Oil output cuts mean Gulf slump to be even deeper - Capital Economics
Middle East & North Africa Economics

Oil output cuts mean Gulf slump to be even deeper

Middle East Economics Update
Written by James Swanston
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The deal struck by OPEC and other oil producers to cut oil output sharply over the coming months will help to put a floor under oil prices, but the reduction in output simply adds to the reasons to expect a sharp downturn in the Gulf economies this year.

  • The deal struck by OPEC and other oil producers to cut oil output sharply over the coming months will help to put a floor under oil prices, but the reduction in output simply adds to the reasons to expect a sharp downturn in the Gulf economies this year.
  • After marathon talks, the oil cartel OPEC and other producers agreed to substantial oil output cuts on Sunday in a bid to calm the oil market. As we had expected, Saudi Arabia played hardball and insisted that all producers share the burden equally. Indeed, at one stage, a Mexican holdout threatened to cause the deal to collapse. In the end, OPEC+ announced a 9.7mn bpd cut (equal to 10% of global supply), starting on 1st May for two months. From July, the reduction will be scaled back to 7.7mn bpd until end-2020.
  • The reaction in oil markets has been muted – indeed, at just under $32pb, the price of Brent crude has been effectively flat since the end of last week. This is not a major surprise given prices had already jumped on the back of US President Trump’s announcement last week that he expected Saudi Arabia and Russia to agree to substantial cuts. But even with these output cuts, the collapse in demand means that the oil market will remain in a large surplus this quarter, keeping prices subdued. (For more, see our Energy Update.)
  • The oil output cuts will create an additional headwind to economies in the Gulf this year. The output agreement will have a mechanical impact on real GDP growth via a lower volume of production in the region’s oil sectors. In Saudi Arabia, lower oil production will shave around 2.5%-pts off headline GDP this year. The hit will reach as much as 6.5%-pts in Kuwait. (See Chart 1.)
  • Despite the recovery in oil prices from its nadir of $22pb, the Gulf countries still face a huge hit to oil revenues this year. In almost all cases, budget and current account positions will fall into deficit. (See Chart 2.) Policymakers are likely to lean on FX savings and international bond issuance to finance these shortfalls and we expect dollar pegs to remain intact. Bahrain and Oman are most at risk of having to devalue, but there are growing signs that financial assistance from the rest of the Gulf will be forthcoming. (See here.)
  • The hit to balance sheets from lower oil revenues will, however, limit governments capacity to provide direct stimulus to support the economy. So far, efforts to deal with the economic fallout from the coronavirus outbreak have focussed on waiving loan repayments and providing cheap and easy credit lines. Meanwhile, several governments have announced plans to cut spending. For example, Saudi Arabia’s finance minister has said that budgeted spending will be cut by a further 5% this year. (See here).
  • All told, efforts to contain the coronavirus had already weighed heavily on economic activity and a fresh round of oil production cuts will cause the economic downturn in the Gulf this year to be even deeper. The limited policy support means that, even once the virus is brought under control, the economic recovery will be slow going. We will formally revise our GDP growth forecasts in our forthcoming Outlook.

Chart 1: Oil Sector Contribution to 2020 GDP Growth (%)

Chart 2: Gulf Fiscal and Current Account
Breakeven Oil Prices ($pb)

Sources: Refinitiv, Capital Economics

Sources: Refinitiv, Capital Economics


James Swanston, MENA Economist, james.swanston@capitaleconomics.com