Oil and beyond – the Gulf economies’ path to new horizons

Key takeaways:

• Growth in the Gulf economies will stall in 2023, with a modest rebound in 2024. We maintain our positive outlook on the region due to stable solvency metrics, a strong demographic profile, and reform progress
• The recent upward shift in oil prices is consistent with sound fiscal and external balances despite the recent slowdown in oil production. The region’s USD peg arrangements look well supported
• Diversification away from hydrocarbon production will be key to the region’s prospects. National ‘Visions’ will act as catalysts for coordinated investments into non-oil and gas sectors
• While the Israel-Hamas conflict is fuelling some concerns over the region’s outlook, we see the GCC countries ultimately striving to avoid regional escalation and maintaining current oil output behaviour.

The Gulf economies’ importance is in the spotlight again with rising oil prices. Hosting the COP28 climate conference, and an invitation for its two largest members to join the ‘BRICS’ club of emerging nations are also raising its profile. What will the coming months, and an approaching era of peak oil demand hold for the region?

The Gulf Cooperation Council nations – Saudi Arabia, the United Arab Emirates (UAE), Kuwait, Bahrain, Oman, and Qatar – punch above their weight economically. They account for less than 1% of the global population but around 2% of global GDP, and over 10% and 20% of gas and oil production respectively. Curbs on Russia’s trade in hydrocarbons have increased their clout as alternative suppliers in energy markets, and events such as the Football World Cup, the Dubai Expo, and COP28 are boosting their status as international hubs. The GCC countries are making efforts to maintain strategic flexibility despite a decoupling of global geopolitical blocs led by the US and China. This summer, Saudi Arabia and the UAE were asked to join the ‘BRICS’, a geopolitical club that loosely joins some of the world’s largest and fastest-growing economies including China’s.

Meaningful but temporary slowdown in 2023

The countries’ focus on strategic flexibility is clear from their active intervention in the oil market. With oil and gas their economic mainstay and Russian supply reduced, 2022 saw stellar growth for many GCC nations: real GDP grew 8.7% in Saudi Arabia and 8.2% in Kuwait. As global growth has slowed in 2023, the Organization of the Petroleum Exporting Countries plus key non-members (OPEC+), including five GCC nations, have cut oil production. Saudi Arabia made additional output cuts. As a result of this, and of sharp interest rate hikes, we expect growth to slow in 2023 to 0.2%¹ across the six GCC economies, with a stronger UAE and Qatar roughly offsetting weakness in Saudi Arabia and Kuwait. Under our assumption of a gradual reversal of oil output cuts in 2024 for some GCC economies, together with eventual rate cuts, we see a modest 2024 growth rebound.

In our view, the slowdown in activities will have limited impact on the GCC countries’ medium-term outlook. The extended output cuts have increased the likelihood of crude oil prices remaining around USD 90 per barrel in the coming months, above the levels needed to balance government books across the region. Since these levels (‘fiscal breakeven prices’) are generally higher than those required to balance the countries’ current accounts, GCC countries will be able to either maintain twin surpluses (UAE, Qatar) or limit fiscal deficits arising from a slower economy (Saudi Arabia, Kuwait).

National Visions, giga projects, and steady reforms

The pursuit of national economic transformation agendas will be the main driving force for the GCC countries’ policies in the years to come. All six have announced long-term economic plans called ‘Visions’ with specific targets for economic diversification, human capital development, and greening of energy supply. Political commitment to these plans looks solid as the region faces challenges from the global shift toward electric vehicles and clean energy. Expected peak oil demand in the next 5-10 years is a potent challenge for the GCC countries where 30-50% of GDP is related to the hydrocarbon sector. For this reason, financing and facilitating projects in the national Visions will be prioritised, and we expect the region’s oil price sensitivity to be particularly high in the coming years.

We expect investments in these projects to grow at a solid pace. Saudi Arabia’s investments in the tourism and entertainment sectors have already been accelerating. Those for even larger ‘giga-projects’ such as NEOM, a vast new sustainable city in the desert, and King Salman International Airport are just beginning. Public sector investments have jumped in the UAE in the past two years and the country leads the region in solar energy investment. The other GCC countries will take their cues from their larger neighbours, although the scope for public investment will vary.

How effectively these projects are carried out will depend heavily on reforms of fiscal frameworks, the energy sector, and labour market structures. While much work still needs to be done, we note some concrete improvements here in recent years. Fiscal dependence on the oil sector has been decreasing due to the introductions of value-added and corporate income taxes (e.g. Saudi Arabia). Caps on retail fuel prices are beginning to be adjusted to reduce the gap with market prices, and electricity output from solar and wind sources has been growing at 61% per year since 2015. Female labour force participation rates have risen sharply in Saudi Arabia, the UAE, and Qatar. A continued uptrend in labour force participation rates would brighten the long-term outlook for these countries, especially since they have the best demographic profiles among emerging markets.