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The Middle East – Oil or Nothing?

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The Middle East region has polarised global investor appetite over the past decade. The surfacing of The United Arab Emirates (UAE), Turkey, Israel and Saudi Arabia in particular, as key pillars for Emerging Market investors since the Global Financial Crisis (GFC) of 2008 and their own impact on the wider world, has significantly attracted more investment focus on the region. Whilst the important industry trend towards more transparent corporate governance and more environmentally and sustainable (ESG) investing globally has put a sharp spotlight onto the region. Oil, within the core Middle East, remains the pivotal commodity and financial instrument that defines the region, and its price fluctuations are critical to the US dollar-based pricing of energy, renewable or otherwise, globally and the economic strength of the major countries within the region.  

Geographically, the Middle East is a region that is located in Western Asia and extends into Eqypt. There are a total of seventeen countries that make up the Middle East, which has a history that dates back to the Middle Ages and is the birthplace of many significant religions still practised today. The Middle East is made up of a vast number of ethnic groups, and as of 2017, the region had an estimated population of over 411 million. The economy of the Middle East is very hard to pinpoint, as there are some countries that are very wealthy, while others are very poor. Saudi Arabia, one of the richest countries, is just one of the countries in the Middle East that relies heavily on the export of oil and oil-related products to maintain its economy. Other areas of the Middle East, such as Turkey and Israel, have a much more diverse economy that includes textiles, tourism, agriculture, cotton, technology and banking.

The ICAEW (Institute of Chartered Accountants for England and Wales) recently published an economic update for the Middle East. 2019, they argue, is seeing the slowest economic growth for the region since the Global Financial Crisis of 2008. Tough US sanctions, a maximum pressure policy against Iran and steep oil production cuts will see the Middle Eastern economy slowing to a more-than-a-decade-long low this year at only 0.1%, down from an estimated 1.4% last year. This slowdown is largely driven by the outsized impact of two of the largest economies in the region, Saudi and Iran when focusing on headline GDP growth. Iran has suffered from deteriorating economic conditions amid the White House’s policy of maximum pressure, with GDP contracting by 7% in 2019. Saudi, on the other hand, is expected to see very limited growth this year at only 0.5%, reflecting renewed oil production cuts by OPEC, which the Kingdom has spearheaded in order to stabilise international oil prices. This has led to a 3.6% contraction in oil production in the Middle East. Specifically, oil production in Saudi Arabia averaged 10.06m b/d in Q1 and 9.78m b/d in Q2 2019, notably below the average of 10.3m b/d in 2018. With the extension of the OPEC supply cuts expected well into Q1 2020, oil production is unlikely to recover meaningfully in the second half of this year. As such, we expect the oil sector to contract by 1.8% in 2019, well below the growth rate of 2.9% registered in 2018. On a more positive note, the PMI surveys of Saudi Arabia, and the UAE, are signalling a recovery in the non-oil private sector.

A key upcoming event in the region will be the long-awaited initial public offering (IPO) of Saudi Aramco that is expected be the biggest equity offering on record, whilst key details are only now being revealed, such as the number of shares on offer, the price range or even an indicative date for the listing. People familiar with the process had said the Kingdom would seek to sell 1 to 3 per cent of the company in total, raising USD20bn-USD60bn, depending on the yet to be agreed price, although a more likely initial USD25bn raise is now expected. Watchers of the IPO say Prince Mohammed has lowered his slights on valuation, with forecasters expecting the company is to be valued between USD1.5trn to USD1.7tn. This valuation is higher than many foreign institutions may be willing to pay, according to the Financial Times. In the company prospectus, published on 6th November, the book-building process will be taking place between 17th November and 4th December. The final price for the IPO is expected to be announced a day later on 5th December. Saudi Aramco has already attempted to make a series of moves to attract income investors — from changing royalty payments and tax rates to announcing a huge minimum dividend of USD75bn a year. The deal itself may go some way to understanding better the underlying investor demand for Saudi assets and oil-related asset demand. All indications are that existing global oil stocks will be trimmed to make room for a more diversified portfolio exposed to the commodity and that the expected dividend payout will be difficult to ignore for some investors. There will though be a large number of global investors who will not take part in the Saudi Aramco IPO because of their specific mandate requirements towards environmental and sustainable investing. Saudi Aramco has attempted in-depth to address the concerns over climate change that would, of course, over time, likely lead to a reduction in global demand for hydrocarbons. Research that has been commissioned by the company forecasts that oil demand will peak from 2035. Even so, the Kingdom of Saudi Arabia has long maintained it will be the last oil producer standing because of its very low costs on a comparative global stage. In essence, all the expectations are that this will be a successful offering that will undoubtedly raise interest in the region and specifically Saudi Arabia, although a significant part of the equity raise may go to local investors.

An interesting related discussion will be around what might the impact be on the underlying oil price. In the past few years, Saudi Arabia within OPEC has been following a policy of adjusting the supply of oil globally in an effort to support the price. This has been met with some success, albeit offset by a growing supply of oil from the United States through shale light to deliver a long-term balancing of supply with demand domestically. However, on 14th November, in a key monthly oil report, the Organisation of the Petroleum Exporting Countries (OPEC) lowered its oil production growth forecast for non-cartel countries for 2020. Citing a downward adjustment to its forecast for the US OPEC expects the United States Shale boom to continue full steam ahead and is projecting that light shale oil output alone will balloon to 17.5 million barrels per day by 2030. As a comparison, total oil production averaged more than 100 million barrels per day (b/d) in 2018. Saudi Arabia, Iran, Iraq and Kuwait contribute around 30 million barrels per day and the United States in aggregate, for all types of oil, contributes over 18 million barrels per day. The OPEC report also expects slightly lowered global demand for oil in 2020. In fact, OPEC sees oil demand coming in at just 32.8 million barrels per day by 2024. Longer-term than this, OPEC is projecting demand growth of 12 million barrels per day over the next two decades.

The oil price itself has risen over 25% in 2019, as measured by WTI, following a sharp fall at the end of 2018, and rose again more recently on the latest OPEC forecasts, despite the weaker demand outlook. The interesting side outcome of listing Saudi Aramco will be around oil supply and the expectation by investors that the corporate will act like other quoted oil giants. To date, Saudi Aramco’s production and investments have been clearly linked to the economic progress of Saudi Arabia and the geopolitical stakeholders it represents and thus has been a key player in the OPEC supply agenda. A listed Saudi Aramco could be expected to break with this strategy. New shareholders in this global leading oil company will not be expecting Aramco’s production volumes to be determined by the OPEC members. If it does not comply with the oil cartel’s wishes, then it can only weaken OPEC’s impact on the oil price going forward. Some independent analysts are concluding from this a lower sustainable oil price through a cycle in the future, as OPEC’s impact on adjusting global supply lessens. Saudi officials are denying that OPEC is being threatened. However, for the time being, it is important to recognise that the sheer size and importance of a successful Saudi Aramco IPO is driving in financial terms. As well as a stronger de-monopolising theme in the Middle East, a more open Saudi Arabia, and a lack of further skirmishes in the region, beyond Yemen, that seems to be in its final stages. At the same time, the anti-Qatar Arab coalition (Saudi Arabia, Bahrain, UAE and Egypt) is openly discussing the willingness to remove some of the current sanctions imposed upon Qatar. In the background as well, a further risk to the oil price would be the lifting of some sanctions on Iran. Reuters recently reported that Iranian oil exports have dropped to just 100,000 barrels per day. This output could recover to 2.5 million barrels a day on a thawing in the war of words between Washington and Tehran, adding further supply onto the global market. All indications are that the oil price may struggle to move higher in 2020, notwithstanding an unexpected geopolitical event in the region.

It is worth spending some time when discussing the Middle East, on Turkey. According to OECD data, Turkey has of late delivered a slower growth rate of 1.1%, touching recession this year, within a growing population of 81 million people, indicating a GDP per capita of USD10,500 and a long term conservative projected growth rate of 1.6%. Unlike most of the Middle East, it is dependent on the import of oil, so the oil price in dollar terms has a large external impact on inflation expectations for the country. In terms of the economic makeup of Turkey, Services (especially finance and tourism) contributes 64%, Industry 28% (mainly public sector) and Agriculture around 8% of GDP (and over 20% of the workforce). Turkey’s economy has shown resilience more recently, in large part because of solid public finances, well-capitalised and well-regulated banking sector and a diverse private business sector. In the latest Focus Economic Report, it noted that the economic downturn, driven by the ongoing spectre of sanctions and geopolitical risk, had eased somewhat in the third quarter this year. In November, industrial production returned to growth for the first time in 13 months, with output expanding 3.4% year-on-year in September, following a 3.6% contraction recorded in August. Inflation is cooling as well, driven by a supportive base effect, and has enabled a looser monetary policy in Turkey. Analysts are now predicting a recovery in the economy in 2020, with the Focus Economics consensus forecast expecting Turkey to expand by 2.4% next year, and 3.2% in 2021. At the end of September, the Turkish Government published a new economic programme for 2020-22 with an ambitious growth target of 5% for the period. Private consumption and investment domestically are expected to be the key drivers of economic growth, but some observers are suggesting that this growth forecast will come at the expense of wider imbalances due to the need to attract large sums of foreign capital and a requirement to keep a loose fiscal policy. Throughout this period, even if the government forecasts are to be achieved, then it is likely that the Turkish lira will remain volatile.

Overall, with bolder and deeper economic reforms in the Middle East, the outlook for the region is one of an improving trajectory. However, it needs to be. Projected GDP growth of less than 1% in 2019 is a fraction of what is needed to create enough job opportunities for the fast-growing young, working-age population. Even in those few countries that are enjoying higher growth, poverty has failed to decline, indicating a need for further reforms to introduce fair competition and promote domestic growth. It is also time for the Middle East to focus on doing more to de-monopolise their markets and, in turn, attract more external foreign investment. The long-term aim has to be to diversify and promote domestic demand of their collective economies to achieve sustainable export-led growth regionally and internationally.


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