Steep fall in oil a threat to Gulf state spending

Financial Fallout: Falling oil prices could play havoc with government spending plans in the Gulf, but economists say the commodity still has room to fall before cutbacks loom.

A view of the construction on oil drilling pads north-west of Dhahran, Saudi Arabia. Oil prices are dropping rapidly on fears of a recession.

Falling oil prices and rising fears of another global downturn could put pressure on government spending plans in the Gulf.

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Regional governments have poured billions of dollars into everything from new schools to better roads and job creation schemes made possible by an unexpected two-year boom in oil markets.

Earlier this year, Saudi Arabia unveiled US$155 billion (Dh569.34bn) of spending on schools, hospitals and other social infrastructure in the next decade.

With oil prices dropping at a rapid pace on recession fears, however, concern is rising that current spending levels may become unsustainable.

"The prices could very easily go into free fall," said Jason Schenker, the president of Prestige Economics in Austin, Texas. "You could be back down to the lows we saw in the last cycle [when prices hit around $36 per barrel]."

"A lot of oil producers are going to feel a lot of pain," he said.

The US benchmark oil price, known as WTI, dropped yesterday to an eight-month low of about $82 per barrel. Prices have dropped by about 16 per cent in less than three weeks following weak economic data from the US, the world's biggest consumer of oil.

The downgrading of the US's credit rating by Standard & Poor's over the weekend, coupled with sovereign debt problems in Europe, have only intensified pressure on global commodity markets.

Stock markets have also fallen as gold prices reached record highs. The US Dow Jones Industrial Average opened down by almost 3 per cent yesterday, its first day of trading since the downgrade.

Merrill Lynch, the US investment bank, fanned the flames of worry about oil prices in a note yesterday saying WTI crude could tumble in price if confidence continues to flag and the world lurches back into recession.

"We believe that WTI crude oil prices could briefly drop to $50 under a recession scenario," the bank said, although it did not change forecasts that put prices next year at an average of $102 per barrel.

An extended fall in oil prices could leave Gulf countries dangerously close to so-called "break-even" levels. The break-even is the price above which analysts estimate oil producers will run government budget surpluses. Below the break-even, governments would theoretically be in deficit and have to cut spending, borrow money or raise revenues from other sources to fill the gap.

For the UAE, the break-even is at $84 per barrel of Brent crude, a grade of oil that now trades at about $106 per barrel, according to International Institute of Finance estimates in May. Saudi Arabia's break-even is above $80 per barrel, the estimates say. Kuwait and Qatar are thought to have lower break-even prices, at between $40 and $50 per barrel.

Any falls below these levels could force governments to scale back development plans or borrow money from international investors to keep them going. But Paul Gamble, an economist at Jadwa Investment Company in Saudi Arabia, said even despite recent price declines, Gulf oil producers still had a comfortable cushion before break-evens were breached.

"It would take quite a big decline in oil prices to have a serious impact on government spending and economic growth," he said, noting Brent crude prices had already averaged above $110 per barrel this year. To bring the annual average this year below Saudi Arabia's break-even price, they would have to almost halve and stay there for the rest of the year, he said.

"It's not a concern as things stand, but it's a risk," he said.

As oil prices fall and global markets tumble, consumers and average investors are also feeling the pain. But financial planners are advising clients to stay calm and wait out the turmoil.

"When markets go down quickly, they go up quickly," said Alwyn Owens, an independent financial adviser in Dubai. "For investors who are in [the markets], this is the nature of markets, and this is just how it works. Things will calm down."