No turning back: preserving diversification gains amid rising oil prices

All eyes were understandably on Vienna at the end of June, and the gathering of oil ministers from the Organisation of the Petroleum Exporting Countries (OPEC). Their decision to increase output was endorsed by the non-OPEC producers who signed up to the original cuts 18 months ago. 

Oil prices are a thorny issue for the Gulf economies as their diversification strategies accelerate.  On the one hand, while lower prices have caused hardship for citizens resulting from austerity and subsidy reduction, they have also added welcome impetus to policy. 

On the other hand, they have caused economic slowdown everywhere, reducing the ability of governments to invest in the infrastructure, both soft and hard, needed to facilitate diversification, and dampening private sector sentiment. 

A number of analysts hope that the decision to increase supply by 1m barrels per day will prevent the price from rising to heady levels, which could lead to governments reversing some of the important, albeit painful, reforms that have been implemented. 

Don’t dismiss supply constraints and geopolitics

My personal feeling – and someone wise once told me never to predict oil prices, so I won’t – is that supply issues will now come to the fore, which, combined with geopolitics, could mean the increase will have a limited impact. 

Investment in all exploration, and notably in US shale fields, so often cited as a major cause of plummeting prices three years ago, has reduced markedly. Given the lead times associated with this sort of speculation, the cycle will have to play out. Inventories have also fallen. 

Add to this the US abandonment of the Iran nuclear deal and impending re-imposition of sanctions, the disruption to supply in Venezuela and Libya, plus uncertainty about the health of the Chinese economy, and it may be that global politics are the greater determinant of prices. That said, it was not that long ago that the unlikely bedfellows of Venezuela and Goldman Sachs were predicting prices of $10 per barrel….

Either way, oil prices remain a major consideration for governments in the Gulf, as the shift towards diversified, knowledge-based economies is, by its very nature, a long-term endeavour. What’s important now is to carry on with the economic restructuring.

Cultural reforms take the economic wheel 

From Saudi Arabia, the big news has undoubtedly been women being allowed to drive. Indeed, this grabbed headlines around the world. This liberalisation in many people’s eyes has been a long time coming; so too was the reopening of cinemas earlier this summer after a 35-year hiatus. 

The economic impact of both these changes cannot be underplayed. 

Women are now able to drive themselves to and from work, and their children to school and back, all without the cost of a driver or taxis. This inevitably will mean less reliance on migrant workers ferrying ladies about. Indeed, both Uber and local ride-hailing app Careem reported many thousands of applications from women to join their ranks. 

This will be welcome news for government strategists trying to reduce the numbers of lower-paid migrant workers and get more Saudis into the workplace. However, as governments across the world are discovering, the gig economy is difficult to analyse, so it will be interesting to see how this is assessed. 

Given the bottom-heavy nature of Saudi society, where the vast majority of people are young and have at least moderate disposable incomes, liberalising the rules to allow cinemas looks set to herald the beginning of a new industry – again, a welcome avenue to further diversify revenue streams. 

Furthermore, the announcement of theme parks and broader entertainment facilities, under the Quality of Life 2020 programme, is set to tap into the approximately $8bn that Saudis spend on recreation abroad each year.  

Emerging market maker

Less headline grabbing than the right of women to drive, but potentially very significant, was the June announcement from MSCI that Saudi Arabia had been granted emerging market status. This came a couple of months after another international index provider, FTSE Russell, awarded the exchange, or Tadawul as it is known locally, the same ranking. 

This is very welcome news, and could see significant inflows to the region’s largest market. The introduction to both indices is being staggered, but the MSCI inflows alone are projected to be in the region of $45bn. 

The hope will not only be for enhanced levels of trading, but a commensurate improvement in the sophistication of regulatory frameworks. Capital markets form an important part of all the region’s diversification strategy, and the increased role of big international institutional investors is seen as a mechanism by which they can deepen and mature. 

The Tadawul rallied on the news, and the impact was felt on neighbouring markets, too. However, broader concerns about slow growth persist in the Gulf. 

The policy sense of stimulus

Abu Dhabi launched a $13.6bn package aimed at kick-starting the emirate’s economy after a three-year slowdown. Lower oil prices have had a serious impact on growth and the ability of the government to pay its dues to contractors, which in turn has had a negative knock-on effect in the all-important private sector. 

GDP growth in the UAE fell to 0.5% in 2017, well below the average of 4.8% between 2000 and 2014. It is notable that Abu Dhabi, the wealthiest of the emirates and a regional heavy-hitter, has sought to address the issue so openly. Alongside the announcement came news of a further easing of licensing requirements for foreign companies, along with the creation of 10,000 private and public sector jobs. 

Analysts who watch the region understand the desire to create public sector jobs against this economic backdrop, but may also voice concerns.  

The size of the public sector has long been troublesome. Indeed, Abu Dhabi has in recent years made significant moves to reduce the size of its civil service, which, as elsewhere in the Gulf, has traditionally been far more attractive to nationals than the private sector, but also comes at a major cost to the government. It is therefore hoped that the desire to create more public sectors jobs is a short-term response, and that instead the main emphasis will be on the private sector. 

As I have written before, diversification isn’t a one-way street, and the fact it has been most advanced by some of the economic hardships experienced in recent years shows the route is also beset by some steep climbs. Now that oil prices are moderately higher, these short-term structural gains, painful though they have been, should not be reversed.