Research Briefing
Emerging markets
Subsidy cuts in the UAE
August 3, 2015
A model for the GCC?
Author
Kevin Körner
+49 69 910-31718
[email protected]
The announcement of the United Arab Emirates on July 22 that they would
deregulate petrol and diesel prices from August 1 caused a minor sensation. It
makes the federation of seven emirates the first amongst the Gulf Cooperation
1
Council (GCC) governments to cut politically-sensitive fuel subsidies long
called for by the IMF and other observers.
Editor
Maria Laura Lanzeni
Domestic fuel prices will still be set by the government (on a monthly basis) but
linked to global market prices, according to the Ministry of Energy. The decision
comes at a time when cheap oil is eating into the budgets of GCC and other oil
producers, increasing pressure but potentially also understanding of the local
population for fiscal and economic reform. The UAE government justified the
move with environmental, generational and economic development reasoning
rather than fiscal considerations.
Deutsche Bank AG
Deutsche Bank Research
Frankfurt am Main
Germany
E-mail: [email protected]
Fax: +49 69 910-31877
www.dbresearch.com
DB Research Management
Ralf Hoffmann
Subsidies weigh on fiscal balances
The UAE’s decision to cut energy subsidies is a strong signal for the Emirates'
willingness to implement long overdue fiscal and economic reforms. The IMF
and other observers of the region have been calling on the GCC countries for
years to reduce energy subsidies in order to safeguard medium to long-term
sustainability of public finances, support diversification and remove
misallocations and distortions in the economy.
1
2015F
20
15
However, Gulf monarchies have been reluctant to change their established oil
wealth distribution systems which are one of their main policies to maintain
social stability. Kuwait in January rowed back on cutting diesel and kerosene
subsidies after protests in parliament. Also the Emirates had so far focused on
economic diversification to reduce hydrocarbon dependence rather than on
subsidy cuts, with the exception of an increase of water and electricity tariffs in
Abu Dhabi in January.
10
5
0
Bahrain Saudi
Arabia
% of GDP
Source: IMF
UAE
Qatar Kuwait Oman
% of fiscal expenditures
But in times of substantially lower oil prices, the costs of maintaining generous
subsidy schemes appear increasingly high for countries which rely almost
entirely on oil revenues to finance their fiscal budgets (80% of total revenues in
the UAE are oil-related). According to a recent IMF report, pre-tax energy
subsidies in the UAE are estimated at USD 12.6 bn (2.9% of GDP or 9% of
2
overall government expenditures, see chart 1) in 2015. This puts them midrange between Saudi Arabia and Bahrain at 4.6% of GDP and Oman, Qatar and
Kuwait at 1.2-1.8%.
1
2
The GCC is an intergovernmental union consisting of six Gulf monarchies: Bahrain, Kuwait,
Oman, Qatar, Saudi Arabia, and the United Arab Emirates.
IMF (May 2015): “How large are global energy subsidies?”
Subsidy cuts in the UAE – A model for the GCC?
GCC feels fiscal pain of cheap oil
2
120
25
20
100
15
80
10
60
5
0
40
-5
20
-10
0
2000
-15
2003
2006
2009
2012
2015f
Oil, USD/bbl (Brent, left)
GCC fiscal balance, % GDP (right)
Source: Deutsche Bank
2015 breakeven oil prices
3
USD/bbl
Bahrain
118.7
S. Arabia
104.6
Oman
90.7
UAE
65.5
Qatar
52.7
Kuwait
47.9
0
50
100
150
Source: Deutsche Bank Research
Fiscal sensitivity to oil prices in UAE
lower than for most GCC peers
4
Fiscal balance, % GDP
30
20
10
0
-10
-20
Pressure to cut subsidies higher in GCC peers than in UAE
While subsidy cuts are an important step for fiscal consolidation and economic
development in the UAE, the pressure to lift subsidies is even higher in several
other GCC countries, mainly for three reasons.
First of all, the fiscal impact of the 50% oil price drop since last summer is
severe. The fiscal deficit resulting from lower oil revenues is expected at 15% of
GDP for Bahrain and Oman this year, for Saudi Arabia even higher at 18%.
Compared to them, the UAE’s fiscal deficit of around 1.8% of GDP, stemming
from a relatively low breakeven oil price of USD 65.5/bbl, appears rather
moderate (see chart 3 and 4). In fact, the UAE are closer to the GCC’s fiscal
“outperformers”, Qatar and Kuwait, which are even expected to keep their
3
surpluses.
Secondly, not all GCC countries can match the Emirates’ vast government
wealth in order to weather revenue shortfalls in times of cheap oil. In the case of
Saudi Arabia, FX reserves are as high as the Emirates’ FX reserves (including
Sovereign Wealth Fund resources) estimated at almost USD 1 trillion. But if
Saudi Arabia had to cover a double-digit fiscal deficit for more than a few years
without tapping debt markets, this would eat up substantial reserves (see chart
5). Government assets in Bahrain and Oman are much more limited, lasting for
less than two years at current budget levels. Together with dwindling oil
reserves (for Bahrain expected to be depleted around 2020 at current
production levels, in Oman around 2030, see chart 7), this leaves these two
countries exposed to severe medium-term fiscal challenges, reflected in
downgrade actions by rating agencies earlier this year.
Thirdly, in all other GCC countries, retail fuel prices are substantially lower than
in the UAE. In Saudi Arabia, heavy subsidisation keeps fuel prices at record
lows of USD 0.07/litre (diesel) and USD 0.16/litre (petrol), worldwide only
surpassed by Venezuela and Libya (petrol) (see chart 6). Compared to their
neighbours, fuel prices in the UAE are already much closer to world markets,
despite price regulation. On July 28, the Ministry of Energy announced that
petrol (95 octane) prices will rise as of August by 24% to USD 0.58/litre
compared to USD 1.1/litre world average. On the other hand, diesel prices,
which were priced above petrol before, will drop by 29% to USD 0.56/litre,
compared to a world average of USD 0.96/litre.
In the current environment of low oil prices, the short to medium-term impact of
subsidy cuts on general price developments in the UAE can be expected to
remain rather muted. First of all, a substitution effect to now cheaper diesel will
already lower the effect of higher petrol prices on inflation. According to the UAE
government estimations, the expenses for petrol account for only 3-4% of
households’ average income, reducing the pass-through to inflation (DB
forecast 2015: 3.6%) further. In this context, risks to social stability in the
Emirates, which are amongst the world’s 25 wealthiest countries in terms of
GDP per capita (around USD 45,000), should not rise substantially. A large
share of the additional costs will be borne by non-nationals, with expatriates
accounting for around 90% of the UAE’s total population.
-30
BHR
KWT
OMN
45 (Brent, USD/bbl)
75 (Brent, USD/bbl)
QAT
SAU
UAE
60 (Brent, USD/bbl)
90 (Brent, USD/bbl)
Source: Deutsche Bank Research
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2
| August 3, 2015
For more details, see Deutsche Bank (May 2015): “Adjusting to lower oil prices: budget
breakeven thresholds” and “Saudi Arabia: Adjusting to Lower Oil Prices”.
Research Briefing
Subsidy cuts in the UAE – A model for the GCC?
Will other GCC countries follow suit?
Government wealth varies strongly
across the GCC
5
1,000
900
800
700
600
500
400
300
200
100
0
450
400
350
300
250
200
150
100
50
0
Government assets, USD bn (left)
Government assets, % GDP (right)
Note: the figure for Bahrain reflects the net assets of
Mumtalakat, which may be largely illiquid.
Sources: Haver, IMF, SWF Institute, Deutsche Bank Research
Retail fuel prices heavily
subsidised in UAE's GCC peers
6
Gulf peers will be monitoring the implementation and public reception of subsidy
cuts in the UAE very carefully. If successful, the Emirates’ move might not only
serve as a regional role model for economic diversification but also for fiscal
reform. Faced with substantially lower oil revenues, GCC peers might see
themselves encouraged to follow suit, also as understanding of the local
population for energy price deregulation may increase. However, who will follow
when and how can be seen as a function of fiscal urgency and political costs.
The clearest case for cutting subsidies would be Oman and Bahrain, given their
precarious fiscal position and insufficient (oil) wealth. In Oman, cutting fuel
subsidies has been on the table for several years already but, so far,
considerations regarding political stability might have prevented corresponding
steps. Bahrain actually has already unveiled plans to phase out subsidies,
including on fuel, electricity and water, while compensating nationals through
cash payments, effectively leaving the burden with the estimated 50%
expatriates among the population. Kuwait appears to favour a more gradual
approach than the UAE, considering cutting fuel subsidies step by step starting
next fiscal year (April 2016).
Qatar, according to the IMF the world’s top per capita energy subsidiser, may
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choose to stand at the sidelines , at least for the time being, given its comfortable
fiscal and economic position. But also here, a further drop of oil prices below
Qatar’s current breakeven oil price of USD 52.7/bbl might be a game changer.
USD per litre (July 27, before UAE subsidy reform)
Decades of oil reserves for major GCC producers
Saudia Arabia
Kuwait
7
Thousand barrels per day (left), bn barrels (right)
Qatar
Bahrain
Oman
14,000
300
12,000
250
10,000
UAE
200
8,000
USA
101.3
6,000
World Average
77.9
150
62.7
4,000
Germany
2,000
0.0
0.5
Petrol
1.0
1.5
2.0
33.6
15.9
5.6
50
0
0
Bahrain
Diesel
100
UAE
Current production, left side
Kuwait
Saudi Arabia
Reserves, right side
Oman
Qatar**
Oil horizon in years*
Source: GlobalPetrolPrices.com
*: Oil horizon is the number of years for which oil production can be maintained at current levels, relative to confirmed reserves.
**: Qatar’s hydrocarbon reserves mainly consist of gas, which is estimated to last for another 161 years at current production
(2012 data).
Sources: EIA, Deutsche Bank Research
The most interesting question remains how the GCC’s largest economy and one
of the world’s largest per-head energy consumers – Saudi Arabia – will approach
the issue. Compared to the UAE, not only is fiscal pressure more profound but so
too are socio-demographic challenges. The average income of the 31 million
population is much lower at USD 25,000 and public discontent about structural
problems such as economic inequality and (youth) unemployment were already a
cause for concern before the drop in oil prices. Whether a public call for water and
energy subsidy reforms by Saudi Arabian Monetary Agency (SAMA) Governor
Almubarak earlier this year might be a signal of the Saudi government’s
willingness to tackle the issue therefore remains to be seen.
Kevin Körner (+49 69 910-31718, [email protected])
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| August 3, 2015
Aside from an increase in diesel prices last year that was understood more as a measure to
prevent smuggling than reduce subsidies.
Research Briefing
Subsidy cuts in the UAE – A model for the GCC?
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| August 3, 2015
Research Briefing