Gulf states to stay hooked on oil and gas for many years to come: Moody's

It will likely take "many years" for countries in the Gulf Cooperation Council to achieve economic and fiscal diversification away from oil and gas, a report by the Moody's credit ratings agency concludes.

Economic diversification are key policy buzzwords in the GCC, whose members include Bahrain, Kuwait, Oman, Qatar, Saudi Arabia and the UAE. But since 2014, progress towards this goal has been only "limited," Moody's says in the report seen by NGW. Declines in oil and gas contributions that did occur in the last seven years were only a result of lower oil prices. In most of the states, oil and gas still account for at least 20% of GDP, over 65% of exports and at least 50% of government revenue.

"The announced plans to boost hydrocarbon production capacity and government commitments to zero or very low taxes make it unlikely that this reliance will diminish significantly in the coming years, even with some progress in economic diversification, which we expect," Moody's said. "Hydrocarbons will continue to drive GCC sovereigns' fiscal strength, liquidity position and external vulnerability for many years."

Moody's expects momentum behind diversification to pick up, but "it will be dampened by reduced availability of resources to fund diversification projects in a lower oil price environment and by intra-GCC competition in a relatively narrow range of targeted sectors." Oil price shocks and the transition towards lower-carbon energy will erode government balance sheets and heighten volatility, the agency said.

Hydrocarbon production amounts to as much as 45% of GDP in Kuwait, around 35% in Qatar and Oman, close to 25% in Saudi Arabia and the UAE, and under 15% in Bahrain, the latter benefiting from well-developed manufacturing and services sectors while having fewer oil and gas resources. And the lack of diversification is even more pronounced in exports, with oil and gas accounting for over 80% of export revenues in Kuwait and over 70% in Saudi Arabia. At the bottom end is once again Bahrain, which generates only around 35% of export revenues from hydrocarbons.

Government's fiscal reliance on oil and gas is high across the board, with the commodities contributing nearly 90% of revenue in Kuwait and 79.2% in Qatar. Bahrain's fiscal dependence is relatively high at 64.1%, while at the bottom of the range is the UAE, where oil and gas contributes 55.6%.

Looking ahead

The push to expand oil and gas production across the GCC states could reverse some of the progress that has been made, and lock countries into dependence on hydrocarbons for longer, according to Moody's. These plans partly reflect an expectation among national oil companies that supply will contract elsewhere, in places where costs are higher and regulators and shareholders are set to restrict investment in hydrocarbon extraction. Some developed nations could follow the recommendations of the IEA, which recently said no more investment in oil and gas was needed as the world pursues its net zero goal.

Saudi Arabia and the UAE both announced plans to ramp up oil production before committing to OPEC+ cuts, which will only remain in force until the end of April 2022. Qatar meanwhile took a final investment decision in February on expanding its liquefaction capacity from 77 to 110mn metric tons/year. Kuwait also aims to expand oil and gas production in the next five years, while growth plans are more modest in Oman and Bahrain. 

GCC states are also looking to build up their downstream industries to add value to their resources.

The slump in oil prices in 2020 led to falls in GCC government revenues and exports of 5-15% of GDP. These are much greater declines than any of the governments could have offset through spending cuts without worsening their economic downturns and undermining the social contract between rulers and their citizens. Exchange rate pegs have helped GCC countries maintain macroeconomic and financial stability over the decades, but they also limit their economic and fiscal ability to absorb external shocks, Moody's says.

Based on current policies and targets, the IEA still sees oil demand growing at a compound annual rate of 0.4% through 2040, and gas consumption at a rate of 1.2%. This gives GCC nations time to diversify their economies and fiscal revenues, but this is assuming that the energy transition does not accelerate.

"If the transition were to accelerate to a faster pace, for instance in line with the large number of net zero targets announced recently or as envisaged in the IEA's sustainable development scenario (SDS), GCC sovereigns would be exposed to further large declines in hydrocarbon revenue and national income, leading to higher debt burdens and an erosion in fiscal and external liquidity buffers," Moody's says.

Oil and gas prices will be lower in SDS than in the IEA's stated policies scenario, and while they may not necessarily collapse, there could be added volatility as the market struggles to find an equilibrium between demand and supply and if there are abrupt changes in policy in favour of decarbonisation.

Still, the odds that assets become stranded in the GCC nations is lower than elsewhere given their lower costs, which will allow them to continue producing profitably for longer than others. 

"Nevertheless, while lower oil prices may not impact the commercial feasibility of oil and gas production, they would further weaken GCC countries' external and fiscal balances and accelerate the pace of their sovereign balance sheet erosion," Moody's notes. "The governments may also find that financing becomes tighter as global investors move away from hydrocarbon-related assets, such as the debt of oil exporting sovereigns."

The countries worst affected would be those with the highest fiscal and external breakeven oil prices – namely Bahrain and Oman but also Saudi Arabia. However, Saudi Arabia's external breakeven oil price is significantly lower than those of the other two countries, and it has much stronger fiscal and foreign currency buffers, giving it more time to adjust to the transition.