Why betting on oil prices is a tricky game

Ever since oil prices plunged in mid-2014, the Gulf Cooperation Council (GCC) economies have been going through some tough challenges. The economic impact of the oil price crash was catastrophic. Since 2015, budget deficits have ballooned to more than $380 billion in the six-nation GCC.

Public debt rose to 33 percent of GDP compared to 13 percent a decade ago, according to the IMF calculations. Foreign exchange reserve losses exceeded $270 billion between 2015 and 2017. Meanwhile, according to data from MEED, projects awarded in the construction sector fell to $97 billion in 2018, the lowest figure recorded in 14 years.

The negative impact of the oil plunge on GCC countries was amplified by a stronger US dollar. Since mid-2014 the US Dollar Index has gained more than 20 percent. It reached a peak of 103.82 in January 2016 and is currently trading near 97. The strength in the US dollar led to a fall in FDIs, real estate transactions and tourism revenues.

Such an economic environment requires expansionary fiscal and monetary policies to encourage businesses borrowing and stimulate investments, which eventually promote economic growth. However, given the peg in GCC currencies except for the Kuwaiti dinar, central banks need to follow the Federal Reserve’s path, which has increased interest rates nine times since December 2015.

For oil prices to return above $100 a barrel, a miracle needs to happen. The Shale revolution helped the US produce a record 12 million barrels a day by the end of 2018, becoming the world’s largest oil producer. Although production growth is expected to slow down, we may continue seeing an addition of approximately one million barrels a day in the several years to come.

The global economic slowdown may also lead to a downgrade in expected demand throughout 2019. While the OPEC and friends have done a great job in attempting to balance the market, the new norm is now seen to be $60 - $70 price tag for a barrel of oil.

Governments in the GCC need to not bet on oil prices, but instead continue with their reform agenda, accelerate diversification planning and branch out to other sectors to become less reliant on oil. The inclusion of GCC bonds in the JP Morgan EMBI Index means that demand will remain high for GCC debt. This will continue to support lending at relatively low rates and support further investments in diversifying the economy.

Hussein Sayed is the Chief Market Strategist at FXTM