Autumn 2012

ECONOMICS PANEL: Oil, tourists and football

Oil is the source of wealth in much of the Mena region – but how far can it go to meeting social costs? This is one question posed to leading Gulf-based investors and an economist as Funds Global asks how the global slowdown is affecting the Middle East. Edited by Nick Fitzpatric.

SACHIN MOHINDRA, PORTFOLIO MANAGER, GCC FOCUS FUND SICAV, INVEST AD

What is the outlook for the oil price and what opportunities or challenges does this create for the region?
I believe oil prices will remain robust for the foreseeable future, even with sluggish global growth. And as long as oil stays around the $90-$100 per barrel mark, the Arabian Gulf countries will make decent income.

Surpluses will be widest in the United Arab Emirates (UAE), Kuwait and Qatar, and lower than was historically the case in Saudi Arabia and Oman because of increased spending.

Unlike the rest of the world, the region will definitely not be constrained by funds, but countries will need to invest prudently in economic diversification projects and the education needed to provide the skills for new industries. Construction and banking sectors should be the main beneficiaries.

How is the development of a shale gas industry in the UK, US and elsewhere likely to affect the Mena gas industry?
I don’t see any major impact on Middle East gas producers in terms of pricing or volume in the short to medium term because the United States will not be an exporter for three or four years. And although the United States was a target market for Qatar, it isn’t a significant market now.

The region will continue selling mostly to China, Japan, Korea and India, and because a lot of the trade is for meeting the long-term energy needs of these countries, it is through relatively stable, multi-year, long-term contracts.  

Are ambitions to create tourist revenues affected significantly by the low growth outlook for economies in Europe and the US?  
Lower tourist numbers from Europe and Japan will be a concern, but there are also positive signs coming from the region at the moment with tourism starting to pick up again in Egypt and business travel to Dubai on the rise.

In time, emerging market tourists, especially from China and India, will increase to compensate, but there may be a transition period when tourist numbers drop. One bright spot may be increasing religious tourism in Saudi Arabia, where visa restrictions could be lifted in coming years.

Will hosting the World Cup in Qatar benefit the country economically, and how might this filter through to the stock market?
The World Cup will definitely lift economic activity in Qatar because of the investment in infrastructure and services, but I think the event itself could also be good for Dubai and maybe even Bahrain. Many football fans will base themselves in the wider region.

In 20 years’ time, which do you feel will be the top five industries in the Mena region?
I think the top industry in the region will be petrochemicals. Regional producers are already dominant because of their cost advantage, but now the region has the higher capacity and benefits from a relative proximity to major demand centres in Asia.

Energy intensive industries such as aluminium will also prosper, and a stronger aluminium industry will lead to development of downstream manufacturing and basic industries.

Logistics and trade will continue to prosper as infrastructure and industry develops. Companies such as DP World and Aramex should do well.

The region’s airlines will continue to benefit because of the region’s geographical advantage as a hub for Europe and Asia, as well as increasing intra-regional trade and tourism.  
Services, including the financial sector, should benefit from the emphasis on economic diversification. 

FAISAL MANSOUR SARKHOU, ACTING CHIEF EXECUTIVE OFFICER, KAMCO

What is the outlook for the oil price and what opportunities or challenges does this create for the Gulf Cooperation Council (GCC) region?
 The majority of GCC economies are oil based and their economies continue to benefit from strong oil prices that would enable Kuwait, UAE, Qatar and Saudi Arabia to invest heavily in infrastructure projects and develop key economic sectors.

In the medium-term, we expect oil prices to remain elevated as world oil demand is forecasted to continue its upward trend during 2013 to reach a year-on-year average of 89.5 million barrels per day.

However, there is much uncertainty surrounding the world’s estimated oil use in 2013, so the downward risk potential has greater probability in the forecast.

Since most of the GCC economies are oil dependent, robust oil prices might result in delaying the implementation of economic diversification plans. The GCC states have the opportunity to benefit from strong oil revenues to develop core economic sectors (industrial and services) that are more sustainable in the longer run.

Is the financing of the growing social cost in the Mena region from oil and/or gas sustainable? Is the social cost having real effects on economies at present?
An increase in government spending, along with heavy reliance on oil revenues, is putting pressure on GCC states’ public finances and pushing oil prices required for breakeven higher. In Saudi Arabia, the break-even oil price for the budget is estimated to have increased to $79 per barrel in the full year 2011 to 2012, up from $47 per barrel in the full year 2007 to 2008.

Therefore, public spending will depend on oil prices in the medium-term. In addition, GCC states might lose the opportunity to develop their economies in the longer run and of diversifying national outputs away from the hydrocarbon sector if financing the significant increase in current expenditures from oil revenues had continued at the same stance.

Spending on social welfare is positive on economic prosperity and consumer spending. However, I do believe that prudent spending on productive sectors as well as infrastructure and services is the only way to boost and develop GCC economies in the long run.

The financing of the social cost in the GCC from oil and/or gas is sustainable in the short-term so long as oil prices remain elevated; however, in the long-term the trend is not sustainable as the young demographics of the region will significantly increase the future welfare costs on public finances.

The cost of subsidisation of staple foods, energy and water on the budget – along with other social subsidies such as education, housing and healthcare – will grow exponentially to reflect the growth in the population as the youth become jobseekers.

Furthermore, despite efforts at liberalisation of economies in the region, the private sector remains underdeveloped with the majority of employees working in the public sector, which will significantly increase the wage bill in the public finances of these countries should they continue to depend on the government, specifically hydrocarbon revenues, for employment.

Combined, these conditions will eat into the profitability of exporting oil, hindering the ability of GCC to reinvest in the oil infrastructure to boost production in order to maintain surpluses.

Therefore, should the region not diversify its revenue streams and decrease the dependence on hydrocarbons, the cost of welfare will not be sustainable and will be detrimental to the growth of regional economies.

In 20 years’ time, which do you feel will be the top five industries in the Mena region?
The top five industries in the Mena region will be led by the hydrocarbon and petrochemical sector. And driven by the massive spending by governments to develop the sector.

Also, real estate is expected to be one of the key sectors, fuelled by economic growth and the favorable demographic profile of the region (a young population) that will increase demand for housing in the longer term.

The banking and financial services sector will remain one of the main pillars of Mena economies. Aviation and tourism are forecasted to grow significantly in the post-Arab spring period.

The potential black horses will be education and healthcare. The importance and impact of both will depend highly on regulations and the direction of growth and development.

RACHEL ZIEMBA, DIRECTOR, CENTRAL EASTERN EUROPE MIDDLE EAST AND AFRICA (CEEMEA) AND GLOBAL MACROECONOMICS, ROUBINI GLOBAL ECONOMICS

What is the outlook for the oil price and what opportunities or challenges does this create for the region?
We see oil prices falling moderately in 2013 to around $100 per barrel Brent as growth slips due to an impending investment slowdown in China, weak growth in US and a hit to risk sentiment from the likely exit of Greece from the eurozone.

We see prices rising only slightly in 2014 as Chinese growth stabilises below trend (4-6%) but consumption-driven growth supports transportation demand, keeping oil supplies
more balanced than that of other commodities.

This oil forecast is relatively benign for the region as geopolitical risks and weaker production from Iran allow regional producers to keep pumping crude, trimming output only modestly to balance weak demand. This suggests hydrocarbon output will be a modest drag on growth in the GCC and that oil revenues will allow fiscal policy to remain supportive.

But the slowdown in oil prices leaves less fiscal space, as government spending has increased sharply. This leaves the countries more precarious and vulnerable, particularly Bahrain, Iraq and to a lesser extent Oman, which have few financial reserves on which to draw.

How is the development of a shale gas industry in the UK, US and elsewhere likely to affect the Mena gas industry?
Aside from Qatar, most of the Mena gas industry is playing catch-up or is maturing and in need of extensive investment (North Africa). GCC countries are particularly gas poor which forces them to use other fuels – diesel, oil – for electricity generation and feedstock – quite inefficient and higher cost, as well as foregoing exports.

Shale gas in the US will pressure global gas prices modestly, putting pressure particularly on incumbent producers like Russia and Qatar. However, infrastructure backlogs, transportation issues and slowly rising domestic demand will limit US liquefied natural gas exports in the next five years.

The bigger concern for the GCC industry is that gas supplies are being found only slowly (excluding Qatar) meaning demand outstrips supply. This could undermine economic development.

How severe is the effect of inflation on the Mena region broadly, and how is it specifically affecting corporate health?
Inflation is only a moderate concern for corporations in the current phase of the business cycle. Weaker growth, government price controls and weak global demand is restraining price pressures – with only a few exceptions. Corporations are a bit more exposed than households to energy costs as governments are starting to slowly scale back on subsidies to industrial users on whom it is easier to increase prices than on consumers. As fiscal balances deteriorate, corporations may be less sheltered than consumers.

Food prices continue to pose an upside risk to overall inflation across the region, which is a large net food importer and remains vulnerable to global trends despite greater reserves. Local companies have been able to benefit from cheaper global materials and discounting – this is a sign of global weakness rather than necessarily strength.

Many people are worried about rampant inflationary pressures in the global economy due to liquidity injections and quantitative easing by the Fed and
other central banks. We still see deflation as the more valid worry for the underlying economy as the slack in output is absorbing some of the pressures and the liquidity is merely easing deleveraging.

Saudi Arabia, Oman, Iraq and Tunisia have the most solid inflation pressures, but it is only Iran where there are really meaningful inflationary pressures.

Is the financing of the growing social cost in the Mena region from oil and/or gas sustainable? Is the social cost having real effects on economies at present?
The increase in social spending in the region is unsustainable across the board with the situation particularly acute in the countries that rely on fuel revenues but have limited fuel production per capita – most notably Algeria, Bahrain, Oman, Saudi Arabia. The UAE, Qatar and Kuwait have a bit more spending space. It is even more problematic for the oil importing countries that have very sparse financial reserves, but widening spending (North Africa).

The social costs and expansion of public wage bills and caution at dismantling subsidy systems are increasing imbalances within the domestic economy towards consumption rather than productivity-enhancing investment, lessening the funds available for infrastructure. The expansion of the public sector and increase in wages is raising the wage rate and unit labour costs within many Mena regions and limiting competitiveness.

Are ambitions to create tourist revenues affected significantly by the low growth outlook for economies in Europe and the US?  
Yes, weaker growth and consumer spending capacity in Europe and the US are a damper on tourists but regional tourists are providing an offset and inflows from emerging market countries are picking up.

North African and Levant countries are most exposed to the slowdown in developed market tourist exports due to weaker demand, political pressures and security concerns, which are dampening tourist revenues and reducing per-visitor spending.

©2012 funds global

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