The effects of low oil prices: A comparative analysis of Saudi Arabia and the UAE

The effects of low oil prices: A comparative analysis of Saudi Arabia and the UAE By

Zakee Ahmed 604882

ISP in International Management 151030016 BSc International Management (MENA)

Submitted: 29th April 2016

Word Count: 9,818 words

School of Oriental and African Studies (SOAS)

Zakee Ahmed 604882

Declaration I have read and understood the School regulation concerning plagiarism and I undertake: o that all material presented for examination is my own work and has not been written for me, in whole or in part, by any other person(s); o that any quotation or paraphrase from the published or unpublished work of another person has been duly acknowledged in this ISP; o that I have not incorporated in this ISP without acknowledgement any work previously submitted by me for any other course forming part of this or any other degree. Signed: Date:

Zakee Ahmed 29th April 2016

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Zakee Ahmed 604882

Abstract

This paper attempts to explore the effects of low oil prices on both Saudi Arabia and the UAE, in light of the recent 2014 decline in oil prices, that still continue to decline today. Most significantly, low prices seem to deteriorate fiscal positions, put pressures on fixed exchanged rates, hinder growth and cause worry as to the sustainability of oil-exporting countries. This paper uses a mixture of literature and secondary data to thematically present its findings, drawing upon the fact that Saudi Arabia should be of a higher focus due to the lack of economic diversification and foreign exchange reserves that exist in the region. Finally, this paper serves as an overall insight into low oil prices, briefly looking at historical instances with a clearer focus on the recent crisis.

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Zakee Ahmed 604882 Table of Contents ABBREVIATIONS

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INTRODUCTION

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METHODOLOGY

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LITERATURE REVIEW

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THE RENTIER STATE AND THE POLITICS OF OIL

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THE RESOURCE CURSE THEORY

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ANALYSIS

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OIL PRICES

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2014 OIL PRICE DECLINE

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FISCAL POLICIES

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EXCHANGE RATES

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ECONOMIC DIVERSIFICATION

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POLITICS

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ENTREPRENEURIALISM

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FINAL COMMENTS AND CONCLUSIONS

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BIBLIOGRAPHY

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Abbreviations

Gross Domestic Product GDP Gulf Cooperation Council GCC International Monetary Fund IMF Organization of Petroleum Exporting Countries OPEC Organisation for Economic Co-operation and Development OECD Rentier State theory RST The Gulf Petrochemicals and Chemicals Association GPCA The Middle East and North Africa MENA The Saudi Arabian Monetary Agency SAMA The Saudi Interbank Offered Rate SIBOR United Arab Emirates UAE

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Introduction

On the 18th April 1977 President Jimmy Carter, the 39th President of the United States, publicly announced to the American people that “the oil and natural gas we rely on for 75% of our energy are running out”, stating this as one of the most unprecedented, inordinate challenges to the country.1 Since this period, a vast number of economists, policy makers and scientists have stressed the worry that oil, the finite resource that allows the world economy to continue operating, will run out. However, the exact opposite has happened. Published in 2012, a Harvard University report by oil executive Leonardo Maugeri predicted that by 2020 there would be a 20 per cent increase in global oil production. Since President Carter’s announcement in 1977, where global oil production stood at 62.71 million barrels per day (mb/d)2, to the first quarter in 2016, and where world oil supply was valued at 96.35 mb/d3, global oil production has increased by 53.6%. Even world crude oil proved reserves, not taking into account the vast amount of oil that could exist without our knowledge, rose by 12% in the period between 2011 and 2014.4

1 Viner, B. (2013). Why the world isn't running out of oil. The Telegraph. [online] Available at: http://www.telegraph.co.uk/news/earth/energy/oil/9867659/Why-the-worldisnt-running-out-of-oil.html [Accessed 10 Apr. 2016]. 2 Earth Policy Institute. (2010). World on the Edge - Energy Data - Oil. [online] Available at: http://www.earth-policy.org/datacenter/pdf/book_wote_energy_oil.pdf [Accessed 1 Jan. 2016]. 3 IEA (International Energy Agency). (2016). OMR - OMR Public. [online] Available at: https://www.iea.org/oilmarketreport/omrpublic/ [Accessed 18 Apr. 2016]. 4 Energy Information Administration (EIA). (2016). International Energy Statistics. [online] Available at: https://www.eia.gov/cfapps/ipdbproject/IEDIndex3.cfm? tid=5&pid=57&aid=6 [Accessed 18 Apr. 2016].

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Zakee Ahmed 604882 On a large scale, oil is responsible for vast amounts of trade globally, for the creation of oil economies such as those that exist within the MENA region, and for the global economic booms and recessions that occur as a result of the highly dynamic oil prices. The fame of oil primarily roots down to its crucial importance in the smooth running of day to day necessities of the modern world, such as transport systems, the gas that provides warmth to households, and even toothpaste.5

The production of this oil continues to be concentrated between Saudi Arabia, the Russian Federation, the United States, the People’s Republic of China, Canada and the Islamic Republic of Iran, who together make up for more than half of world oil production.6 More importantly, in terms of net trade Saudi Arabia is the largest exporter of oil in the world, followed by the Russian Federation, Kuwait and the United Arab Emirates (UAE).7 With this leading role come some detrimental, as well as advantageous economical, social and political effects. As the world demands such a large amount of oil from these countries, they have become heavily engaged with the trade of oil and thus are somewhat dependent on the source of income received from this. The economies have less incentives to focus on additional sources of income, since there exists more incentive to exploit the trade that is so seemingly beneficial, and on constant global demand. It is this macroeconomic structure of these economies that this paper will 5 Gleich, A. (2014). 10 (Unexpected) Uses of Oil. [online] Oil Price. Available at: http://oilprice.com/Energy/Energy-General/10-Unexpected-Uses-of-Oil.html [Accessed 19 Apr. 2016]. 6 International Energy Agency (IEA). (2016). IEA Energy Atlas - Oil. [online] Available at: http://energyatlas.iea.org/?subject=-1920537974 [Accessed 18 Apr. 2016]. 7 International Energy Agency (IEA). (2016). IEA Energy Atlas - Oil. [online] Available at: http://energyatlas.iea.org/?subject=-1920537974 [Accessed 18 Apr. 2016].

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Zakee Ahmed 604882 delve into, as the heavy reliance on oil revenues formulates a connection between the value at which oil is priced, and the welfare of the economies exporting the good. High oil prices provide many Arab oil states with high government income, the revenues of which are at the heart of both economic and political structures and policies. However, the drops in oil prices have revealed that with such high dependency on oil revenues, in some cases accounting for up to 80% of GDP, those political and economic structures founded around stable oil prices begin to flounder. This dissertation will identify in what ways these structures disintegrate, analysing each variable affected as a consequence of low oil price.

Methodology

This paper will primarily use a historical comparative method in evaluating and analysing the effects of low oil prices on Saudi Arabia and the UAE. This comparative analysis will consist of a considerable amount of examination of secondary data, due to the proliferation of data that exists on oil prices with specific reference to both the macroeconomic and microeconomic structures of Saudi Arabia and the UAE. Noteworthy at this point is the “dismal state of economic statistics in the GCC in general, a situation that has been repeatedly lamented by the International Monetary Fund,”8 meaning that there has been a lot of theory on this

8 Luciani, G., Hertog, S., Woertz, E. and Youngs, R. (2012). Resources Blessed: Diversification and the Gulf Development Model. Berlin: Gerlach Press, p.1

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Zakee Ahmed 604882 subject area as opposed to concrete data that would portray the reality of the situation.9

“progress or lack thereof should be judged at the disaggregated rather than the aggregated level. It is only through a detailed analysis of which economic activities are expanding and which not, which obstacles have been overcome and which remain, that reasonable conclusions may be drawn on the impact of natural resources on growth and causes of whatever outcome is found”10

In light of this, the analysis section of this paper endeavours to decompose the macroeconomic variables, along with fiscal and sociopolitical policy implications, both of which have experienced the effects of oil prices. The literature review aims to give a historical overview of the main arguments and theories on the topic of oil prices and any other relevant linked discussions, as well as provide the necessary definitions, both of which will be utilized throughout the analysis. For this reason, the analysis will focus more heavily on current data from 2014-2016, while of course still referring back to older data when necessary.

9 Ibid. 10 Ibid, p.16 11

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Literature Review

In analysing the economic, social, political and environmental effects of low oil prices in both Saudi Arabia and the UAE, it is of upmost importance to understand the context in which they occur. In 1978, only momentarily after the worlds first oil boom, Seers duly noted that “those vested with political power in the oil rentier states tend to forget that oil revenue will inevitably decline in due course, and aim simply at achieving temporary prosperity”.11 What he was referring to 38 years ago could not be more accurate. Historically, oil prices have fluctuated heavily, and continue to do so as the low oil prices that currently exist in the market will no doubt rise at some point in the near future.12 The GCC countries, along with many others both within the MENA region and globally, can be categorized as states that rely on oil as a large proportion of their national income. Accruing 90% of their revenues from the trading of oil abroad, Arab oil states are able to supply and have control over public services with minimal demand for any form of taxation. These are the characteristics of the RS proposed by Hazem Beblawi and Giacomo Luciani, two prominent scholars on RST. Thus, oil revenues, contributing so heavily to oil states’ income, are at the heart of how these countries operate socio-politically and economically. Therefore, the price of oil is a heavily significant factor 11 Seers, D. (1978). The life-cycle of a petroleum economy. Journal of African Development, 1(1).

12 Halligan, L. (2015). Why it won't be long before oil prices rise again. [online] Telegraph.co.uk. Available at: http://www.telegraph.co.uk/finance/comment/12047399/Why-it-wont-be-longbefore-oil-prices-rise-again.html [Accessed 29 Apr. 2016].

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Zakee Ahmed 604882 in determining the sustenance of these operations, as with a high price they have been capable of providing goods and services almost always free of charge, constantly maintaining and improving their economies, with very low opposition, at a fully functional level. As a consequence, when oil is priced at a lower value these states begin to face difficulties in their macroeconomic structures since a large proportion of their income is diminished, effecting exchange rates and which demands a change in fiscal policy, the necessity for economic diversification, as well as increased entrepreneurialism. Such changes however, have conjured quite significant levels of opposition, and since the rentier state is characterized by the intertwining of politics and economics, entire oil dependent countries in question can be destabilized as a consequence of low oil prices.

The Rentier State and the Politics of Oil

In ‘The Patterns and Problems of Economic Development in Rentier States: The Case of Iran’, the economist Hossein Mahdavy first hypothesized the concept of a rentier state as “countries that receive on a regular basis substantial amounts of external rent,” usually in the form of capital gained by countries owning a natural resource. For instance, payments for use of the Suez Canal and oil revenues created by governments of oil exporting countries.13 In ‘The Rentier State’, Hazem Beblawi and Giacomo Luciani 13 Mahdavy, H. (1970). The Pattern and Problems of Economic Development in Rentier States: The Case of Iran. In: Studies in the Economic History of the Middle East, 1st ed. Oxford: Oxford University Press, p.428

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Zakee Ahmed 604882 further developed Mahdavy’s theory, with Tim Niblock and Monica Malik stating that they “marked the most significant step forward in the elaboration of the theory”14, serving as “the basis of much subsequent rentier state analysis of Arab oil-producing states”.15 Niblock, a professor at the Middle East Institute, is said to have contributed to some of the most accurate efforts in assessing Saudi Arabian economic development.16 Beblawi proposed the idea of a ‘rentier economy’ whereby the economy is “substantially supported by the expenditure of the state whilst the state itself is supported by the rent accruing from abroad”.17 Niblock and Malik emphasised this by stating the most important aspect of the rentier economy is the extent to which this rent determines the form and structure of the economy, along with the actual external origin of these revenues.18 Above the rentier economy, Beblawi labels the ‘rentier state’ as “any state which derives a substantial part of its income from foreign sources and under the form of rent”, agreeing with Madhavy’s original definition. Furthermore, Luciani alludes that as an approximation, at least 40% of the government’s income should constitute of oil revenues for a country to fall under the rentier state category.19 In ‘Resources blessed: Diversification and the gulf development model’, Luciani describes the rentier state theory as focusing on the fiscal foundations of the state20, 14 Niblock, T. and Malik, M. (2007). The political economy of Saudi Arabia. Abingdon, Oxon: Routledge, p.14 15 Op. Cit. The political economy of Saudi Arabia, p15 16 Looney, R. (2008). Review of The Political Economy of Saudi Arabia. Middle East Journal, [online] 62(4), pp.716-718. Available at: http://www.jstor.org/stable/25482581 [Accessed 24 Feb. 2016]. 17 Beblawi, H. and Luciani, G. (1987). The Rentier state. London: Croom Helm, p.11 18 Op. Cit. The political economy of Saudi Arabia, p15 19 Beblawi, H. and Luciani, G. (1987). The Rentier state. London: Croom Helm, p.70 20 Luciani, G., Hertog, S., Woertz, E. and Youngs, R. (2012). Resources Blessed: Diversification and the Gulf Development Model. Berlin: Gerlach Press, p.6

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Zakee Ahmed 604882 with those states involved in oil revenues of particular focus due to the nature of oil generating huge amounts of rents.21

A vast number of scholars and political scientists have utilised the framework outlined above to understand the respective economies of Saudi Arabia and the UAE. This paper uses comparative analysis of Saudi Arabia and the UAE, both Gulf states, as it is these regions that succeed the most in fulfilling the characteristics of the rentier state: mass amounts of oil reserves, heavy investment in oil production, dependency on oil revenues, limited size native populations, autocratic forms of governments and exposure to global markets. Niblock and Malik argue that perhaps the most fundamental feature of a rentier state is the centrality of the state.22 In his chapter ‘The Macro-behaviour of Oil-rentier states in the Arab region’, Abdel-Fadil expresses:

“the state becomes the main intermediary between the oil sector and the rest of the economy. It receives revenues which are channelled to the economy through public expenditure, and since public expenditure generally represents a large proportion of national income, the allocation of these public funds between

21 Ibid, p.7 22 Op. Cit. The political economy of Saudi Arabia, p.15 16

Zakee Ahmed 604882 alternative uses has great significance for the future development pattern of the economy.”

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Beblawi and Luciani emphasise this by stating “a corollary of the role of the few, in a rentier state the government is the principal recipient of the external rent in the economy”24. Although the rent received by the nation affects the majority of those in the state, the government is the main recipient and distributor of rents, allowing them full control over how the country will develop economically and socio-politically. As this paper will show in the paragraphs below, the centrality of the state is core to understanding how states such as Saudi Arabia and the UAE are able to function, and how a reduction in the rent received by the state would affect the manner in which they operate.

The second key characteristic that can be seen in rentier states is the vast autonomous forms of government. According to Skocpol, in an autonomy “the state formulates and pursues goals which are not simply reflective of the demands or interests of social groups, classes or society”. 25 The state becomes almost completely independent from the rest of society and thus does not feel any sense of threat from the citizens. In fact, Niblock and Malik note how all aspects of society become heavily dependent on the

23 Abdel-Fadil, M. (1987). The Macro-behaviour of Oil-rentier states in the Arab region. In: H. Beblawi and G. Luciani, ed., The Rentier State, 1st ed. London: Croom Helm, pp.83103. 24 Beblawi, H. and Luciani, G. (1987). The Rentier state. London: Croom Helm, p.52 25 Evans, P., Rueschemeyer, D. and Skocpol, T. (1985). Bringing the State Back In, p.9

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Zakee Ahmed 604882 state.26 This is a stark contrast to regions in the West such as Britain, where the governments are dependent on its citizens in terms of taxation and democratic electoral support. The state exists as a supplier of extensive subsidies, the main employer of labour and a link for lucrative business contracts.27 Beblawi describes how the rentier state is in fact a subset of a rentier economy, which involves only a minority in the generation of the rent/wealth, whereas the majority of the population are only involved in utilisation of the rent.28 The state’s role of being a distributor began with “land gifts”29, developing into what is now a system where the state acts as a benefactor for the private and public sector.30 The economist Yates took this further, stating how “external rent liberates the state from the need to extract income from the domestic economy”31, thus, as Luciani expresses in his edited chapter ‘Allocation vs. Production States: A theoretical framework’, the rentier state becomes an allocation state as opposed to a production one.32 The state determines who to favour and to what degree,33 thus the motive for public individuals and businesses to excel in the economy diminishes as it is more rewarding for people to work for the public sector rather than the limited private sector. According to Al-Dekhayel, the financial and informative power of the state

26 Op. Cit. The political economy of Saudi Arabia, p.16 27 Ibid, p.16 28 Beblawi, H. and Luciani, G. (1987). The Rentier state. London: Croom Helm, p.51 29 Ibid, p.53 30 Ibid 31 Yates, D. (1996). The Rentier State in Africa. Trenton, NJ: Africa World Press. 32 Luciani, G. (1987). Allocation vs. Production States: A Theoretical Framework. In: H. Beblawi and G. Luciani, ed., The Rentier State, 1st ed. London: Croom Helm, pp.62-82. 33 Op. Cit. The political economy of Saudi Arabia, p.16

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Zakee Ahmed 604882 safeguards the government against opposition to state policy, and even limits the avenues through which any opposition could be expressed.34

In fact, a significant lack of political representation exists within rentier states. Beblawi and Michael Ross propose that representation, one of the necessary components of democracy, is directly linked to the presence of taxation.3536 In rentier states, the common statement ‘no taxation without representation’ is replaced by ‘no representation without taxation’. 37 Luciani elucidates that “it is a fact that whenever the state essentially relies on taxation the question of democracy becomes an unavoidable issue, and a strong current in favour of democracy inevitably arises”.38 This is clearly not the case in Saudi Arabia and the UAE, where economic wellbeing serves as a replacement for political rights.39 Ross suggests two “causal mechanisms” of rentier states: the rentier effect and the repression effect. He expresses how these are determinants that hinder democracy.40 In ‘Carbon Democracy’, Timothy Mitchell agrees with Ross in stating that there exists a positive correlation between the transformation to democracy and increases in taxation.4142 The rentier effect states that when governments receive sufficient funds in terms of oil revenues, they

34 Al-Dekhayel, A. (1990). The State and Political Legitimation in an Oil-Rentier Economy: Kuwait as a `Case Study. unpublished PhD thesis. University of Exeter. 35 Beblawi, H. and Luciani, G. (1987). The Rentier state. London: Croom Helm, p.53 36 Ross, M. (2001). Does Oil Hinder Democracy? World Politics, 53(03), p.332 37 Op. Cit. The political economy of Saudi Arabia, p.17 38 Beblawi, H. and Luciani, G. (1987). The Rentier state. London: Croom Helm, p.73 39 Op. Cit. The political economy of Saudi Arabia, p.17 40 Op. Cit. Ross. P.332 41 Ibid, P.332 42 Mitchell, T. (2013). Carbon democracy: Political power in the age of oil. London: Verso, p.21

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Zakee Ahmed 604882 are less likely to tax the population, with the population less incentivised to be represented. Ross reveals that a significant amount of spending on patronage through oil revenues has a ‘dampening effect’ on democratization pressures.43 In accordance to what has been analysed before, Ross agrees that “group formations’, a vital pre condition for democracy, are hindered by oil wealth.44 Niblock and Malik reiterate this, stating “social groupings are not strong enough to pursue their interests or even to claim the right of representation”.45 The “repression effect”46 talked about by Ross explains how oil revenues are used to fund high military and social security budgets, which in turn can be used to impede democratic aspirations.47

In conjunction with this, Karl Moene notes how this rentier mentality gives rise to corruption and a profligate and structurally driven waste of resources.4849 The MENA region is homogenously home to the cultural practice of ‘wasta’, a term that can be translated as nepotism. Wasta promotes the gain of rewards via favouritism instead of merit, and is embedded in the hiring process of business in the region. * notes how it is almost unheard of for firms in the region to engrain a no nepotism policy, thus deteriorating the value of education, hard work and qualifications, as a consequence of the nature of the rentier state. 43 Op. Cit. Ross. Pp.333-334 44 Ibid 45 Op. Cit. The political economy of Saudi Arabia, p.17 46 Op. Cit. Ross. P335 47 Ibid 48 Op. Cit. The political economy of Saudi Arabia, p.17 49 Karl, M. and Chand, K. (1999). Controlling Fiscal Corruption. World Development, 27(7), pp.1129-1140.

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The third dynamic is what Beblawi refers to as the ‘rentier mentality’, a specific type of economic behaviour that is distinguished through a break in the work-reward causation.50 He argues that “no more than 2 to 3 per cent of the labour force is engaged in the production and distribution of oil, which adds up to between 60 and 80% the GDP.” 51 Society is thus left to compete for a share in the oil rent.52 Social and economic interests are:

“organised in such a manner as to capture a good slice of government rent. Citizenship becomes a source of economic benefit. Different layers of beneficiaries of government rent are thus created, giving rise, in their turn, to new layers of beneficiaries. The whole economy is arranged as a hierarchy of layers of rentiers with the state or the government at the top of the pyramid, acting as the ultimate support of all other rentiers in the economy”53

Yates agrees with Beblawi’s analysis that rentier states don’t just comprise of governments as rentiers, but also citizens, affirming that “Rentierism is a parasite that violates the most sacred doctrine of liberal ethos. Hard

50 Beblawi, H. (1987). The Rentier State in the Arab World. In: H. Beblawi and G. Luciani, ed., The Rentier State, 1st ed. London: Croom Helm, p.52 51 Beblawi, H. (1987). The Rentier State in the Arab World. In: H. Beblawi and G. Luciani, ed., The Rentier State, 1st ed. London: Croom Helm, p.53 52 Op. Cit. The political economy of Saudi Arabia, p.16 53 Op. Cit. Beblawi, H. The Rentier State in the Arab world, p.53

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Zakee Ahmed 604882 work.”54 Through oil revenues, the population become accustomed to wealth without much work, rather than the productive labour incentives set up in many market led economies such as those in Europe. Niblock and Malik elucidate that this is fortified by legislation that condemns foreigners who wish to do business in the regions without the alliance with a local partner.55 Citizenship becomes another substantial gain as they act as kafils (sponsors) for the foreigners,56 undergoing no hard work but nevertheless receiving a proportion of the income.57 The rentier mentality has significant effects on the productivity and thus performance of the state as skilled individuals leave industries for contracts with the affluent oil sector of the economy, being replaced by imported specialist foreign workers, and flourishing entrepreneurs disembark on their aspirations for profitable government employment, while manual labour is allocated to migrant workers who send their wealth out of the economy in the form of remittances.

The Resource Curse Theory

The resource curse theory was ignited by Alan Gelb in 1988 and Richard Auty in 1990, with Jeffrey Sachs and Warner conducting an economic

54 Yates, D. (1996). The Rentier State in Africa. Trenton, NJ: Africa World Press, p.18 55 Op. Cit. The political economy of Saudi Arabia, p.17 56 Op. Cit. Beblawi, H. The Rentier State in the Arab world, pp.52-53 57 Ibid, p.56 22

Zakee Ahmed 604882 analysis of countries in 1995.58 The literature puts emphasis on governance failure and economic mechanisms. Those focusing on governance believe that resources could be a boost to growth, which has not proven to be the case because economists have pointed to the prevention of diversification and deindustrialization as a consequence of being a resource rich country. Furthermore, prices on the world market are notoriously volatile, especially in the case of oil which puts resource dependent countries such as Saudi Arabia and the UAE, at higher risks of external economic fluctuations. Auty and Gelb conceived two development trajectories focusing on low and high rents, with the GCC demonstrating a situation of high rent. Resource rent has been frequently linked to increased levels of corruption and rent seeking behaviour.

More importantly, the resource curse outlines that a “reliance on the export of raw materials or natural resources generated deindustrialisation or prevents diversification”.59 The Dutch Disease attempts to justify this statement, by representing the negative effects an economy experiences with a sharp inflow of foreign currency, for example the discovery of huge amounts of oil. The theory argues the excessive inflows of foreign currencies results in the appreciation of the domestic currency, reducing the competitiveness of the country’s other products on the global market. However, Luciani elucidates that the GCC serve as a counter argument to the conventional Dutch Disease. They offer vast amounts of public sector employment to nationals, an excess of subsidisation of consumer 58 Op.Cit. Luciani, G., Hertog, S., Woertz, E. and Youngs, R, p.1 59 Ibid, p.9. 23

Zakee Ahmed 604882 products, and selected investment, for example housing.60 Luciani argues that this “stimulates supply in the non-tradable sector, maintaining nontradable prices relatively low”.61

60 Ibid, p.19 61 Ibid 24

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Analysis

Oil prices

A report published by the World Bank states that “there are particularly interesting parallels between the recent episode and the collapse in oil prices in 1985-86”62, referring to the severe drop in oil prices in the second half of 2014, signifying the end of a stable four-year period where oil was valued at roughly $105 per barrel. 63 The same report illustrates how in the period between 1984 and 2013, there were an additional five instances of declines in the price of oil of 30 per cent or more in a six-month period.64 These episodes were accompanied by significant changes in world economy and oil markets, and can be grouped into:

1985-1986: Increase in the supply of oil and change in OPEC policy 1990-1991 and 2001: U.S. recessions 1997-1998: The Asian crisis 2007-2009: The global financial crisis

62 Understanding the Plunge in Oil Prices: Sources and Implications. (2015). Global Economic Prospects. [online] World Bank, pp.155-164. Available at: https://www.worldbank.org/content/dam/Worldbank/GEP/GEP2015a/pdfs/GEP2015a_chapt er4_report_oil.pdf [Accessed 19 Feb. 2016]. 63 Ibid 64 Ibid

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Figure 1: Largest annual oil price declines65

Out of all the instances of oil price declines shown in figure 1, the oil price decline that began in June 2014 has been among the three largest over the past three decades.66 The other two declines that have been of similar significance is the decline in 1986, when OPEC cut production, and in 2008-2009 in the early developments of the global financial crash.

The build up to the1986 oil price crash will be briefly described and analysed as this allows the paper to introduce the vast power and significance of OPEC.

The 1960 Baghdad Conference marked the creation of the now infamously powerful Organization of the Petroleum Exporting Countries (OPEC), an intergovernmental organization with the supposed aim to “co-ordinate 65 International Monetary Fund (IMF), (2015). Global Implications of Lower Oil Prices. [online] Available at: https://www.imf.org/external/pubs/ft/sdn/2015/sdn1515.pdf [Accessed 18 Mar. 2016]. 66 Ibid

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Zakee Ahmed 604882 and unify petroleum policies among Member Countries, in order to secure fair and stable prices for petroleum producers; an efficient, economic and regular supply of petroleum to consuming nations; and a fair return on capital to those investing in the industry.”67 Originally, OPEC was formed with Iran, Iraq, Saudi Arabia, Kuwait and Venezuela, however the end of 1971 welcomed Qatar, Nigeria, United Arab Emirates, Algeria, Indonesia and Libya to the group.68 Throughout the 1960s and the beginning of the 1970s, the price of oil was relatively stable, as the power to price oil lay in the hands of transnational oil companies from the west that “kept the world oil price relatively stable”.69 However, at the end of 1973 oil prices soared from $4.31 per barrel to $10.11,70 an increase of just over 134%. This was mainly due to a lack of supply in the market as OPEC enforced an oil embargo, known as the ‘Arab oil embargo’,71 on certain countries from the West including the USA, as a result of their support to Israel in the Arab-Israeli war in 1973.72 The embargo lead to a reduction in OPEC oil production by 4.3 million barrels a day73, and was a significant factor to the economic stagnation that shaped the global recession that followed.74 This point in history is extremely significant to recognize as it revealed the 67 OPEC. (2016). OPEC: Brief History. [online] Available at: http://www.opec.org/opec_web/en/about_us/24.htm [Accessed 7 Jan. 2016]. 68 Ibid 69 Yan, L. (2012). Analysis of the International Oil Price Fluctuations and Its Influencing Factors. American Journal of Industrial and Business Management, 2(2), pp.39-46. 70 Macrotrends. (2016). Crude Oil Prices - 70 Year Historical Chart. [online] Available at: http://www.macrotrends.net/1369/crude-oil-price-history-chart [Accessed 19 Apr. 2016]. 71 Op. Cit. OPEC. Brief History. 72 Gawrych, G. (1996). The 1973 Arab-Israeli War: The Albatross of Decisive Victory. Fort Leavenworth, Kan.: Combat Studies Institute, U.S. Army Command and General Staff College. 73 Annual Statistical Bulletin. (2008). [online] OPEC. Available at: http://www.opec.org/opec_web/static_files_project/media/downloads/publications/ASB200 8.pdf [Accessed 3 Mar. 2016]. 74 Op.Cit. Gawrych.

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Zakee Ahmed 604882 dangers of OPEC to the global community, with the organisation itself recognizing the true power that they possessed in influencing other countries.75 In his book “OPEC: Instrument of Change”, Ian Seymour notes how the 1973 oil price increases affirmed to the global powers and the wider public that OPEC was in fact a cartel,76 in the sense that they were, and still are, an organization that uses its power over supply to manipulate prices and the levels of production using an array of tactics.77 Furthermore, within the boundaries of the OECD, the International Energy Agency (IEA) was created in 1974 as a result of the pressing threat from OPEC,78 with the objective of being “an autonomous organisation which works to ensure reliable, affordable and clean energy for its 29 member countries and beyond”, focusing on energy security, economic development, environmental awareness and engagement worldwide.79

The next global oil price shock occurred during the 1979 Iranian Revolution, resulting in the loss of approximately 2.5 million barrels of oil production per day between the end of 1978 and the middle of 1979.80 This lack of supply in the market significantly increased the price of oil, from £ to £.81 The Iran-Iraq war in 1980 worsened the situation, as both 75 Kutlu, O. (2015). War, crises, global economy drive oil prices in history. Journal of

Turkish Weekly. [online] Available at: http://www.turkishweekly.net/news/178440/warscrises- global-economy-drive-oil-prices-in-history.html [Accessed 10 Apr. 2016]. 76 Seymour, I. (1980). OPEC: Instrument of change. London: Macmillan. 77 O'Sullivan, A. and Sheffrin, S. (2003). Economics: Principles in action. New Jersey: Pearson Prentice Hall, p.171. 78 Irawan, P. (2012). Understanding the Global Rivalry between OPEC and IEA. Vienna, Austria. 79 International Energy Agency (IEA). (2016). About us. [online] Available at: http://www.iea.org/aboutus/ [Accessed 10 Mar. 2016]. 80 Oil and Development: The Role of OPEC - A historical perspective and Outlook to the Future. (2005). OPEC Secretariat. Vienna, Austria: OPEC. 81 Ibid

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Zakee Ahmed 604882 Iran and Iraq cut back oil production heavily leading to an even larger increase in price.82

Both the 1973 and 1979 increase in oil prices ignited the worldwide search for alternative supplies of energy. Countries such as Britain felt the effects of the price shocks, as the price of petrol soared, workers demanded higher wages and inflation reached more than 24%.83 An article by the Guardian newspaper reports that “there was even talk in Britain of rationing using coupons left over from the second world war”.84 These negative effects resulted in technological developments that reduced the intensity of oil consumption and created the extraction of oil from numerous offshore fields, notably the North Sea, Alaska,8586 Siberia, the Gulf of Mexico,87 and the Soviet Union who turned into the world’s largest producer of oil at the time.88 By 1986, non OPEC oil production had risen by 10 million barrels per day from just 3 years before.89 Countries like the UK eventually became a net exporter.

82 Ibid 83 Macalister, T. (2011). Background: What caused the 1970s oil price shock? [online] the Guardian. Available at: http://www.theguardian.com/environment/2011/mar/03/1970s-oil-price-shock [Accessed 10 Mar. 2016]. 84 Ibid 85 Op. Cit. The Guardian. What caused the 1970s oil price shock? 86 Understanding the Plunge in Oil Prices: Sources and Implications. (2015). Global Economic Prospects. [online] World Bank, pp.155-164. Available at: https://www.worldbank.org/content/dam/Worldbank/GEP/GEP2015a/pdfs/GEP2015a_chapt er4_report_oil.pdf [Accessed 19 Feb. 2016]. 87 Bromley, S. (2013). American Power and the Prospects for International Order. Oxford: John Wiley & Sons, p.95. 88 Washington Post, (1980). World: Saudis Edge U.S. on Oil, p.2. 89 Ibid

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Zakee Ahmed 604882 The effects of higher oil prices were two-fold; a depressing demand and a growing non OPEC supply of oil. OPEC’s market share in the 1970s was approximately 50%, however this was drastically reduced to less than a third in 1985.90 OPEC attempted to cut supply in order to maintain high oil prices, however the limited demand that did exist in the global economy was being mainly met by non OPEC producers. In December 1985 Saudi Arabia, the de facto leader of OPEC, changed its policy in order to expand its market share.91 Oil production per day dropped from 10 million barrels in 1981 to 3.4 million in 1985.92 With the aim of stabilizing the price of oil, OPEC required members to fulfill production quotas.93 However, various OPEC members disobeyed this and refused to participate or expanded their reserves to produce higher quotas.94 In response, Saudi implemented a policy of production at full capacity creating an excess supply in the market, giving rise to a 61% reduction in oil prices, going from $24.68 per barrel to $9.62 between January and July in 1986.95 According to the World Bank, “following this episode, low oil prices prevailed for more than fifteen years”.96

2014 Oil price decline

90 Hershey Jr, R. (1989). Worrying Anew Over Oil Imports. The New York Times. 91 OP. Cit. World Bank. Understanding the Plunge. 92 Yergin, D. (1991). The Prize: The Epic Quest for Oil, Money, and Power. New York: Simon & Schuster. 93 Ibid. 94 Ibid. 95 OP. Cit. World Bank. Understanding the Plunge. 96 Ibid

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Zakee Ahmed 604882 According to a report by the IMF, and the brief overview above, the 1986 oil price crisis was predominantly due to the supply-side, whereas the 2008-2009 crisis was “almost entirely demand-driven”.97 The most recent oil price shock that began in 2014 can be said to be mostly responsible for supply-side reasons.98 In 2014 China, the second largest global consumer of oil, dropped its demand for the hydrocarbon, with Brazil, Russia and India also lowering oil intake.99 The price of oil works in terms of basic economic supply and demand. With both the US and Canada using unconventional methods of fracking for domestic oil extraction and production, the overall reduction in demand caused the price of oil to drop. In response, Saudi Arabia, the de facto leader of OPEC, increased production massively to crush those in the U.S. using fracking methods, however this excess supply caused the price of oil to plummet.

Fiscal Policies

In Saudi Arabia, oil revenues comprise of approximately 90% of government fiscal revenues and around 85% of export revenues. 100 Similarly the UAE, commonly proposed as a more diversified and less petrochemical dependent economy, relies on oil and gas for 65% of the total government fiscal revenue,101 with more than 50% of total revenue 97 Op Cit. International Monetary Fund (IMD). Global Implications of Lower Oil Prices 98 Ibid 99 Ibid. 100 International Monetary Fund (IMF), (2015). Saudi Arabia: Selected Issues. [online] Washington, D.C. Available at: https://www.imf.org/external/pubs/ft/scr/2015/cr15286.pdf [Accessed 26 Mar. 2016]. 101 International Monetary Fund (IMF), (2015). United Arab Emirates: Selected Issues. [online] Washington, D.C. Available at:

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Zakee Ahmed 604882 from exports coming from oil.102 This heavy reliance on oil revenues for government spending in the GCC countries has numerous implications in terms of low oil prices, as a reduction in oil revenues severely limits the governments fiscal capabilities, forcing them to find alternative methods of funding such as drawing upon sovereign wealth funds and reserve assets, introducing taxation, reducing subsidies, and increasing debt through external loans.

One of the most drastic effects of the recent decline in oil prices has been a contraction in fiscal policy measures. The GCC region has recently been characterised by fiscal deficits, which are expected to expand to 12.5% of GDP this year, an increase from 9% in 2015.103 Declining oil revenues have forced governments such as Saudi Arabia and the UAE to reach into bank deposits and dig into foreign reserves. In March 2016, Moody’s, the international ratings agency, identified Saudi Arabia, the UAE, Kuwait, Bahrain and Qatar under a review for a cut in credit ratings.104 Saudi Arabia, amongst Bahrain, and Oman, will fiscally deteriorate at a faster rate than the likes of the UAE, Qatar and Kuwait due to the vast amount of financial reserves that the last 3 countries possess, providing them with

https://www.imf.org/external/pubs/ft/scr/2015/cr15220.pdf [Accessed 28 Mar. 2016]. 102 Al Sadoun, A. (2016). How diversification will drive the UAE through times of low oil prices. The National. [online] Available at: http://www.thenational.ae/business/economy/how-diversification-will-drive-the-uaethrough-times-of-low-oil-prices [Accessed 31 Mar. 2016]. 103 Moody's, (2016). As low oil prices weaken GCC fiscal metrics, reserves and reforms to determine credit outlook. Global Credit Research. [online] Available at: https://www.moodys.com/research/Moodys-As-low-oil-prices-weaken-GCC-fiscal-metricsreserves--PR_345998 [Accessed 13 Apr. 2016]. 104 Saadi, D. (2016). Fiscal deficit of Gulf economies to widen on low oil prices. The National. [online] Available at: http://www.thenational.ae/business/economy/fiscal-deficitof-gulf-economies-to-widen-on-low-oil-prices [Accessed 1 Apr. 2016].

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Zakee Ahmed 604882 with time to adjust their policies whilst sustaining the socio-economic daily needs. Indeed, the IMF outlines this stating that the oil price drop requires oil exporters to endeavour in fiscal adjustments, the size and rate of which depends on the size of buffers that exist within each region.105

Although Saudi Arabia has around $624 billion in its reserve assets (the latest figures from December 2015), the nation has recently cut spending by 13.8% from its 2015 levels.106 Low oil prices have resulted in the nation accruing a 2015 deficit of around 16% of GDP.107 According to SAMA, February and March 2016 marked the first time since January 2009 ( the earliest time frame with statistics online) that the money supply rate dipped into negatives.108

Low oil prices have damaged the fiscal positions of both Saudi Arabia and the UAE. In 2015 Saudi Arabia released a budget plan that had severe plans to cut government spending, reducing its budget deficit an expected 21% of GDP in the fourth quarter of the year, to an actual value of 15% of GDP.109 Meanwhile, analysis of the UAE shows a similar scenario in 105 Op Cit. International Monetary Fund (IMF). Global Implications of Lower Oil Prices 106 Wells, N. (2016). Saudi Arabia struggles to cope with cheap oil. CNBC. [online] Available at: http://www.cnbc.com/2016/01/31/saudi-arabia-struggles-to-cope-with-cheapoil.html [Accessed 20 Feb. 2016].

107 Bloomberg.com. (2015). A Breakdown of the 2016 Saudi Budget and Its

Implications. [online] Available at: http://www.bloomberg.com/news/articles/2015-12-28/a-breakdown-of-the-2016saudi-budget-and-its-implications [Accessed 29 Apr. 2016].

108 SAMA. (2016). Money Supply. [online] Available at: http://www.sama.gov.sa/enUS/Indices/Pages/MoneySupply.aspx [Accessed 20 Apr. 2016]. 109 Bouyamourn, A. (2016). Lower oil prices hit UAE and Saudi Arabia economies. The National. [online] Available at: http://www.thenational.ae/business/economy/lower-oilprices-hit-uae-and-saudi-arabia-economies-latest-pmi-survey-shows [Accessed 13 Mar. 2016].

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Zakee Ahmed 604882 reaction to low oil revenues, with the region growing by a mere 2.8% in the fourth quarter of 2015,110 the smallest value since the period after Dubai’s 2009 real estate crisis.111 Furthermore, an evaluation of data from the Central Bank of the UAE reveals the governments poor fiscal position, with a deficit increase to 19.1 billion dirhams, coupled with a 23% reduction in revenue112 and the start of 2016 indicated a 9.9% fall in government spending compared to the previous quarter.

Exchange rates

For decades, both the UAE and Saudi Arabia, amongst other Gulf countries such as Kuwait, have retained rigid pegs to the U.S. dollar.113 In 1997, the UAE Dirham was fixed at an exchange rate of 3.6725 dirhams to the dollar,114 with Saudi Arabia holding a rate of 3.75 riyals to the dollar since 1986.115 The purpose of these fixed exchange rate systems are twofold: to prevent currency fluctuations, and to eradicate uncertainties in international transactions.116 In doing so, engaging in trade becomes more 110 Op. Cit. Bouyamourn, A. 111 Spencer, R. (2016). Dubai's financial crisis: Q&A. The Telegraph. [online] Available at: http://www.telegraph.co.uk/finance/financialcrisis/6668281/Dubais-financial-crisis-aQandA.html [Accessed 18 Mar. 2016]. 112 Central Bank. (2016). Central Bank of the United Arab Emirates. [online] Available at: http://www.centralbank.ae/en/ [Accessed 18 Apr. 2016]. 113 Luciani, G., Hertog, S., Woertz, E. and Youngs, R. (2012). Resources Blessed: Diversification and the Gulf Development Model. Berlin: Gerlach Press, p.17 114 Central Bank of the United Arab Emirates, (2005). Quarterly July - Sept 2005. Statistical Bulletin. [online] Available at: http://centralbank.ae/en/pdf/StatBull/SBull-q32005.pdf [Accessed 11 Feb. 2016]. 115 Maverick, T. (2016). Saudi Arabia's Big Mess. Wall Street Daily. [online] Available at: http://www.wallstreetdaily.com/2016/01/26/saudi-arabia-u-s-dollar/ [Accessed 17 Feb. 2016]. 116 Raghu, M. (2016). Saudi Arabia and its US dollar peg dilemma. The National. [online] Available at: http://www.thenational.ae/business/economy/saudi-arabia-and-itsus-dollar-peg-dilemma [Accessed 15 Apr. 2016].

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Zakee Ahmed 604882 attractive, and traders will be more willing to invest. A reliance on oil revenues is equal to a considerable reliance on the dollar, as oil exports are purchased in the US currency and thus if the currencies were not fixed, any fluctuations in the exchange rate would lead to a dramatic reduction in oil revenues.

In both Saudi Arabia and the UAE, low oil prices, and thus a decline in oil revenues, strains the countries’ fiscal balances and hinders economic growth, starkly contrasting an expanding US economy with a growing interest rate. These low oil prices have presented substantial pressures on the countries’ currency policy, due to the amplified cost of maintaining the fixed rate to the peg. This is more consequential for Saudi Arabia as more than 73% of government revenues come from the oil sector, compare to 50% of the UAE, making them more dependent on the US dollar.117 However, both countries are left with an ultimatum: is the fixed exchange rate sustainable enough for them to follow US monetary policy, or is the pressure so significant that they need to reconsider and devalue?

If they choose to follow suit and maintain the fixed exchange rate, the squeeze in monetary conditions may come at the risk of a loss in growth. SAMA suggests that a 100 basis point increase in SIBOR (the kingdom’s interest rate) will be followed by a drop in 90 basis points in GDP in the following quarter, and 95 basis points in the quarter after.118 If the countries’ choose to deviate from the peg, arbitrage opportunities would 117 Ibid 118 Op. Cit. Rughu, M. Saudi Arabia and its US dollar peg dilemma 35

Zakee Ahmed 604882 arise from the different in interest rates between the two currencies. Saudi would have to buy riyals by selling dollars from its reserves, in order to counter this. Furthermore, an increasing US interest rate would require SAMA to diminish its foreign-exchange reserves up to the point that it depletes all of its dollars. With Saudi’s estimated $87 billion deficit in 2016, clearly this has huge cost implications.119 Thus, low oil prices can be seen to present a strenuous pressure on oil-exporting countries.

However, analysing the riyal against the dollar (shown in figure #) in correlation with low oil prices reveals that the currency faced similar pressures during the decline in oil prices of 1993 and 1998, with the currency stabilising over a given amount of time. In fact, according to the international lender Standard Chartered:

“Although speculation and the move in currency forwards could continue in the short term, our view is that the Saudi Arabian Monetary Agency (SAMA) is in control of the currency. FX reserves are almost double Saudi Arabia’s money supply. In addition, SAMA is effectively the sole provider of USD and SAR liquidity to Saudi banks.”120

119 Ibid 120 Op Cit. Kaminska, I. 36

Zakee Ahmed 604882 Figure 2: Dollar to Riyal exchange rate fluctuations121

The Bank of International Settlements reveals that the dirham increased by approximately 10% in real terms in 2016122 against the UAE’s trading partners, increasing real estate prices and thus further hindering growth in the region. Effectively, the spot-rate fluctuations are a result of speculation.

Economic Diversification

The IMF contends that “low oil prices also underscore the need for real and financial sector reforms to foster diversification of oil exporters’ economies”.123

121 Kaminska, I. (2016). Busting currency pegs, Saudi Arabia edition. The Financial Times. [online] Available at: http://ftalphaville.ft.com/2015/02/06/2115381/bustingcurrency-pegs-saudi-arabia-edition/ [Accessed 20 Mar. 2016]. 122 Bouyamourn, A. (2016). Lower oil prices hit UAE and Saudi Arabia economies. The National. [online] Available at: http://www.thenational.ae/business/economy/lower-oilprices-hit-uae-and-saudi-arabia-economies-latest-pmi-survey-shows [Accessed 13 Mar. 2016]. 123 Op Cit. International Monetary Fund (IMD). Global Implications of Lower Oil Prices

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Zakee Ahmed 604882 In 2012, Luciani contended that for countries such as Kuwait, Qatar, Saudi Arabia and the UAE, “the time when oil revenue will start declining because of declining oil production and prices not increasing enough to compensate, is decades away”.124 However, this paper has shown that this statement is not entirely true, there is indeed a pressing risk of low oil revenues to countries in the GCC amongst other oil-exporting countries. For decades, oil-exporting governments have attempted to diversify their economies with an aim to become less reliant on oil revenues by boosting the non-oil sector. High oil prices usually decompose the priority of such aims as governments sit in vast amounts of ‘petrodollars’ and spend with no budgets, no limitations and virtually no accountability to anyone but themselves. However, low oil prices can be said to almost have a positive effect in this respect to the likes of Saudi Arabia and the UAE, as the reduction in oil revenues, through fiscal constraints and worries about deficits, incentivises governments to actually invest time, money and thought into diversifying their centralised economies that rely so heavily on oil. Luciani alludes to this, stating “periods of rising oil prices and revenues have generally distracted the governments from pursuing economic diversification, although the diversification priority became a prime objective again during periods of falling oil prices and rising budgetary deficits”.125

124 Op. Cit. Luciani, G., Hertog, S., Woertz, E. and Youngs, R. Resources Blessed: Diversification and the Gulf Development Model, P.27 125 Ibid, P.6

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Zakee Ahmed 604882 Many economists have expressed the need for oil economies to diversify their economy in terms of expanding the non-oil good sector even further. The UAE, which once used to be primarily oil based, acts as a pivotal example of an economy that has succeeded in diversifying its economy, making it less susceptible to oil price shocks and more accessible to draw upon financial resources from other avenues than hydrocarbons. 2010 marked the launch of vision 2021, the UAE development plan with the aim of a sustainable future, less reliant on oil, through investing in new high growth sectors using an international competitive advantage.126

The threat of low oil prices has resulted in the region as a whole investing in the vast petrochemicals industry, which started in the early 1970s out of necessity rather than as an aim to diversify, by utilising he gas byproduct emitted in the oilfields, which was a huge source of pollution, not to mention an unnecessary exhaustion of natural resources. The downstream hydrocarbon industry in the GCC is mainly (95%) represented by the GPCA, who claim that, being the second largest manufacturing sector in the region, they represent 2.9% of the region’s GDP, representing $97.3 billion.127 Given that the UAE constitutes a 11.9 million tonne petrochemical portfolio, 128 and overall the industry employs more than 148,900 people,129 from a macroeconomic perspective, the fear of

126 Op.Cit. Central Bank of the UAE. 127 Gulf Petrochemicals & Chemicals Association. (2014). Petrochemicals and Chemicals In The GCC. [online] Available at: http://www.gpca.org.ae/gpca/theindustry/petrochemicals-and-chemicals-in-the-gcc/ [Accessed 2 Apr. 2016]. 128 Op. Cit. Al Sadoun, A. How diversification will drive the UAE through times of low oil prices. The National 129 Ibid

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Zakee Ahmed 604882 low oil prices has given rise to vast socioeconomic benefits to these economies.

Although the petrochemical industry actually relies on oil as a major input, analysis of the price trends shows that the impact of lower oil prices does not fully transfer over to the price of polyethylene, the main plastic product involved in the petrochemical industry. During the period of June 2014 to January 2016, the price of oil declined by 72%, whilst the global polyethylene price dropped by 35%.130 In fact, in all the major oil price drops since 2003, notably the global financial crash in 2008 and the euro debt crisis in 2012, polyethylene prices were less volatile.131 This relatively smaller price drop illustrates the weakened volatility in the petrochemical goods compared to their upstream counterparts.132

This shows how the GCC has actually succeeded in some respects in diversifying their economies. The GPCA creates 3 additional jobs in supporting industries for every job created in the petrochemicals sector, 133 thus benefiting not only the wealthy in the region but also the middle and lower class. Abdulwahab Al Sadoun, the secretary general of the GPCA, advocates that low oil prices should not be seen as as a time of crisis, rather than “dwelling on the negatives”, powerful countries such as Saudi

130 Op. Cit. Al Sadoun, A. How diversification will drive the UAE through times of low oil prices. The National 131 Ibid 132 Ibid 133 Gulf Petrochemicals & Chemicals Association. (2014). Petrochemicals and Chemicals In The GCC. [online] Available at: http://www.gpca.org.ae/gpca/theindustry/petrochemicals-and-chemicals-in-the-gcc/ [Accessed 2 Apr. 2016].

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Zakee Ahmed 604882 Arabia and the UAE should see this time as “an opportunity to evolve rather than decline”.134

Politics The economic diversification of the UAE has acted as a buffer to the effects of low oil prices, however; Saudi has experienced significant turmoil, especially politically. As aforementioned, stable oil prices allow for rentier states to have continued access to funds, which in turn guarantees their political survival and that of the economy. With lesser funds in periods of lower oil prices, Anoush Ehteshami has outlined how Saudi Arabia needed to implement taxation, direct and indirect, cut subsidies, privatize and abolish some free facilities, which stimulated political opposition and desire for representation across the whole of the Arabian Peninsula in the 1990s, most notably following the oil collapse in 19841986. 135 During that period, pressure on Saudi King Fahd from his citizens, religious and liberal, as well as a business petition signed in 1990 pushed the Kingdom to introduce its first consultative body, ‘Majlis al Shura’ by 1993.136 Citizens had called for an extension of the Sharia Law, more freedoms and the consideration of economic reforms in view of the financial turmoil of the preceding 10 years.137 This was followed by a wave of reforms including the establishment of petitions in 1995, and a new 134 Op. Cit. Al Sadoun, A. How diversification will drive the UAE through times of low oil prices. The National 135 Ehteshami, A. and Wright, S. (2008). Reform in the Middle East oil monarchies. Reading, Berkshire, UK: Ithaca Press, P.59 136 Ibid 137 Ibid

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Zakee Ahmed 604882 press and publication law in 2001, allowing for the freedom of independent publishers to print.138 These increased political freedoms and the newly individual agency of the Saudi citizen, is of crucial importance since it marks a departure from a rentier state with complete control over the public, to an increasingly democratic political body.

These responses to low oil prices can perhaps act as a warning to Saudi Arabia by illustrating that their authority can be greatly undermined by low oil revenues. In line with Ross and Mitchell’s arguments on ‘no taxation without democracy’, the Saudi government was forced to respond to taxation as a result of low oil prices, with an increased amount of political freedoms. Given that only 26% of Saudi’s GDP is generated from other sources of income,139 the question arises thereafter, of how far Saudi will go in providing more freedoms, and political participation in response to the necessity of taxation due to a lack of funds in periods of low oil prices, to please its population. Unless other sources of income are incited, like the situation in the UAE, a shift towards a more democratic rule would surely decompose the distribution structure of the rentier economy, which is currently in the hands of a small group of elites.

Recent requests for loans of up to $8 billion to keep “public finances afloat”140 perhaps help to illustrate current fears over the recent drop in oil

138 Ibid 139 Op.Cit. Raghu, M. 140 Reuters UK. (2016). Exclusive: Saudi Arabia seeks $6-8 billion bank loan to shore up state coffers. [online] Available at: http://uk.reuters.com/article/us-saudi-loanidUKKCN0WB0K1 [Accessed 11/04/2016]

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Zakee Ahmed 604882 prices from $100 in 2014, to $30 in March 2016.141 Not only has Saudi requested loans but it has also started to sell its foreign assets and is promoting domestic bonds.142 It is clear that the current regime in Saudi is attempting to maintain control and order of the rentier state and economy from these initiatives, perhaps with the fear of needing to hand over further power to the public, as witnessed in earlier oil price drops. Although they appear to be attempting to maintain a healthy income of funds, perhaps in order to reduce public havoc, the recent austerity measures and plans for the introduction of VAT, as well as taxes on soft drinks and tobacco,143 suggest that the current economic reforms may be followed by political reform, which may well occur in conjunction with renewed demands for representation. Both Qatar and Oman have also asked for loans144 this year while the UAE has proven to be immune to these political developments, since they have access to other sources of income as previously discussed.

Entrepreneurialism

In recent years, the UAE has had a strong focus on including entrepreneurialism in their strategies aimed at further diversifying their economy. By investing capital, time and education into small business 141 Ibid 142 Sheffield, Hazel. (2016) More Details Have Emerged About Saudi Arabia's First Bank Loans More Than a Decade. The Independent. http://www.independent.co.uk/news/business/news/saudi-arabia-is-looking-for-6-8-billionin-bank-loans-to-keep-its-public-finances-afloat-a6922546.html [Accessed 29/04/2016] 143 Ibid 144 Ibid

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Zakee Ahmed 604882 initiatives, the government produce incentives for individuals to flourish and not only succeed and raise capital for themselves, but also for the regional economy. Low oil prices can be said to be a cause for the drive to invest in entrepreneurship due to the fear of running huge debts, stagnating economic growth and huge unemployment in both the UAE and Saudi Arabia

The success of the UAE can be put down to a variety of reasons. Launched in 2007, Abu Dhabi invested in an independent agency, the Khalifa Fund for Enterprise Development, which serves to train and fund Emirati entrepreneurs and small businesses.145 Furthermore, Dubai SME, an integrated division of the Department of Economic Development in Dubai,146 acts as a hub for local entrepreneurs to transform their ideas into successful businesses, as well as to support them in all developmental phases of the potential business.147 The striving businesses start-ups can be seen as a buffer for low oil prices . On the other hand, Saudi Arabia is characterised with isolationist policies and a severe amount of ‘red tape’ on businesses, for example for a foreign worker to perform business in the region they must work in alliance with a national. Furthermore, the amount of legal administrative work in setting up a business in both regions is well in excess when compared to the UK, for example.

145 Khalifa Fund. (2016). About Khalifa Fund. [online] Available at: https://www.khalifafund.ae/SitePages/Home.aspx [Accessed 29 Apr. 2016]. 146 Dubai DED. (2016). Department of Economic Development. [online] Available at: http://www.dubaided.gov.ae/English/Pages/default.aspx [Accessed 22 Mar. 2016]. 147 Dubai SME. (2016). About Us. [online] Available at: http://www.sme.ae/English/aboutus/Pages/default.aspx [Accessed 22 Mar. 2016].

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Zakee Ahmed 604882

Final comments and conclusions

Saudi Arabia and the UAE, along with the GCC and other oil-exporting countries, face a vast number of obstacles to achieving a sustainable, economically healthy, and socially advanced future. The continued extensive dependency on the hydrocarbon industry has proved two things: that vast, wealthy and advanced economies can strive on the sale of a natural resource, time and time again, and that reliance on a natural resource can have serious implications for a country.

Since the start of the trade in oil, the price of the commodity has fluctuated recurrently. This paper has shown the extent of these fluctuations, briefly outlining how they are determined by basic supply and demand in the global market. This paper takes the stance that OPEC, once a manipulative, powerful, dominating cartel, is no more. The U.S, once a net oil importer, now produces around 9.3 million barrels of crude oil a day,148 approximately equal to that of which Saudi Arabia producers. With non-OPEC supply on the rise, and a weakened global demand for oil, OPEC have truly lost a significant share of their market power. Furthermore, a growing worldwide interest in renewable forms of energy pose huge threats to the oil dominant economies in the Gulf. Unless they gradually invest more finance and time into the technological, capital and

148 Petroleum & Other Liquids - U.S. Energy Information Administration (EIA) 2016Energy Information Administration (EIA). https://www.eia.gov/petroleum/, accessed April 20, 2016.

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Zakee Ahmed 604882 physical production of renewable energy, hydrocarbon dependents severely risk being left behind.

From a macroeconomic perspective, this analytical paper has portrayed that one of the most severe and significant threats from declining oil prices is that of fiscal unsustainability. Saudi Arabia would have to sell oil at $87.20 per barrel just to break even,149 however based on historical analysis on oil prices, this price seems far away. The UAE’s target is very similar, at $73.60.150 Both countries have huge sovereign wealth funds and foreign reserve assets, however this can only buffer low oil prices in the short run. Indeed, the IMF has warned the Gulf in 2015 to tread with care on their reserves, stating that countries apart from Kuwait, Qatar and the UAE would spend their funds within 5 years.151 Thus, both countries along with the GCC need to implement medium to long term fiscal policy reforms in order to sustain economic growth and political peace and in order to avoid outright bankruptcy, with Saudi Arabia facing a more imminent pressure than the UAE. Drawing on this, this paper has tended to have a slightly heavier emphasis on Saudi Arabia rather than the UAE, due to the fact that Saudi are much less economically diversified than its GCC member. However, both the UAE and Saudi Arabia have implemented such reforms with efficiency following the recent drop in oil prices, perhaps suggesting that low oil prices have in fact created a ‘window of

149 Vela, J. (2016). Year in review 2015: Plunging oil prices. The National. [online] Available at: http://www.thenational.ae/business/energy/year-in-review-2015-plunging-oilprices [Accessed 14 Jan. 2016]. 150 Ibid 151 Op. Cit. Vela, J.

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Zakee Ahmed 604882 opportunity’ for the oil rentier states. In 2015 for the first time the UAE reduced subsidies, also increasing the price for electricity and water. Saudi Arabia has taken a similar stance.

This paper proposes that low oil prices has a strong effect on Saudi Arabia and the UAE in terms of economic diversification, entrepreneurship, fiscal policy, exchange rates, unemployment and politics. However, it should not be assumed that low oil prices are the most significant worry to the region. Youth unemployment, higher than 25% in most GCC countries,152 threats of terrorism from states such as Egypt, a lack of clean water and food security for neighbouring countries such as Yemen, and an increasing amount of poverty in the MENA region, presents huge challenged for the region as a whole to tackle in the future. The GCC should look past the problematic nature of low oil prices, and grab the opportunity to structurally transform their economies for the future generations to come.

152 Rethinking Arab Employment. (2016). Introduction. [online] Available at: http://reports.weforum.org/rethinking-arab-employment/introduction/ [Accessed 29 Apr. 2016].

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