The failure of Opec+ to agree on a production increase from August at its most recent meeting this month saw oil prices rise to their highest level in more than two years. Historically, higher oil prices have been welcomed by GCC oil producers as they have allowed governments to increase spending and drive economic growth in the region’s non-oil sectors while also boosting the assets of sovereign wealth funds, which have been invested for future generations.
While higher oil prices have already contributed to higher-than-expected government revenue in the GCC this year, Emirates NBD expects governments in the region to prioritise the reduction of deficits rather than increasing government spending.
Moreover, the benefit to regional budgets depends not only on the price of a barrel of oil but also on how much crude oil is being pumped and sold at that price.
Our analysis of regional budget break-even oil prices suggests that only the UAE would record a budget surplus with oil prices at $75 a barrel this year while Saudi Arabia’s budget would be close to balanced – a significant improvement on last year’s 11.2 per cent budget deficit but one that still offers limited scope to increase spending.
The deficits of other GCC countries are expected to narrow significantly from 2020 but would still require additional financing to meet their existing spending commitments.
Certainly, if Opec+ does not reach an agreement on increasing oil production in the coming weeks, oil prices could rise even further. While this would provide an additional boost to budget revenue, we do not expect this to translate into significantly higher spending in the region, particularly as most countries have committed to medium-term fiscal reforms to reduce their reliance on oil revenue and limit expenditure growth.
Consequently, we do not expect faster non-oil sector growth on the back of sharply higher government spending over the next couple of years.
Higher oil prices may delay some of the necessary fiscal reforms that need to be undertaken to put some of the GCC budgets on a more sustainable footing in the long term.
Moreover, if Opec+ does not agree to gradually increase oil production in the second half of this year, this will probably be negative for headline gross domestic product growth in 2021.
Even with a gradual increase in crude oil production in the second half of the year, oil sector output is expected to be lower than it was in 2020. If there is no increase in production from August, then the contraction in the oil sector of GCC oil-producing countries could be deeper than we currently expect.
The price of higher oil revenue for GCC countries is then slower GDP growth.
For the rest of the world too, there is a cost. Higher oil prices would feed through to higher inflation, which is already surging in many countries as service sectors reopen, supply chains remain disrupted and shipping costs rise.
[We] expect governments in the region to prioritise deficit reduction rather than increasing government spending
Khatija Haque
While the major central banks – the US Federal Reserve, the European Central Bank and the Bank of England – have indicated they will look through what they consider “transitory” inflation for now, some emerging market and European central banks have already responded to higher inflationary pressures by raising interest rates, which could slow economic growth in these markets even as they have yet to recover from the Covid-19 pandemic.
Emirates NBD’s base-case scenario is that Opec+ will come to an agreement that will allow for some increase in oil production from August. This should support oil prices in the current range of $70 to $75.
There are two alternatives that, in our view, have a lower probability. The first is that no agreement is reached and oil production remains unchanged in the coming months and the second is that individual Opec+ members increase production outside of a broad Opec+ agreement.
In the first no-increase scenario, oil prices could rise sharply from where they are now, boosting oil producers’ budget revenue but at the cost of regional and, potentially, global growth.
In the second scenario, where oil producers increase production outside an Opec+ agreement, oil prices could fall sharply from current levels. However, with demand recovering, we are unlikely to see a repeat of the April 2020 price collapse.
Oil prices could fall to between $55 and $65 a barrel in this scenario. Higher oil production would support regional GDP growth while lower oil prices would support global economic growth, even if budget deficits in the GCC would be slightly wider in this scenario than the others.
Khatija Haque is chief economist and head of research at Emirates NBD.
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How Tesla’s price correction has hit fund managers
Investing in disruptive technology can be a bumpy ride, as investors in Tesla were reminded on Friday, when its stock dropped 7.5 per cent in early trading to $575.
It recovered slightly but still ended the week 15 per cent lower and is down a third from its all-time high of $883 on January 26. The electric car maker’s market cap fell from $834 billion to about $567bn in that time, a drop of an astonishing $267bn, and a blow for those who bought Tesla stock late.
The collapse also hit fund managers that have gone big on Tesla, notably the UK-based Scottish Mortgage Investment Trust and Cathie Wood’s ARK Innovation ETF.
Tesla is the top holding in both funds, making up a hefty 10 per cent of total assets under management. Both funds have fallen by a quarter in the past month.
Matt Weller, global head of market research at GAIN Capital, recently warned that Tesla founder Elon Musk had “flown a bit too close to the sun”, after getting carried away by investing $1.5bn of the company’s money in Bitcoin.
He also predicted Tesla’s sales could struggle as traditional auto manufacturers ramp up electric car production, destroying its first mover advantage.
AJ Bell’s Russ Mould warns that many investors buy tech stocks when earnings forecasts are rising, almost regardless of valuation. “When it works, it really works. But when it goes wrong, elevated valuations leave little or no downside protection.”
A Tesla correction was probably baked in after last year’s astonishing share price surge, and many investors will see this as an opportunity to load up at a reduced price.
Dramatic swings are to be expected when investing in disruptive technology, as Ms Wood at ARK makes clear.
Every week, she sends subscribers a commentary listing “stocks in our strategies that have appreciated or dropped more than 15 per cent in a day” during the week.
Her latest commentary, issued on Friday, showed seven stocks displaying extreme volatility, led by ExOne, a leader in binder jetting 3D printing technology. It jumped 24 per cent, boosted by news that fellow 3D printing specialist Stratasys had beaten fourth-quarter revenues and earnings expectations, seen as good news for the sector.
By contrast, computational drug and material discovery company Schrödinger fell 27 per cent after quarterly and full-year results showed its core software sales and drug development pipeline slowing.
Despite that setback, Ms Wood remains positive, arguing that its “medicinal chemistry platform offers a powerful and unique view into chemical space”.
In her weekly video view, she remains bullish, stating that: “We are on the right side of change, and disruptive innovation is going to deliver exponential growth trajectories for many of our companies, in fact, most of them.”
Ms Wood remains committed to Tesla as she expects global electric car sales to compound at an average annual rate of 82 per cent for the next five years.
She said these are so “enormous that some people find them unbelievable”, and argues that this scepticism, especially among institutional investors, “festers” and creates a great opportunity for ARK.
Only you can decide whether you are a believer or a festering sceptic. If it’s the former, then buckle up.
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Mercer, the investment consulting arm of US services company Marsh & McLennan, expects its wealth division to at least double its assets under management (AUM) in the Middle East as wealth in the region continues to grow despite economic headwinds, a company official said.
Mercer Wealth, which globally has $160 billion in AUM, plans to boost its AUM in the region to $2-$3bn in the next 2-3 years from the present $1bn, said Yasir AbuShaban, a Dubai-based principal with Mercer Wealth.
“Within the next two to three years, we are looking at reaching $2 to $3 billion as a conservative estimate and we do see an opportunity to do so,” said Mr AbuShaban.
Mercer does not directly make investments, but allocates clients’ money they have discretion to, to professional asset managers. They also provide advice to clients.
“We have buying power. We can negotiate on their (client’s) behalf with asset managers to provide them lower fees than they otherwise would have to get on their own,” he added.
Mercer Wealth’s clients include sovereign wealth funds, family offices, and insurance companies among others.
From its office in Dubai, Mercer also looks after Africa, India and Turkey, where they also see opportunity for growth.
Wealth creation in Middle East and Africa (MEA) grew 8.5 per cent to $8.1 trillion last year from $7.5tn in 2015, higher than last year’s global average of 6 per cent and the second-highest growth in a region after Asia-Pacific which grew 9.9 per cent, according to consultancy Boston Consulting Group (BCG). In the region, where wealth grew just 1.9 per cent in 2015 compared with 2014, a pickup in oil prices has helped in wealth generation.
BCG is forecasting MEA wealth will rise to $12tn by 2021, growing at an annual average of 8 per cent.
Drivers of wealth generation in the region will be split evenly between new wealth creation and growth of performance of existing assets, according to BCG.
Another general trend in the region is clients’ looking for a comprehensive approach to investing, according to Mr AbuShaban.
“Institutional investors or some of the families are seeing a slowdown in the available capital they have to invest and in that sense they are looking at optimizing the way they manage their portfolios and making sure they are not investing haphazardly and different parts of their investment are working together,” said Mr AbuShaban.
Some clients also have a higher appetite for risk, given the low interest-rate environment that does not provide enough yield for some institutional investors. These clients are keen to invest in illiquid assets, such as private equity and infrastructure.
“What we have seen is a desire for higher returns in what has been a low-return environment specifically in various fixed income or bonds,” he said.
“In this environment, we have seen a de facto increase in the risk that clients are taking in things like illiquid investments, private equity investments, infrastructure and private debt, those kind of investments were higher illiquidity results in incrementally higher returns.”
The Abu Dhabi Investment Authority, one of the largest sovereign wealth funds, said in its 2016 report that has gradually increased its exposure in direct private equity and private credit transactions, mainly in Asian markets and especially in China and India. The authority’s private equity department focused on structured equities owing to “their defensive characteristics.”
