Rising oil prices dampen global growth

In its latest World Economic Outlook the International Monetary Fund (IMF) has warned of the continued downside risks to global growth from trade tensions, shocks to the European economy, the slowdown in China and high debt. It lowered its forecast for global growth this year to 3.3 percent from 3.5 percent in January, which was already lower than the projections the Fund made in October. However, these projections could be in for a tailspin if oil prices continue to maintain their present upward trajectory.

If it materializes, the trade tensions between the United States and the European Union (EU), could hamper global growth. The US-EU trade tiff escalated in early April with the EU preparing retaliatory tariffs against the US over subsidies to aircraft manufacturer Boeing Company. This came immediately after President Trump threatened to impose tariffs on $11 billion of EU products in response to unfair subsidies to European plane maker Airbus.

The IMF pointed out that prospects of fresh US-EU tariffs, even as US-China trade tussle continues to simmer, underlines the ongoing risk to the global economy from trade tensions between major economies or blocs. The US and China have imposed reciprocal tariffs to the tune of $360 billion on each other’s goods over the past nine months.

However, the threat posed to global growth from trade tussles and geopolitical skirmishes are exacerbated by recent surge in oil prices and the potential for it to rise even higher. Oil prices are poised to increase in the coming weeks, as the US tightens sanctions  in an attempt to choke Iranian oil out of the global market. Last week the US administration announced that it would not renew the waivers that had allowed eight countries to continue buying Iranian oil.

The waivers, which are set to end on 2 May, could see Iranian oil exports sinking to near zero as customers seek other sources to buy oil. The Organization of Petroleum Exporting Countries (OPEC) has said it would ensure the market had adequate supplies of oil in the wake of sanctions drying out Iranian oil supplies. But OPEC has also mandated a production-cut among its members to deplete market surpluses and raise prices. The pact, signed in December by the OPEC and its non-OPEC allies, including Russia, limits their oil output by 1.2 million barrels per day.  According to the Joint Ministerial Monitoring Committee set up to ensure conformation of the pact, there was 106 percent compliance to the production cut in February, and accordingly, the March output by OPEC fell by 534,000 barrels per day to 30 million barrels per day.

The OPEC mandated production cuts have cut into global supplies that were already constrained by fall in output from other major oil producers such as Venezuela, Libya and Nigeria. The US imposed sanctions on Venezuela and the government’s energy company PDVSA, has severely limited shipments from the oil-rich nation.

Oil production in Venezuela has dipped to such an extent that the country with the world’s largest reserves is preparing to import crude for the first time in five years. The nation’s output fell below 1 million barrels a day to a 16-year low in March, amid rolling power blackouts and US sanctions. In Libya, recent production increases have been threatened as the country grapples with the growing possibility of a civil war. Meanwhile, in Nigeria, production and export difficulties have seen the country’s output tumble.

In the OPEC grouping, Saudi Arabia, Kuwait and the UAE are the three countries most capable of ramping production to the volume needed to stabilize the market, but all three are also committed to maintaining the OPEC mandated production cuts. Moreover, Saudi Arabia, which has been shouldering the brunt of  production cuts so far, has seen its crude oil exports fall by 277,000 barrels to just under 7 million barrels per day in February from the month before. The kingdom is currently sitting on just over a million barrels of spare capacity. Production cuts have also had an impact on Kuwait where oil production hit a nine-month low of 2.71 million barrels per day in February.

Tightening supplies and receding worries of a slowdown in China, where the economy grew by a steady 6.4 percent in the first quarter, have boosted demand and pushed oil prices to five month highs. Brent crude was trading at $74.25 on Thursday, 25 April, up 0.56 percent from their last close and notching a rise of almost 40 percent from the prices prevailing at the start of the year.

How the market reacts when the waivers on Iranian oil expires on 2 May will be an important bellwether for how oil moves in the days ahead. But Saudi Arabian Energy Minister Khalid Al-Falih said he sees no need for immediate action, while the International Energy Agency said “comfortable” levels of spare capacity remain. The market is obviously trying to find its footing and make sense of the heightened geopolitical uncertainty; what OPEC is going to do is likely to be the main driver of crude oil prices over the next few months.

How oil prices fare  is critical to the economies of the six-nation Gulf Cooperation Council (GCC) bloc. Despite strong desire, attempts to diversify the economy in most Gulf Cooperation Council(GCC) states has been a mixed bag, with some states implementing resolute measures and others making tepid moves at best. Although the GCC states are eager to diversify their dependence on income from hydrocarbon resources, oil continues to play a dominant role, constituting up to 46 percent of total GDP of the six-nation bloc. As such, the decision by OPEC-plus countries to cut oil production at a time of global demand will limit the oil sector’s contribution to overall growth in 2019.

It is hoped that the non-oil sector in the GCC, forecast to grow by 3.1 percent, will take up the slack and become the primary engine of growth in 2019. It bears pointing out that though technically it is labeled as ‘non-oil’, the sector is dependent on government spending which in turn is linked to oil revenues. Fortunately, government encouragement for the non-oil sector in the region is expected to get a boost in the coming years through various stimulus plans aimed at supporting the private sector.

Aiming to diversify the economy from its inordinate dependence on the oil sector and hydrocarbon income resources, GCC governments are increasingly investing in infrastructure and construction projects, many of which involve partnerships with the private sector. In Saudi Arabia, ongoing reforms as part of the country’s Vision 2030 are spearheading major projects, while in the UAE and Qatar mega constructions are taking place in the lead up to the World Expo 2020 in Dubai and the 2022 FIFA World Cup Football in Qatar.

The relative instability of oil prices that careen in response to international market vagaries highlight the importance of developing a robust non-oil sector based on fiscal and structural reforms, so that the economy is less reliant on the government’s oil income. In the meantime, let us be thankful that GCC governments are still playing a dominant role in stimulating economic growth.

 – Staff Report