Dubai: Recent increase in oil prices to $70 a barrel from $52 at the end of 2020 will reduce the borrowing needs of GCC states in the immediate future. However, credit vulnerabilities will continue to persist, according to rating agency Moody’s.
“Oil prices are now around $20 above our average assumption for 2021. If sustained during the rest of the year, higher oil prices will reduce the immediate government borrowing and external financing needs of GCC sovereigns, most significantly for Kuwait, Oman and Qatar,” said Alexander Perjessy, VP- Senior Analyst at Moody’s.
Higher oil prices will increase the resources available to advance economic-diversification projects. However, the rating agency has sounded caution on the duration and durability of the current rally.
Output driven rally
According to Moody’s, amidst the uncertain nature of the recent oil price increase there is a risk that the higher than budgeted oil prices will prompt governments to relax their fiscal consolidation efforts planned for the year and increase spending in areas that may be difficult to reverse when oil prices are lower like social spending and wages.
Despite still weak global oil demand, crude oil prices have risen in anticipation of a strong economic recovery in 2021 on the back of the global vaccination drive and large government stimulus packages, especially in the US.
The oil price rally has also been supported by the greater than expected production restraint from the members of the Organization of Petroleum Exporting Countries (OPEC), especially Saudi Arabia. In February, OPEC as a whole produced 15 per cent fewer barrels of crude oil per day than it produced on average during 2019.
Relief to fiscal situation
While Moody’s expects a spike in government revenues from higher oil prices, it comes with the risk of governments relaxing the fiscal consolidation efforts.
The rating agency estimates that sovereigns with the lowest budgetary break-evens [minimum oil price required to balance the budgets] higher oil prices could even result in fiscal surpluses and help to reverse some of the large debt increases during 2020, provided the additional revenue is not used to fund higher than budgeted spending.
“We estimate that a $20/barrel increase in the average oil price could improve GCC fiscal revenues (and government balances) by around 5-10 per cent of GDP relative to our current forecasts. Due to their large size of the oil and gas sector relative to the overall GDP, the effects would be most pronounced for Qatar, Kuwait and Oman,” said Thaddeus Best, an analyst at Moody’s.
Risk of spending spike
Moody’s is skeptical on the strength of the current oil rally.
“We do not expect the current oil price rally to be sustained. While oil prices will be volatile, occasionally breaching our medium-term $45-$65/barrel range, we expect prices to move to the middle of that range over time,” said Perjessy.
The rating agency sees a risk that higher oil prices will exacerbate underlying credit weaknesses if the GCC governments take advantage of higher than budgeted oil revenues to increase spending in order to support domestic economic recoveries.
S&P expects oil prices to moderate over longer term. This along with the government net debt and net external debt, and relatively limited fiscal and economic reform momentum constrain any immediate positive rating revisions.
“It should be noted that we differentiate between structural and cyclical changes in oil prices. We lowered most of the ratings on sovereign hydrocarbon exporters since the structural change in the oil market beginning in the second half of 2014,” said Trevor Cullinan, an analyst at S&P.
“Since our ratings already factor in our view of such structural changes, we do not expect cyclical price changes to significantly affect our ratings.”
Many hydrocarbon exporters have experienced a deterioration in their fiscal and external balance sheets as lower oil prices resulted in sustained and sizable fiscal and external borrowing needs. These have been met either by debt accumulation or asset draw-downs.
“Even if fiscal and external deficits of hydrocarbon exporters improve in the near term on the back of higher oil prices, it would likely take longer for their stock positions to be strengthened back to pre-2015 levels,” said Cullinan.