Reuters

Peg Mackey Dubai, May 1, 2003

Oil windfall no panacea for Gulf Arab economies

Stronger crude prices may build up Gulf states' petrodollar coffers, but producers should not see this as a panacea and should press ahead with reforming their oil-based economies, analysts said on Wednesday.

An unexpected windfall may delay urgently needed economic reforms in the region, which straddles half of the world's oil reserves, they said. Any potential negative effects would be most acutely felt in Saudi Arabia, the world's largest oil exporter.

"Saudi Arabia clearly is a low-cost producer, but a very high-needs producer," said Brad Bourland, chief economist at Saudi American Bank. "The kingdom's revenue needs are much higher than the market supports -- even at today's prices."

The bulk of Saudi Arabia's revenues are consumed by spending on fixed and expanding budgetary items, such as government salaries and subsidies for a young and growing population.

"Now they need about $20-$21 a barrel to break even," said a senior Bahrain-based banker.

"Although their production costs are low, the recurring costs and operational costs for the economy are so high they are eating up those revenues and not providing much left over for other things.

At some point, the amount of oil income generated even at high prices will be unable to keep pace with the economy's needs, the banker said. Governments must find other ways to stimulate growth -- preferably via a diversified private sector that can take over as the economic driver.

To mobilise the private sector, Saudi Arabia must lessen its dependence on petrodollars and pursue its ambitious liberalisation package rolled out by de fact ruler Crown Prince Abdullah after the 1998 oil price crash, analysts said. Analysts said Riyadh should, in particular, move to tax a high-growth private sector and work to promote it. But so far, the pace of reform -- urgently needed to help tackle chronic unemployment in the kingdom -- has been slow. "A lot of reforms are in the hopper -- such as the capital markets law and new tax measures -- but they haven't emerged in final form yet," said Bourland. The situation is much the same in neighbouring Kuwait. "I'm not sure Kuwait will continue its reform policy, and that mistake may be made through the Gulf," said leading Kuwaiti economist Jasem Saadoun. "When prices are high, we forget everything and repeat our mistakes."

Oil prices have recovered steadily after last year's fourth quarter slump, with OPEC's basket price just under $26 a barrel -- surpassing cartel power Saudi Arabia's target of $25.

Prices are expected to remain robust as the United States leads the world into economic recovery and threatens military action against major oil producer Iraq, traders say.

DUBAI SETS EXAMPLE Gulf Arabs might be better off following diversification plans such as those adopted by the Dubai emirate in the United Arab Emirates, whose oil output has shrunk to about 165,000 barrels per day (bpd) from 400,000 barrels bpd 10 years ago.

Bankers say Dubai has set an example by investing in alternative industries such as tourism and transport. It is also striving to become a regional banking and internet hub.

For non-Arab Iran, robust oil prices may act as a double-edged sword. The extra revenue would reinforce its oil stabilisation fund, but it also strengthens the hand of conservatives opposed to reforms aimed at fostering foreign investment.

Any revenue above Iran's current budgeted oil price of $19 per barrel rolls into the fund, created to protect the economy against oil price volatility. It now holds about $8 billion.

"The oil stabilisation fund encourages growth in the non-oil sector and allows for the completion of many unfinished development projects," said Siamak Namazi of Tehran-based Atieh Bahar Consulting.

"But when there is a petrodollar surplus, the anti-foreign investment lobby makes a stronger debate against foreign investment."

Their campaign was unlikely to meet success in the energy sector, which has lured billions of dollars in foreign funds, analysts said. But domestic Iranian companies are playing a bigger role by providing oil and gas equipment and services.

"Today Iran does not need money as much as it needs technology," said Namazi. "And cutting-edge technology comes through foreign investment."