The oil curse

Oil producing countries in the Gulf have failed to avoid the pitfalls that so often plague developing countries with vast natural resources. Despite the various warning signs over the last 30 years, Gulf economies are still too dependent on the price of oil.

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By  Massoud Derhally Published  February 4, 2003

|~||~||~|Talk of a war in Iraq and worker strikes in Venezuela have caused wide fluctuations in the oil market, sending the price of crude in the US as high as $35 a barrel. But while the increase in the price of oil may seem like a good thing for the exchequers of oil rich states, it is seriously setting back the cause of economic reform in GCC countries.

Oil revenues still account for some 50-90% of total government revenues, depending on the country. According to figures from the Economist Intelligence Unit, 70-80% of the government’s revenue in Saudi Arabia still comes from oil and that depends largely on the price of oil in a given year. In the UAE, oil revenues are 86% of government revenues. In Kuwait it accounts for 92%.

While some countries like the UAE have succeeded in maintaining an external account surplus, which has helped it accrue assets that have strengthened its monetary standing, and provided the latitude to respond to oil price fluctuations, countries like Saudi Arabia have not followed through on fundamental structural changes to their economies.

The increase in the price of oil may provide more for the treasury of GCC states, helping governments increase their budgets, lessening deficits and boosting the economy. “That is the direct impact,” says Joe Kawkabani. “Most of the budgets in the region are based on US $18 a barrel and most governments have surpluses and will use this to boost the economy,” he adds.

But this cash injection also delays crucial economic reforms. Even in the 1990s, when prices were in a slump, governments paid lip service to reform and hardly any structural changes took place. “With no hope of more revenue, governments still didn’t reform, and the mere talk of reform ended as soon as prices recovered in the summer of 1999,” says one oil analyst. “I find it very significant that all GCC governments are running fiscal deficits despite the ‘high’ oil prices. Moreover, economic reform is much easier when, despite the deficits, the government can count on higher oil prices to soften the blow,” adds the oil analyst.

“When prices reach their current levels and budget deficits consequently fall and spending levels can rise, it becomes easier for those inside government who are reluctant to engage in painful economic reforms to delay the process,” says Simon Williams, deputy head and senior economist at the Economist Intelligence Unit in London.

“It doesn’t have to be this way and arguably it shouldn’t be. The best time to engage in reform to address the kinds of problems emerging in countries like Saudi Arabia is when prices are high, and the government has funds to soften the short term blows associated with reductions to the welfare and subsidy systems, and privatisation. Unfortunately, the lessons of the period since the last oil price collapse in 1998/99 is that many Gulf governments will not act forcefully until they feel they have no choice.”
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Gregory Gause, a renowned oil and Gulf expert at University of Vermont, agrees. Recent higher prices are an unfortunate boon to the Saudi government, he says. “They make it easier to meet the demands on the budget of a growing population. However, by allowing the government to muddle through, the higher prices do, to some extent, put off the need to make more fundamental economic and political decisions.”

In January, the Saudi American Bank (SAMBA) highlighted in a report on the Saudi economy that the kingdom had failed to capitalise on the fluctuating oil prices and that the country faced a number of challenges. “The past three years have been the three best years for oil revenues of the past 20 years, [but] the government did not use this period to reduce its debt or significantly grow central bank foreign assets,” said SAMBA in the report. “The government enters the next downturn, should it occur soon, with less of a financial cushion than in the past,” the report added.

“Based on oil industry and International Energy Agency (IEA) forecasts, there will be no room for increased OPEC-10 (OPEC minus Iraq) production until at least 2006 if prices stay above 20 dollars a barrel,” says SAMBA’s chief economist Brad Bourland. “In such an environment, Saudi Arabia faces unattractive oil policy choices: defend current prices in the mid-twenties per barrel with no growth in production and revenues year over year. Or, let prices drop to discourage new non-OPEC oil capacity in order to capture a larger market share in out years. With the government’s ever-growing spending needs, neither policy choice offers much hope that the policy goal of “sufficient income” will be met in the next several years,” Bourland adds.
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When asked about the pace of change in Saudi Arabia, Mai Yamani, a research fellow at the Royal Institute for International Affairs in London said, “Instead of embarking on serious reforms they are always postponing. There are all these initiatives, but they are not followed through. When you hear about reforms, I say ‘Are they adequate? Do they meet the aspirations, the demands of the people? I don’t think they are yet.”

Yamani makes a valid point. Real GDP growth in Saudi Arabia was put at only 0.74% in 2002, lower than the 1.1% recorded in 2001 and 4.8% of 2000. Nominal GDP is estimated to have grown by 2.3% to SR695 billion ($185.3 billion) in 2002, but is projected to drop by 2.5% this year. That miniscule real GDP growth of 0.74% was in spite of the private sector’s growth of 4.2% in real terms in 2002.

It is again forecast to grow by 3.5% this year, a healthy rate compared to the global average, but barely in line with population growth of 3.5-4% annually. The conclusion is clear: the private sector needs to grow even more quickly.

Oil rich Kuwait faces a similar challenge to that of Saudi Arabia. According to the National Bank of Kuwait (NBK), factors lending strength to oil prices, while contributing to fiscal and external surpluses in the short term, are likely to weaken the prospects for Kuwait’s economy in the long run. The bank says that, “fiscal conditions make it more difficult for the government to push through its economic reform program on the grounds of economic necessity.

“The more such reforms are delayed, the harder the process becomes… Privatisation remains elusive in the near term, as political issues are likely to delay key legislation concerning reforms, privatisation and opening up the oil sector. For the reform program to go ahead, the public must become convinced that sacrifices need to be made today to ensure a more promising future.”
There are some positive signs, however. Qatar has developed a policy of diversification away from oil, mainly funded through liquefied natural gas (LNG) schemes and foreign investment.

The small country, which has the third largest known natural gas reserves and the largest non-associated gas field in the world, has so far invested billions of dollars in developing and marketing its gas reserves. It is using the revenue generated to initiate a diversification scheme that aims to reduce the economy’s reliance on oil and gas revenues.

In fact, Qatar is perhaps at the very stage the UAE was at fifteen years ago. In a recent survey, the International Monetary Fund applauded the United Arab Emirates on turning the “oil curse” into a blessing. The survey highlighted the Emirates’ achievements and its ability to use the benefits of oil production to achieve tangible results in other sectors within the country.

“The country has managed to avoid the pitfalls that so often plague developing countries with vast natural resources,” the Fund said. “Although regional disparities remain important, the country as a whole has benefited from its hydrocarbon wealth.”

The UAE, which accounts for 10% of the world’s known oil reserves and 4% of gas reserves, was commended by the Fund on achieving real economic growth of 9% in the 1990s. The Fund attributed the growth to low tariffs and a free market. The survey went on to say that fluctuations in the oil market have not adversely affected the country as it has taken measures that have insulated its economy from wide swings in the price of oil.

At times like these, higher oil prices should strengthen the resolve of governments to escape the oil curse, lessen the dependency on oil export revenues and the vulnerability of the economy to high oil prices. The driving factor should be the implementation of structural changes and economic reform.

This should not be something that governments theorise, but that they actually translate into tangible and concrete actions on the ground that lay the foundations for future economic growth. As Sheikh Yamani, the former oil minister of Saudi Arabia, who is still an authority on world oil markets, once said, “The Stone Age came to an end not for a lack of stones, and the oil age will end, but not for a lack of oil.”
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