III. Oil Market Outlook, Global Setting, and Regional Developments
The economic outlook of the GCC countries, including ability to meet their major challenges, will be shaped most directly by factors influencing the demand for oil and oil products. Oil and gas revenue account on average for about 75 percent of total government revenue and such exports comprise 65 percent of total exports (Chart 6). While there are variations among countries, these shares are nevertheless significant in all countries.
Besides the obvious impact on government finances and the balance of payments, changes in oil earnings have broader implications for domestic economic activity in the GCC countries. Non-oil economic activity is heavily influenced by domestic government expenditure, which itself is dependent on oil revenue. Moreover, most large-scale economic activities in the public domain (petrochemicals and oil-based basic manufacturing) are closely linked to developments in the oil sector.
The continuing weakness in real oil prices reflects structural changes in the international oil market reinforced by: (i) technical innovations involving both a lower energy intensity in production and a greater substitution of other energy sources; and (ii) increases in global oil reserves and oil production outside the GCC/OPEC area.
As the structural elements are unlikely to be reversed over the medium term, the outlook for oil prices in the period ahead depends most directly on the pace of economic recovery in the major consuming regions and on the increase in supplies from non-OPEC sources. An added uncertainty is the possible re-entry of Iraq as a major exporter of oil, which would have a dampening effect on oil prices to the extent that the additional supplies could not be accommodated by lower output from other producers.
Most analysts seem to agree that the combination of slow increase in global demand for oil, higher output from other regions, and increased market penetration by non-OPEC countries will dampen oil prices and limit gains in market share by the GCC countries in the period ahead. On this basis, the GCC countries' average oil export price is projected to rise only marginally in nominal terms--thus declining in real terms--and export volumes to expand by only 1 percent annually through the end of this decade. In the process, while the GCC countries would contribute about one half of total OPEC output, OPEC output as a share of global demand for oil is expected to decline from about 40 percent in 1995 to 37 percent by the end of the decade.
Against the backdrop of an uncertain oil market, adjustment efforts in the GCC countries are being implemented within an international economic environment which is undergoing fundamental changes on several fronts. Two trends are of particular importance:1
• First, the ongoing global trade liberalization is expected to gradually lead to lowering of tariffs; dismantling of nontariff trade barriers; reduction in producer subsidies; expansion of trading blocks; and the strengthening of the institutional framework under the auspices of the World Trade Organization.2
• Second, the continuing globalization and integration of financial markets will further facilitate private capital flows and create new financing options for many developing countries, along with greater risks.
There would naturally be short-term costs associated with the resulting resource reallocation, but these trends also offer significant potential for welfare gains in developing countries if proper conditions are in place. The basic and perhaps the most important requirement is a stable domestic macroeconomic setting. Within this framework, a large and adaptable trade sector and a sufficiently diversified economic base would be required in order to benefit from a rapidly changing international trade environment. Moreover, the benefits to the economy from closer links to international capital markets could only be maximized through a diversified domestic financial sector and open and well-functioning markets which are well supervised and regulated.
At first glance, the GCC countries with their open and liberal trade regimes and a large external trade sector appear to be well-placed to benefit from the global trade reforms. However, the conventional measures of the degree of openness and the extent of integration of the GCC economies with the rest of the world need qualification. While in the GCC countries the share of total external trade to GDP (almost 100 percent in 1992-94) is probably among the highest in the world, and per capita exports (US$4,000 in 1994) reach the levels of industrial countries, these measures of openness are heavily influenced by oil trade (Chart 7).
Given the present production and export structure, the direct benefits to the GCC countries from the global trade reforms are likely to be limited, at least initially:
• On the export side, the reforms would be neutral to GCC exports of oil and oil-related products and, under the existing restrictions on GCC exports of petrochemical products, the benefits would be small. Other exports and re-exports are largely to other countries in the region and are unlikely to be affected directly by global trends.
• On the import side, the anticipated gradual reduction in food subsidies in the European countries is expected to raise the cost of food imports. However, the impact on the GCC countries would be relatively small as some countries are becoming increasingly self-sufficient in basic foodstuffs, or rely to a large extent on food imports from the region.
Accordingly, the global trade reforms would be expected to have at best a neutral impact on the GCC countries in the short run, while the longer term benefits would depend on the success of efforts to diversify the economies.
Despite liberal exchange policies, the links between the equity markets in the GCC countries and the international capital markets have not been strong because: (i) there are restrictions on direct foreign participation in domestic equity markets; (ii) the financing requirements of a dominant public sector have been typically met through bank borrowing; and (iii) equity markets have been dominated by a few large--and mostly closed and family owned--private sector companies.3 At the same time, excluding joint ventures in the oil and gas sectors, direct foreign investment in the GCC countries has been insignificant because of the small domestic market, public sector control on major operations (e.g., petrochemical industries), and the high cost of production.4 As such, the direct benefits to the GCC countries from a closer integration of capital markets would only be significant if the domestic markets become more diversified and open.
There are two important developments shaping the Middle East. First, the prospect of a comprehensive, just, and durable solution to the Arab-Israeli conflict has raised optimism for reallocating over time resources in some countries from military expenditure to more productive uses at a time when investment disincentives associated with sociopolitical risk factors would be reduced.5 Second, the recent European Union (EU) initiative aimed at promoting investment flows, removing trade barriers, and creating free trade zones has improved the prospects for a closer economic integration between Europe and the countries in the Mediterranean basin.
The resolution of the Arab-Israeli conflict would be expected to expand trade and investment opportunities in the Middle East over time, particularly joint-venture projects. Indeed, some GCC countries have already explored such projects in the energy field. The overall benefits would, of course, be much smaller than those that could accrue to the "front line states" from the resolution of a prolonged and costly conflict.
The direct positive spillover to the GCC countries from the closer integration between some countries in the region and Europe would be relatively small at the outset. The EU initiative does not cover the GCC countries at this time. Moreover, the taxation of petroleum imports remains a highly contentious issue in the discussions between the GCC and EU countries. Nevertheless, there could be some indirect effects from the expected broader implications of closer economic links between some of the Middle Eastern countries and the EU.