This month, Moody’s downgraded Oman’s credit rating below investment grade. The sultanate, often a test case for the rest of the region, has tried hard to wean its economy off oil-dependence. But its downgrade is a sign of how difficult this is, and a warning to the rest of this region.
In response to a lack of fiscal progress, the ratings agency assessed Oman’s long-term bonds at Ba1 with a negative outlook, down from Baa3, the lowest investment-grade level. Fitch had already downgraded the country to BB+ in December, and S&P cut it to junk as early as May 2017. Oman ran a budget deficit even in 2014, before the sharp oil price fall late that year. It has steadily cut its deficit since 2016, but it is still a high 9 percent of GDP and the country has taken few serious steps to improve it. The oil market is not going to bail it out.
Oman’s short-term support of the deal with Opec, Russia and some other states to cut production has worked in the short-term in boosting prices. That was perhaps a necessity when Brent crude dropped below $28 per barrel in January 2016. But in reviving the oil price, the Opec+ group has surrendered market share and has given a boost to shale producers and other regions. The “lower for longer” mantra that gripped the industry around 2016 has dissipated, encouraging renewed investment.
The Opec+ group has achieved near-total compliance to its planned cuts, and has been assisted by the unplanned losses from Iran and Venezuela, deliberate production cuts in Canada, and a reasonably strong world economy. Yet even with these favorable tail-winds, it has raised oil prices to only $67 per barrel.
US shale production is forecast by the International Energy Agency to continue growing strongly to 2024, and other non-Opec peers as well as Opec nations such as Iraq are boosting capacity. Of course, geopolitical upsets may lead to temporary spikes in prices, but a global economic slowdown is more of a threat, and would send prices tumbling again.
Every year that goes by brings the day of reckoning nearer. Overall car sales in China, the US and Europe dropped last year – sharply in China – but electric vehicle sales grew strongly. If that trend continues, in a few years the internal-combustion-engine fleet will start shrinking as older vehicles are scrapped. To survive, oil-fuelled cars will have to become much more efficient – but that, of course, reduces their consumption.
Other sectors the oil exporters are relying on for demand growth – industry, petrochemicals, heavy trucks, trains, ships and planes – will come under growing pressure from some combination of renewable energy, batteries and synthetic fuels.
Despite this gloomy long-term outlook, temporarily higher prices have relaxed the urgency for reform across the Gulf, including in Muscat, especially when they went over $80 per barrel in November. But at likely future prices, without fundamental, difficult and painful reforms, nearly all major oil exporters will run substantial and inescapable budget deficits. And, without other major export earnings, current account deficits will put pegged currencies under pressure. In 2016, Oman would have needed $87 per barrel to run a current account surplus; Bahrain, $92 per barrel.
Oman is in a weaker position than its other neighbors. True, its energy industry is well-run and technically innovative. It has sought to wring the most out of its resources with new refineries, petrochemicals, oil storage and trading ventures, along with the non-oil economy – ports, mining, metals and tourism. But this can only go so far to compensate for more difficult geology.
The sultanate’s oil production is much smaller than any GCC peer except Bahrain, as well as other big rivals such as Iran and Iraq, only partly compensated by its liquefied natural gas exports. New production relies on complex enhanced oil recovery, with the resulting millions of barrels per day of waste water extracted with oil, and hydraulically fracturing deep, low-permeability gas formations. This has sustained production, but only at a higher cost, limiting the state’s net proceeds.
For now, Oman has no urgent debt redemptions, and foreign-exchange reserves are adequate. In the longer term, or if oil prices drop sharply again, the dollar-pegged Omani riyal may come under pressure to devalue. This would be a way of forcing a fiscal adjustment the government has been unable to achieve – by cutting the dollar value of the state’s commitments in salaries and benefits.
The devaluation would not do much to spur Oman’s export industries immediately. Eighty-six percent of its exports consist of oil, gas, petrochemicals and a few other basic materials such as stone and metals, with cost bases predominantly in dollars. A weaker currency would quickly feed through into higher wages for expatriates, inflation and likely demands by state employees for cost-of-living increases.
Bahrain has a worse rating, B2 from Moody’s, four steps below Oman, a much higher debt load – 88 percent of GDP – and few foreign assets. But it’s always been expected that, as a small economy politically close to Saudi Arabia and the UAE, Manama would be bailed out if required. And indeed, in October, its two allies plus Kuwait pledged a fiscal support package, in return for reforms, including the introduction of VAT, and cuts to subsidies and spending.
Oman is a trickier case. Though a GCC member and Western-friendly, it has not joined the boycott of Qatar, and maintains political channels to Iran. Though its Gulf neighbors have supported it financially in the past, this time they may demand more in return, particularly from an eventual successor to Sultan Qaboos, who would lack his authority.
The crisis is not now. But to maintain its freedom of action, even its economic and social stability, Oman needs sustainable non-oil export industries that generate enough taxes, direct or indirect, to fund the government and create citizen employment. If it can crack the code few other oil states have managed, it will be an example worth following; if not, it could be the harbinger of worse trouble across the region.
Robin Mills is CEO of Qamar Energy, and author of “The Myth of the Oil Crisis.”