Jadwa Special Report: Oil Market Boosts Economic Outlook

Published: April 9, 2012

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Editor’s Note:

Saudi Arabia’s Minister of Petroleum and Mineral Resources Ali Al-Naimi was critical of high oil prices last month, writing in a Financial Times op-ed:

“High international oil prices are bad news. Bad for Europe, bad for the US, bad for emerging economies and bad for the world’s poorest nations. A period of prolonged high prices is bad for all oil producing nations, including Saudi Arabia, and they are bad news for the energy industry more widely.”

Well, that may be true but increased revenue is an obvious short term silver lining for Saudi Arabia to be had from a run up of oil prices on the global market and the Kingdom’s increase in production to meet global demand. That combination is likely to press Saudi Arabia’s oil income in 2012 to record highs according to Riyadh-based Jadwa Investment.  Today Jadwa released a special report that revised their economic forecasts including reaching record large budget and current account surpluses.  We are pleased to share that report here for your consideration and thank Mr. Paul Gamble, Jadwa Head of Research and his colleagues for the insightful reports they produce.  They have become an invaluable collection of resources for understanding developments in Saudi Arabia’s economy.  SUSRIS’ reprinting of these reports regularly includes links to the original printing which provides very important charts and graphs.  Today we are pleased to add a link to the Arabic version of the original report in addition to a link to the English version.


[Complete report [English] with very helpful charts, graphs and tables at this link.]

[Complete report [Arabic] with very helpful charts, graphs and tables at this link.]


Buoyant oil market boosts economic outlook

Oil markets have been tight so far this year, with prices and Saudi production above our expectations. We have revised up our forecasts for both, meaning that oil revenues will be at a record level in 2012. This will enable the Kingdom to record large budget and current account surpluses. We have kept most of our assumptions for the non-oil economy unchanged. Early data show that the performance of the non-oil economy has been strong over the first few months of 2012, which is in line with our forecast.

The key pressure point in global oil markets is Iran. Threats of military action against Iran’s nuclear program and worries about potential retaliation have added a risk premium to prices and the ongoing tightening of sanctions against the country has compelled some buyers of its crude to turn elsewhere. Independent sources report that Iranian output in March was the lowest for a decade, with EU imports falling in advance of a complete ban on Iranian oil imports from July and the US threatening sanctions on financial institutions that transact with the Iranian Central Bank (the main recipient of the country’s oil receipts).

Source: Jadwa

These tensions have been aggravated by disruptions to supply, most significantly in South Sudan, but also in Syria, Yemen and the North Sea. In response, the Kingdom has held production at a very high level. Official data put oil production at 9.87 million barrels per day in January and the Oil Minister has indicated that output reached 9.9 million barrels per day in March. Additional supply from the Kingdom has been sufficient to meet demand for oil, but it has been unable to reduce the risk premium currently attached to oil prices. Indeed, the more the Kingdom produces, the lower its spare production capacity becomes, meaning the smaller the cushion to cope with new supply disruptions. Concerns about available spare production capacity are weighing on market sentiment.

Uncertainty about oil supply is encouraging some emerging market consumers to increase stocks. There are reports that India, China and other Asian countries are adding to their strategic reserves, which is putting more pressure on demand. At the same time, commercial stocks in OECD countries at the end of January were below their five-year average for the seventh consecutive month according to the International Energy Agency (IEA). Furthermore, global demand has strengthened and economic data from the US, Japan and many other Asian economies has generally been encouraging so far this year. The closure of nuclear facilities has also boosted oil demand from Japan.

As a result, Brent crude has averaged $120 per barrel so far in 2012. We have revised up our forecast for Brent to reflect the current high level of prices and now expect it to average $111.9 per barrel this year. We still anticipate that oil prices will fall during the remainder of the year. The demand outlook remains fragile, not least because of the impact of high oil prices on economic growth. The Eurozone is set to spend most of the year in recession and ongoing debt reduction (by public and private sectors) will dampen growth in much of the world. The weaker backdrop will affect emerging markets.

In contrast, global oil supply has been buoyant. Despite the drop in Iranian output, total Opec supply is estimated by Bloomberg at 31.2 million barrels per day in March, the highest since October 2008 and 9 percent higher than in March 2011. Iraqi output is the highest for over a decade and Libyan production has climbed to around three- quarters of its pre-conflict level. Although it will take longer for the remaining Libyan output to return, as this requires the return of skilled expatriates (which needs an improvement in security conditions), Iraqi output should continue to rise and non-OPEC supply is expected to pick up. There is also a strong chance that IEA members will release oil from their strategic stocks.

Softening demand and rising supply will lower oil prices. In addition, we think the most likely scenario is that an accommodation will be reached between Iran and its adversaries that will allow tensions to defuse, putting further downward pressure on prices. The Kingdom has publically stated its discomfort with the current level of prices and will keep output high until prices begin to ease, but as this gathers momentum we expect a gradual decline in oil production. Nonetheless, with output greater than we had previously expected, we have revised up our forecast for average Saudi oil output in 2012 to 9.6 million barrels per day.

Higher oil revenues will boost the Kingdom’s budgetary position. Oil revenues are the source of around 90 percent of budget revenues, which are now expected to reach an all-time high of SR1.15 trillion. We do not think that the government will respond to another year of bumper oil revenues by increasing spending. The one-time nature of the payments made in the first half of last year (such as the bonus to public-sector workers) means it is likely that government spending will be lower this year than it was in 2011, though we have made an upward adjustment to our forecast to SR757 billion, in part because there look to be more recipients of unemployment benefit than we had anticipated.

The bulk of the extra oil revenues will be used to build up savings in the form of foreign assets at SAMA. SAMA foreign assets were up by $20 billion in the first two months of the year and we expect an increase of more than $100 billion over the whole of 2012. Higher savings give comfort that elevated levels of spending can be maintained for a number of years, as the reserves can be drawn down in the event of revenue shortfalls.

Very high government spending will remain the main stimulus to the economy and high oil revenues have supported business and investor confidence so far this year. Early economic data for 2012 (covering the first two months) has been good. Consumer spending, cement sales and various measures of imports were all well up on the same period of last year and in line with or above the fourth quarter level. Our impression is that progress on awarding contracts and project implementation has been stepped up, major new projects have been launched recently and business surveys paint a generally strong picture. This is in line with our expectations and we have not altered our forecast for non-oil growth, but the increase to our projection for oil production means we have raised our target for total real GDP growth to 5.1 percent.

Although strong domestic demand has pushed up inflation this year, we maintain our view that the weak external environment will cause inflation to moderate over the remainder of 2012. International food prices are down almost 10 percent in year-on-year terms (according to the UN Food and Agriculture Organization), gold prices are close to a three-month low and most other commodity prices have been fairly subdued. There is little sign of dollar weakness or underlying inflationary pressures in the global economy, though oil prices are beginning to push up headline inflation rates. For the Kingdom, rents are the main risk to our inflation forecast. Rental inflation has jumped from 8 percent in December 2011 to 9.3 percent in February. It appears that higher incomes and government payments have lifted demand for rental property and encouraged landlords to raise rents. Once a sufficient supply of new government housing becomes available, rental inflation will decline.

Higher oil revenues will cause the Kingdom’s external position to remain very strong. We are now projecting a current account surplus of $154 billion (25.1 percent of GDP). No data on non-oil exports is available for 2012, though petrochemical prices suggest they have had a reasonable start. Imports have probably grown rapidly over the 20 first few months of the year. Official data on imports has not yet been issued, but cargos unloaded at the ports (data covers January) and letters of credit opened for new imports (January and February) are both up by over 20 percent in year-on-year terms. Imports of construction materials are up strongly, though foodstuffs lead the way owing to very large grain imports. Although imports will grow at a faster pace than exports this year, they come from a much lower base, so we anticipate a trade surplus of $234 billion.

The risks to our forecast have not changed. Tensions with Iran remain the key risk, and while these have impacted on oil prices, it is not clear that local businesses and particularly stock market investors have fully accounted for them. Aside from this the risks are the same as we outlined in our The Saudi economy in 2012 report issued at the end of last year. While intervention from the European Central Bank seems to have averted a banking crisis and contained the region’s debt problems, for the moment, serious challenges remain and the region is likely to be in recession this year. Budgetary problems, and the political responses they generate, pose important risks across Europe, the US and Japan. Given the willingness and ability of the Kingdom’s government to continue spending, we see little serious risks to our healthy outlook from within the Saudi economy.


About Jadwa Investment - Jadwa Investment is a Saudi Closed Joint Stock company operating under the supervision of the Saudi Arabian Capital Markets Authority (CMA). Under the CMA decision published on August 21, 2006, Jadwa was awarded a license to offer all types of investment services including dealing, managing, custody, arranging and advising. All investment services offered by Jadwa Investment are supervised by a Shariah Supervisory Board and are fully Shariah-compliant.

For comments and queries you can contact the authors:

Paul Gamble, Head of Research
Brad Bourland, CFA, Chief Economist


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