Houthi-allied tribesmen in Yemen brandish their weapons

Oil prices shape Gulf states’ geopolitical moves

  • Gulf states are facing huge budget deficits due to low oil prices
  • They are already beginning to reduce spending on military, foreign aid and domestic programs
  • The biggest geopolitical impacts include reduced funding for Egypt, less involvement in the Yemen conflict and a burgeoning partnership with Russia

The countries of the Gulf Cooperation Council (GCC) – Bahrain, Kuwait, Oman, Qatar, Saudi Arabia and the United Arab Emirates – have all been hit hard by the precipitous drop in oil prices over the past two years. The degree to which each of these states has been affected varies, but all have had to reduce spending. This has important geopolitical impacts – from reduced funding for aid and military activity, to cuts in domestic spending that could escalate instability.

Low oil prices will force GCC members to run budget deficits for at least the next five years. Their spending plans were calculated with an assumption that oil prices would come to about $85 per barrel on average. Today, oil prices are about 40 percent lower, hovering near $50. The countries’ combined losses in 2015 were estimated at some $350 billion. Despite a gradual recovery in oil prices, the losses may rise to as much as $500 billion in 2016 as expenditure commitments pile up.

There are two major differences among GCC members. First is the size of the shortfall in cash flow they are facing. Saudi Arabia’s is the biggest: its budget can be balanced only with oil costing about $101 per barrel. The UAE comes out in the best shape – its budget breaks even with oil at approximately $70 per barrel.

Low oil prices will force GCC members to run budget deficits for at least the next five years

The second major difference is between the GCC’s oil producers (Saudi Arabia, the UAE, Kuwait, Bahrain and Oman) and Qatar, whose main export is gas. The fall in gas prices has also put a big dent in Qatari finances, though the country’s main spending commitments are mostly domestic, and therefore easier to control. Saudi Arabia and the UAE, in contrast, have to shoulder foreign spending commitments, including aid and military initiatives.

In order to plug the gap, both Riyadh and Abu Dhabi have resorted to liquidating many of their investments around the world. For Saudi Arabia, this amounted to a reported $70 billion in 2015. At least some of the recent jitters in global equity markets come from fears that the GCC states’ sovereign wealth funds will continue to pull cash out of their equity investments – and potentially debt, particularly United States treasury bonds.

The main geopolitical effects include reduced funding for Egypt, the search for an exit from the Yemen conflict, as well as dialogue with Russia on cooperation between OPEC and non-OPEC countries, which will inevitably lead to a compromise on Syria. GCC countries will hold back domestic spending on infrastructure, welfare and subsidies. They will also implement new taxes and try to manipulate oil production quotas to impede Iran’s reentry into global markets.

Egypt aid

Saudi Arabia, the UAE and Kuwait have underwritten Egypt’s stability ever since the Muslim Brotherhood was removed from power in 2013. Together, these countries have pumped some $17 billion into various forms of aid for Cairo. Qatar, which has a long history of supporting the Muslim Brotherhood, had subsidized the previous government in Egypt (arousing significant consternation from its GCC sister states). The new funding replaced the Qatari money, as well as $2 billion in annual aid from the U.S. (Washington cut off the money on the accusation that the overthrow of the Muslim Brotherhood regime had amounted to a military coup against a democratically elected government.)

GCC countries will have less leverage to influence Cairo’s foreign policy choices through aid

But the collapse in oil prices has led Saudi Arabia and the UAE to rethink their near-open financial commitments. King Salman’s April 2016 visit to Egypt was in part designed to push the funding away from pure largesse and toward more economically sustainable measures, including loans, infrastructure projects and private equity investments.

The most likely scenario is therefore the restoration of balance to the relationship between Egypt and the GCC states. Egypt is well on its way to becoming a regional power again and GCC countries will have less leverage to influence Cairo’s foreign policy choices through aid. However, Egypt’s recent rise in domestic trouble – which has led the government to clamp down on journalists – could sap energy away from priorities abroad.

Yemen exit

The second geopolitical impact of falling oil prices is the search for a way out of the military campaign in Yemen, the cost of which by now exceeds $50 billion. Most of this expense has been footed by Riyadh and Abu Dhabi. In addition to equipment and ammunition, they are reportedly paying for mercenaries, mainly from South America and South Africa. These are expenditures that need to be paid for promptly, and their impact on the budget is immediate.

The Iran-backed Houthis have proven tough, well-supplied and well-trained adversaries. They have not buckled under military pressure and prevented the Saudi-UAE forces from gaining victories early on. The conflict has become a stalemate, with Riyadh and Abu Dhabi emphasizing air power. However, the bombing of civilian targets has lost them the support of the international community.

A construction team works on a high-speed railway in Saudi Arabia
Saudi Arabia will likely cut back on infrastructure initiatives, such as this high-speed rail project to connect the cities of Mecca and Medina (source: dpa)

In the most probable scenario, Riyadh and Abu Dhabi will turn down the intensity of their campaign. This will mean ceding the initiative to the Houthis (and potentially by extension Iran) to determine the direction of the conflict.

Relationship with Russia

The emerging Saudi Arabia-Russia rapprochement has several drivers, including the loss of faith in U.S. Middle East policy, the shale revolution, and Moscow’s rising influence in the region, evidenced with the presence of its naval and air bases on Syria’s Mediterranean coast. Falling oil prices are hitting Russian finances as well: its budget breaks even at $106 per barrel. This has led Riyadh to attempt to ally Russia with OPEC. The resulting “Super OPEC” could control some 45 percent of global oil production.

Riyadh and Abu Dhabi will turn down the intensity of their campaign in Yemen

Accomplishing this will require Riyadh to come to an understanding with Moscow over the war in Syria. Russia supports Syrian President Bashar al-Assad, while Saudi Arabia is demanding his immediate ouster. The benefits that a detente would offer – especially in fiscal terms – make compromise likely. The most probable scenario involves the sides agreeing to allow Mr. Assad to head a transitional government; he would be removed after a new, permanent government is put in place.

Domestic spending

The strain on budgets has led GCC states to try to rein in their welfare and infrastructure programs. In Saudi Arabia, these amount to some $500 billion over the next five years. The UAE’s ambitious Plan 2030, which includes funding for transportation, housing and energy sector investments, also depends on high oil prices. Banking sector liquidity, the engine of both oil wealth distribution and money circulation, has all but dried up for most of the private sector, straining businesses. A sign of this came at the end of April, when construction company Saudi Binladen Group, one of the largest contractors in the region, laid off 50,000 workers.

Saudi Arabia and the UAE have young populations – more than 50 percent are under 21 years old – and significant income disparities. Considering this, the most likely scenario is for the countries to enhance domestic security measures to mitigate the impact of falling domestic expenditures and enable a continuation of external spending, albeit at reduced levels.

The collapse of OPEC negotiations on production cuts are a harbinger of things to come

One of the most important unknowns is the impact of introducing value added tax (scheduled for 2018 in both countries) and reducing utility subsidies. These countries have little culture of taxing income, and many ordinary citizens suspect that such measures are only meant to benefit particular individuals, rather than the state as a whole. The timing will be critical to how the populace reacts.

Iran factor

The collapse of OPEC negotiations on production cuts – which Riyadh insisted Iran also make – are a harbinger of things to come. This is perhaps the purest example of the impact of low oil prices on geopolitics in the region.

Iran needs to replenish its coffers by producing as much oil as it can sell. Riyadh wants to manage supply to support prices. Both consider the other its archenemy, and both know that each will benefit only at the expense of the other. It seems this clash will only intensify.

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