by Dr Hessah Al-Ojayan
Since crude oil hit a recent high of $107.9 a barrel in June this year, the closing price has been gradually declining reaching $82.6 on October 16th. This level is the lowest since July 2012. The decline is driven by the increase in supply coupled with a weak demand. More supply is mainly coming from the the US and Libya, with the US oil production increasing by almost 14% compared to last year. Libya’s production, having recovered from the civil war, has also increased from 200,000 barrels per day (b/d) in April this year to reach about one million b/d in September. Further adding to prospective global supply, Paraguay announced this week that it has discovered oil for the first time. Weakening demand is also adding pressure on oil prices, with the Kuwait News Agency (KUNA) recently announcing that Germany cut its oil imports from the Organization of the Petroleum Exporting Countries (OPEC) by 2% this year. The International Monetary Fund (IMF) has cut its projection for global growth in 2014 from 3.4% in July to 3.3% and its forecast for 2015 from 4% to 3.8%, which also does not bode well for global energy demand. On the back of the IMF growth forecast revisions, the International Energy Agency (IEA) had to cut its estimate for demand for OPEC crude oil by 200,000 b/d for 2015.
With OPEC producing 43% of the world’s oil, falling oil prices will negatively affect the revenues of many of its member countries and will eventually force them to consider cutting down production; many of them have a national budget breakeven price of above $90/barrel. Officials in Saudi Arabia, Iran, Kuwait and the UAE showed no public intention of reducing production. However, confidential information was leaked from Kuwait, stating that Al-Khafji field, a joint venture between Saudi Arabia and Kuwait that produces 300,000 b/d, is being shut down due to environmental concerns. Also, the Kuwaiti Alqabas newspaper reported on October 20 the possibility of shutting down another joint field, Al-Wafra, which produces 110,000 b/d, because the Kuwaiti Labor ministry was refusing to renew the identification cards of Saudi Chevron company employees. These shutdowns would reduce Kuwait’s oil production by around 10%. Globally, the final decision on how many barrels to produce per day will be made during OPEC’s next meeting, on November 27.
Kuwait produces between 2.5 to 3 million b/d and exports 80% of them to East Asia, with the remaining 20% going to Europe and the Americas. 90% of Kuwait’s revenues come from oil. Annually, 75% of total revenues are used for national expenditures, which amounted to about K.D 23 billion for the fiscal year 2014-2015 (approximately $80 billion), with the remaining 25% allocated to the Kuwait Investment Authority (national sovereign fund) for the purpose of supporting future generations. The breakeven oil price for the Kuwait budget is $75 per barrel. Beyond that, national expenses would exceed revenues. The current oil price of $90 per barrel is alarming and it is critical that Kuwait starts putting forward a contingency plan in order to avoid a possible financial deficit. It is time to call for a radical transformation.
The K.D 23 billion of Kuwait’s budget are distributed between 5 categories, called ‘chapters’. The first chapter takes up 24% of the budget and covers salaries and wages. 16.8% goes to the second chapter, which covers goods and services. 1.2% of the budget is allocated to the third chapter that covers transportation, equipment and supplies. 8.6% is allocated to the fourth chapter, which covers construction projects and public acquisitions, while the remaining 49% is allocated to the fifth chapter, which covers miscellaneous expenditure and transfer payments.
Depending on the severity of the price fall, different potential mitigating strategies could be considered. Ranking the strategies in decreasing order of preference and potential support from society, these are:
- The fifth chapter consumes about half of the budget (49%). Cutting down foreign direct aid expenditures, along with others, would have a significant impact on the budget.
- There is currently a significant drag on public services, subsidies and infrastructure by expats, who comprise 82.6% of the total labor force of 2,296,255. Imposing fees or tariffs on expats for using public services and goods would help increase government revenues.
- The government could reduce subsidies and increase fees. This idea was recently circulated in the media, but was met with strong opposition because it would decrease income available for consumption. To mitigate the opposition, the government should simultaneously introduce price controls (i.e. ceilings) to protect consumers from increasing prices of goods and services. This would then help dilute the impact of a reduction in subsidies.
- Kuwait is a tax free country. Imposing taxes on citizens and residents would reduce citizens’ income available for consumption, but would help boost government revenues. The idea of paying taxes was heavily opposed by some religious Muslims classifying it as ‘not Halal’, even though, a variety of taxes were imposed in the old Islamic world specifically during the Omar Bin Al-Khatab era. He imposed a 10% tax on non-Muslim merchants and 2.5% on Muslim merchants; as well as taxes on crops and animals. On the other hand, many citizens prefer to postpone paying taxes until Kuwait is ranked higher in the world Fraud index; in 2013 Kuwait dropped by 3 ranks, from 66 to 69 (among around 170 countries). In general, paying taxes would help boost the welfare of Kuwaiti society.
- Devaluation of the Kuwaiti Dinar. If one US dollar could buy more Kuwaiti Dinars, this would hold government revenues constant but would reduce Dinar purchasing power; this is likely to prove unpopular with domestic consumers.
At its upcoming November meeting, should the OPEC refuse to reduce production, many states will have tough decisions to make given the potential for incremental downside in oil prices. With the upward revisions to spending in key GCC oil producers (i.e. Kuwait and Saudi Arabia), the balance between oil prices and social order is more precarious than ever. After the Arab Spring, it is clear that Arab populations are demanding to be heard; and as the GCC is more integrated with respect to global trade compared to North Africa, OPEC action and GCC government response(s) are not simply a regional issue but a global issue with international ramifications.
Dr Hessah Al-Ojayan is Kuwait Programme Visiting Fellow at the MEC. She is also Assistant Professor of Finance at Kuwait University. Her research interests include Islamic finance and economics, GCC and emerging capital market, SMEs, and the history of finance and economics in the Middle East.