, the global supply of natural gas liquids also rose strongly. This includes increased production from OPEC producers such as Qatar and Saudi Arabia, as NGL output is not constrained by quotas.

© Arab News 2010