Oil at $30 (Dh110) per barrel is a temporary possibility in 2009 but for oil to average that level throughout the year would require a bigger economic meltdown than anyone expects, says a new ING report sent to Emirates Business.
ING's world real GDP growth base case for 2009 points to oil prices between $50 and $90/bbl by 2010. Long-term average oil prices suggest 'fair value' is $58/bbl, and having seen an overshoot in 2007-08, ING fears an undershoot in 2009-10. So a worst-case scenario of oil at $30/bbl could perhaps be justified from this angle, but the banking major believes it is "highly unlikely".
Even if oil averages this in 2009, the GCC's fiscal power to boost domestic GDP is far greater than that of the other economic powerhouse analysed in the report – Russia. ING maintains that years of surpluses accumulated by GCC states will hold them in good stead in the unlikely scenario of oil averaging $30 in 2009.
In the report titled "Oil at $30/bbl in 2009? Implications for GCC and Russia," ING maintains that "it requires massive global demand destruction in 2009 (10 per cent year-on-year), or world real GDP growth falling by three per cent year-on-year – below even the most bearish forecasts in the market for every economy" for oil to average $30 this year.
Under that worse-case scenario, ING says the GCC's fiscal position would deteriorate sharply, with the average budget balance of the region turning from a 20.5 per cent GDP surplus this year to a 15.2 per cent GDP deficit – close to the 20-year worst seen in 1990-1991. This assumes expenditure growth of 19 per cent year-on-year (19 per cent for current, 20 per cent for development spending), down from an expected 28 per cent year-on-year in 2008, but still above the six-year average.
Moreover, as the report points out, not all GCC countries would be hit in a similar way, owing to various levels of oil dependencies. Kuwait and Saudi Arabia have the budgets most sensitive to oil prices in the GCC. According to estimates, for each $1 drop in the annual oil price, their budgets lose 0.6-0.7 per cent of GDP. At the other end of the spectrum, Oman and Bahrain seems to be the least sensitive (0.3 per cent of GDP budget balance loss for each $1-drop in the annual oil price).
However, the GCC has accumulated a massive chunk of foreign assets – a feature they did not have back in the late 1970s or even early 1990s. While no data is available on the various sovereign wealth fund (SWF) balance sheets, accumulated current account surpluses in the region since 1980 suggest that the GCC held at least $915bn in foreign assets at the end of 2007. Adjusting additionally for capital account surpluses, we estimate that at the end of 2007, total foreign assets held by the GCC countries (SWF + official foreign exchange reserves) amounted to $1670bn, more than twice the region's GDP.
Even if we discount a 40-per cent loss on those assets throughout 2008 – a highly conservative assumption (it does not take into account reserves accumulation over 1H08) – the GCC still held $1 trillion in foreign assets by end-2008, i.e. almost the size of their economies.
The report concludes that while oil at $30/bbl will hit the main macroeconomic aggregates hard, the GCC is better protected than in the 1970s. With the oil cycle reversal set to hit the GCC more than any other country in the world (due to their oil dependency), they now have the strongest 'fiscal' firepower in the world to smoothen the adjustment – unlike in the 1970s.
However, by its own admission, oil at $30 is an extreme assumption. For oil prices sustainably at $30/bbl over 2009-2010, ING finds that the necessary underlying demand destruction corresponds to a real world GDP growth drop of -3 per cent year-on-year in 2009. Based on ING's forecasts for the world's largest economies, this would require a 15-per cent decline in all the rest. "Oil averaging $30/bbl is clearly a very extreme scenario," the report points out.
"The US would need to shrink by more than two per cent, Chinese GDP would need to be zero and many countries would see GDP fall by 10 per cent in 2009," it adds. For Russia, under these assumptions, the government can cover its deficit in 2009, and have two per cent of GDP left in the Reserve Fund. Exports would likely collapse initially but the current account would not go too deeply into the red (two per cent of GDP), and there would be a considerably weaker rouble (20 per cent weaker than parity). GDP could drop by one per cent, but with downside risks.
Under the same worst-case scenario, for the GCC, ING reckons that 2009 nominal GDP growth would look horrible (30 per cent year-on-year), and both the current accounts and budgets would fall into deep deficits (around 15 per cent of GDP), owing to higher oil dependency than Russia. But these projections are assuming that the authorities would inject 'only' 11 per cent of GDP into their economy. "With 100 per cent of their regional economy's GDP lodged in SWF and forex reserves, they can do much more than that and beat the rest of the world in the Great Domestic Growth Stimulation saga," notes the report.
Working the argument upside down, ING arrives at a different, more realistic price of oil in 2009. The bank expects world real GDP growth to reach a mere 0.9 per cent year-on-year in 2009. This, according to the correlation, points to oil demand dropping by four to five per cent – conservatively – in 2009, to 82m bpd (vs 85.9m bpd expected by the EIA). Looking at the simple correlation between oil demand and prices, this would point in turn to oil prices dropping 40-50 per cent year-on-year by 2010, on a conservative basis again. This would effectively translate into an oil barrel averaging $51/bbl by 2010.
To return to ING's base case for oil, analysts at the bank hold the view that oil prices have fallen sharply for the 'wrong' reasons in recent months: concerns over low economic growth and low demand. But since the bank claims to remain more cautious than most on the global economic outlook and oil demand growth next year, it does see risks for lower prices still – in the short term at least. The bank analysis nevertheless envisages a worse case for oil prices at $30/bbl for 2009.
For Russia, the other economy analysed in the report, the $190bn amassed by the Russian government in its coffers will have to come into play to sustain the economy. In particular, the Reserve Fund (RF) intended for covering shortfalls in the oil and gas transfer exceeded $132bn as of end-October. According to ING calculations, even with Urals at $30/bbl, the Russian government would be able to cover its deficit comfortably in 2009, and would still have at least two per cent of GDP left in the RF.
A further fall in the oil price, to $40/bbl or $30/bbl in 2009, would undoubtedly put additional strain on Russia's public finances and would probably cause the economy to register a few quarters of zero or negative growth. However, the risk of a further fall in oil prices is not the primary worry at the moment. The Russian government has pumped tens of billions of dollars in injections into the economy, and can afford to cough up more if oil prices fall further.
The key question is whether the rescue aid is efficiently channelled to those in need. At the moment, only a few large companies have received direct aid from the government; most of the rescue funds distributed to the top banks have yet to find their way into the economy. On a rainy day, ING believes the Russian government's ability to sort out the implementation issues, and not allow bureaucratisation, corruption and other inefficiencies imbedded in the system to rule the day, may prove crucial for the near-term outlook, whatever the oil price may be.