B&E | Energy Macroeconomics : Top 5 Factors To Watch Out For in 2016

B&E | Energy Macroeconomics : Top 5 Factors To Watch Out For in 2016

By Dyala Sabbagh
Partner at The Gulf Intelligence

B&E | Energy Macroeconomics : Top 5 Factors To Watch Out For in 2016

A myriad of macroeconomic factors are colliding this year to create a string of uncertainties that have worried energy producers around the world. It is still unclear how Beijing plans to manage China’s first major economic wobble in nearly three decades, subsidy cuts in Gulf countries that have long enjoyed oil wealth are still underway and the US has raised interest rates for the first time in a decade.

Plus, the Saudi Arabian riyal fell to a record low against the US dollar in the one-year forwards market in mid-January and state-owned Saudi Aramco, the world’s largest oil producer, said it is eying an initial public offering (IPO) this year. Questions abound over whether region’s economic Goliath is falling. Europe is still posting minimal economic growth and the majority of the BRICS economies (Brazil, Russia, India, China and South Africa) are struggling to find their fiscal feet.

All of these macroeconomic factors feed into what underpins the character of the global economy - confidence. The bearish sentiment means many investors that have typically rushed to funnel cash into oil and gas projects are now tentative, including those in the Middle East. Tightened budgets is one of the reasons behind Royal Dutch Shell’s decision to withdraw from a $10bn development of the Bab sour gas reserves with Abu Dhabi National Oil Company (ADNOC), while Total is reducing its global workforce by 4,000 and the UAE’s Sharjah-based Dana Gas is cutting its headquarter workforce by 40%.

Perhaps confidence in the macroeconomic outlook will improve as the year progresses if China’s economy stabilizes, the US’ plans to increase interest rates becomes clearer and the subsidy cuts in the Gulf help boost coffers.  

China’s Fiscal Transformation 

The treasury of the world’s largest economy faces a challenging year and energy producers are not immune, but China’s outlook is not as bleak as global headlines suggest. The devaluation of China’s currency, the yuan, last August fueled fears that China’s debt-driven burst onto the global stage over the last decade could crumble and take the bulk of Asia’s energy demand down with it. But the Chinese economy is still expected to grow by around 7% in 2016 – albeit the slowest full-year growth since 1990 – and Beijing’s double-freeze on China’s small stock market in early January primarily affected sentiment, rather than actual business.

Beijing’s plans to start switching to more sophisticated market reforms in 2016 could lead to a safer and consumer-based economy – clarity that will benefit economies worldwide. Energy producers in the Middle East are expected to benefit from China’s historical trade links that has endured for over two millennia, as Beijing ramps up its One Road, One Belt programme along the new Silk Road. Trade between the UAE and China is already growing at 16% annually and China is now the UAE's second largest trade partner – volumes stood at $54.8bn in 2014. Beijing’s aversion to wade into regional politics will continue to charm trade partners like Oman, the UAE and Iraq and the historic Sino-Iran trade accord will regain momentum following the lifting of sanctions on Iran in January.

Saudi Arabia Enters Uncharted Territory

Saudi Arabia is entering uncharted territory – budget deficits, subsidy cuts and initial public offerings are not terms usually associated with the Kingdom. Saudi Arabia’s oil-centered economy, where petroleum accounts for 80% of its revenues, will spend less this year, rapidly trying to balance the weight of lower oil prices and the escalating costs of the Saudi-led coalition’s first year of operations in the Yemeni war. Financial pressures mean the Kingdom’s initial subsidy cuts, which saw petrol prices rise by up to 50% in late-2015, could be deepened this year. So far, Saudi Arabia’s forecast budget deficit of 326bn ($87bn) riyals equates to 16% of GDP.

The possibility of an IPO of state-owned oil giant Saudi Aramco is to many an indication of how the cash-strapped Kingdom is looking to raise finances. Some energy professionals counter that Riyadh’s vast foreign exchange reserves will protect the treasury from the worst of the low oil prices this year, saying that Saudi Aramco’s move reflects the country’s confidence and effort to introduce market reforms. A third explanation is that the tentative IPO illustrates Riyadh’s attempt to ring fence its market share by inviting international partners into the fold, especially at a time when sanctions are lifted on Iran, the Kingdom’s main competitor in the region.

US Interest Rates

The much-anticipated increase in US interest rates – the first rise in a decade – will have far reaching consequences in 2016, raising borrowing costs for both corporates and consumers at a time when low oil prices are triggering budget deficits. Another hike to interest rates is expected in March, so companies at home and abroad that have not already factored in the change need to adjust quickly to the US’ new fiscal landscape. Emerging market currencies are expected to move as they absorb the shock, especially in emerging economies like Turkey, Malaysia and Brazil. But the Philippines, India and Korea are likely to remain stable.

The low oil price combined with rising interest rates marks the final straw for small and medium US shale oil as many look to declare bankruptcy, curbing both shale production and new infrastructure projects until oil prices climb above $50/bl again. The US has 5,000 drilled and unused wells that could bring another 4mn b/d of new supply to the market at 100-200 b/d each – a welcome fiscal boost if oil prices recover later this year.

Africa’s Middle Class Emerges

With many energy hubs in the Middle East and North Africa beset by political strife, Gulf and Asian investors are eyeing the largely stable democracies in the East African Community (EAC). Tanzania, Kenya and Uganda are spearheading East Africa’s economic prowess; growth forecasts for the region are 5.6% and 6.7% for 2015 and 2016, respectively. Middle class households in eleven sub-Saharan African countries - including Tanzania, Kenya and Uganda - are expected to more than double from 15m people to over 40m by 2030, according to Standard Bank’s research. The subsequent economic growth and appetite for oil products from the continent’s own reserves, Gulf and Asian suppliers, is vast.

The East African Community (EAC) hopes to invest around $1.5bn to build 1,454km of intraregional and domestic pipelines over the next few years. The longest pipeline will be the 784km route through Kenya – Uganda – Rwanda, which should significantly bolster fuel trade between the three countries. Tanzania, Kenya and Uganda are amongst several East African countries addressing wobbly regulatory frameworks by establishing bidding rounds – a more transparent way to allocate resources. Tanzania hopes to use its 55tcf of natural gas reserves to become a liquefied natural gas (LNG) exporter by 2025, while Tullow and Canada’s Africa Oil have identified 600m bls of oil reserves in Kenya’s South Lokichar basin.

Geopolitics

Economics and geopolitics are permanent bedfellows and the year ahead sees major changes in both. The political turmoil in the Middle East is unlikely to improve in the short-term, with souring relations between Saudi Arabia and Iran adding a fresh dose of uncertainty to a backdrop of war in Syria, Iraq and Yemen. Wars are costly and the Yemen war in particular is weighing down Saudi Arabia’s economy as it spearheads a coalition into a second year of air-strikes and fighting against the Houthis in Yemen.

Saudi Arabia’s attention is also firmly fixed on Iran’s economy, which has been honed by nearly a decade of sanctions. The country's inflation rate has dropped from around 45% in 2013 to 10% in 2015 and while Iran lacks the economic might of Riyadh, it is highly ambitious and has already built a network of relationships for potential energy supply contracts that stretch into Europe, the Gulf and Asia. And outside of the Gulf, geopolitics are putting a strain on Europe’s economy as an influx of refugees squeeze budgets, especially in countries that are also grappling with rising unemployment. 

About The Author:

Dyala Sabbagh
Dyala Sabbagh is a founding partner of Gulf Intelligence. Formerly Mideast Bureau Chief for Dow Jones Newswires and an international broadcast journalist who has presented the BBC and CNBC signature Middle East business programs. 

She is a much sought after Moderator and Master of Ceremonies for government, corporate and charity events across the region, that have included special guests U.S. President Bill Clinton, Queen Rania of Jordan and Sir Bob Geldof. During her print and broadcast career, Dyala has interviewed a cross-section of business and political leaders. 

Dyala started her career in banking with CSFB, and moved onto media. She has a BSc. in Economics and History from the University of London and an MA in Arab Studies from the School of Foreign Service, Georgetown University, Washington D.C.

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