Capital spending fuels revenue need

The Abu Dhabi Government needs to recoup more from its oil and gas industries after its total expenditure more than doubled in four years because of its ambitious economic development plans.

Oil exporters, such as the UAE, once tailored spending to projected receipts and booked huge surpluses because of conservative crude price estimates.

Increased spending by the Abu Dhabi Government is pushing up the level of oil revenue that the emirate needs to balance its budget, official documents show.

The higher outlays, a direct result of the Government's ambitious economic development plans, have helped smooth the effects of the global economic recession but could have wide-ranging implications for the flow of money into the Government's international investment funds and its oil production strategy, experts say. The Government's total expenditure has more than doubled in four years to Dh207.4 billion (US$56.46bn), outpacing a conservative estimate for revenues this year of Dh122.6bn, according to a prospectus issued last month for a government-guaranteed bond. Projected spending is up 10.7 per cent compared with 2008 when the average price for oil was 36 per cent higher than it has been this year.

That shift is indicative of a changing financial paradigm taking hold across the Gulf. Governments that once tailored spending to projected oil receipts and booked huge surpluses because of conservative oil price estimates are now vowing to press on with economic development plans costing tens of billions of dollars a year - even if doing so means tapping into past oil savings to pay for budget deficits.

The prospectus for Waha Aerospace, a government-controlled aircraft financing subsidiary of Waha Capital, does not give a full picture of Abu Dhabi's fiscal position because it does not detail the total level of revenues flowing to all entities related to the Government, including sovereign wealth funds and the Abu Dhabi National Oil Company (ADNOC), analysts say. Last year, the emirate's economy took in as much as Dh250bn of gross receipts from exports of oil, natural gas and chemicals, the prospectus showed, but only Dh121.7bn went directly into the Government budget. The rest of the money, presumably, went to oil partner companies, covered the cost of output and was deposited in the accounts of other government entities, including the Abu Dhabi Investment Authority (ADIA) and the Abu Dhabi Investment Council (ADIC).

Government organisations such as ADIA and Mubadala Development also took in large, unspecified streams of income from other sources, including financial investments and oil and gas production overseas. The prospectus suggests, however, that Abu Dhabi's deficits - and the accompanying change in its fiscal philosophy - are taking at least a light toll on the emirate's past oil savings. After the Government overspent its budget by Dh126.5bn last year, some funds were channelled back to the Government, the prospectus said, as "the deficit was financed by transfers from ADIA and ADIC".

Spending on new developments, rising wages and imports were absorbing a greater proportion of revenues, said Rachel Ziemba, a senior analyst who covers sovereign wealth for Roubini Global Economics, a think tank based in the US. "Abu Dhabi and the UAE have, like many oil-exporting countries, gradually absorbed the increase in oil prices as domestic spending and investment picked up," she said. "With the dearth of private capital to the UAE since mid-2008, the Government has had to step in further to provide financing to a number of projects given the weak project finance environment."

Estimates for the Abu Dhabi Government's overall "break-even" oil price, the level above which government entities as a whole take in more revenues than they spend, differ widely. Ms Ziemba said it was likely to be more than $60 per barrel, while Fitch, the credit ratings agency, said it was $50 a barrel in a note last December. The Waha prospectus suggests the oil price necessary to balance the Government budget - though not necessarily the level required to achieve a balance of trade - could be higher.

Last year, about 69 per cent of the $45.95bn of oil export revenues reported in the prospectus went into the Government budget. Assuming Abu Dhabi exports the same amount of oil this year and contributes the same percentage of revenues to the Government, the price of oil would have to average above $100 per barrel to cancel out a projected deficit of Dh84.87bn. That deficit projection was made on the assumption of $60 per barrel oil.

Whatever the exact level, though, no one doubts that the break-even has been increasing substantially from estimates that ranged from $15 to $30 a barrel just three years ago. Last year, as export oil prices in Abu Dhabi fell 35 per cent to $63 a barrel and spending concurrently increased sharply due to large infrastructure commitments, a Dh16bn cash injection into banks and other expenditures, the Abu Dhabi Government spent a total of Dh251.7bn, exceeding the gross value of oil, gas and chemicals exports. It is impossible to tell from the prospectus if the Government and its investment entities as a whole took in more cash than they spent but it was doubtless the closest they have come in years to registering a real deficit.

"Government investment vehicles have received less capital as more has been spent on rising wages, new developments," Ms Ziemba said. "This means that Abu Dhabi funds have had less new capital across the board, particularly in 2009 when oil prices fell." The Government's balance sheet has begun to feel the effects of large capital investments such as the Dh26.5bn Khalifa Port and Industrial Zone and the Abu Dhabi International Airport expansion.

But deficit figures alone do not give the full picture of an emirate that still has huge reserves to draw on, said Thaddeus Malesa, a Gulf oil analyst based in Dubai for PFC Energy, the energy consultancy. "It's very opaque as far as what revenues are going to the state itself," he said. The deficit was a deliberate result of government policy, he said, that continues to prioritise payments to ADIA and other investment funds while pressuring government-owned companies to cut costs.

"You do not have an acute fiscal problem in Abu Dhabi - I think it's a fictitious deficit at the end of the day," he said. "They want [government-owned] companies to operate like private companies, they want these projects to be financed independently." PFC maintains its own measure of required oil revenues: an estimate of what oil price is needed to ensure the country runs a trade surplus, meaning it exports more than it imports.

Abu Dhabi needs an oil price of only $18 to break even under such a measure, Mr Malesa said. "Among OPEC producers, they are actually the most comfortable country," he said. "If you want to look at tipping points about when things might change in these OPEC producers … it's really much better to look at this measure." The Government, however, does see continuing deficits as a problem, as evidenced by recent announcements that it would look at ways to modify parts of its 2030 development plan and create a new office within the Department of Finance to monitor the emirate's debt levels.

"As a result of the global financial crisis and its impact on Abu Dhabi's economy in 2009, a reassessment of certain goals set out in the 2030 Economic Vision, including in particular the planned GDP growth and the population assumptions underlying the 2030 Economic Vision, is being undertaken," the prospectus said. Higher revenues are also within sight: if Abu Dhabi decided to pump oil at full capacity, instead of a current rate held down by OPEC quotas, production would increase by 410,000 barrels per day (bpd), worth Dh41.5bn annually at current prices.

Of course, a sudden output increase would itself drive down oil prices. OPEC countries will meet to consider a gradual roll-back of quotas in October. Abu Dhabi is unlikely to change its moderate stance in OPEC that member states should take account of both their own fiscal needs and the health of the world economy when deciding on production volumes, said Dalton Garis, an assistant professor of economics at the Petroleum Institute in Abu Dhabi.

Abu Dhabi had too much political capital at stake to risk antagonising western allies and other major oil importers such as China, he said. "I don't think in public they're going to be hawks," he said. "I think they're going to work assiduously to maintain their relative anonymity, as has become absolutely characteristic of the UAE." In the longer-term, Abu Dhabi has already signed a number of construction contracts that will begin to expand the emirate's oil production capacity, towards a goal of raising it to 3.5 million bpd by the end of the decade, from slightly under 2.8 million today.

The other option is to wait for higher oil prices, something predicted by many oil analysts within the next two years. Forecasts for next year by investment banks such as JPMorgan Chase and Nomura range from $90 to $100 a barrel. "Oil could be $110 by the end of 2011 or 2012," Mr Garis said, which would, at a stroke, put to rest Abu Dhabi's fiscal worries. @Email:[e-mail] @Email:[e-mail]