It's boom time for Middle Eastern capital markets. Thanks to the strong oil price, confidence among the region's governments and companies is sky-high. But rather than blowing the windfall on showy architecture and fast cars, they are intent on developing world class infrastructure and financial services to prepare for a future without hydrocarbons. And the international capital markets are increasingly willing to help finance this future.
Is $50 the new $20? More prosaically, is the two decade era in which oil prices hovered around the $20 per barrel level behind us for good? Brad Bourland, chief economist at Samba, a Saudi bank, in Riyadh, believes it may be.
His half yearly report on the Saudi economy, published at the end of August, points to "a growing consensus of structural change in the oil market that will keep oil prices above $50 per barrel". But he adds that "even this may sound conservative, with oil prices now hovering around $75." In fact the average highest price for Saudi oil in 2006 (often sold to the global benchmarks at a discount), according to Bourland's model, was $70.26 on August 7.
That view is one that some bankers appear to share. Jeffrey Culpepper has watched the Gulf region develop since he joined Chemical Bank in 1986, and has recently become head of Merrill Lynch's global markets and investment banking operations in the Middle East. He believes that insatiable appetite for Middle Eastern crude will mean that in the oil market $70 may become the new $40.
For Saudi Arabia, which in 2005 accounted for 22% of the world's crude oil reserves, the effect of the strength in oil prices is obvious enough, but no less impressive for that. Bourland's report predicts that in 2006 the kingdom will post record oil revenues and record trade and budget surpluses in the context of a staggering 20% growth in nominal GDP — all of which will be achieved with low inflation. "Now in its fourth year, we still believe this boom is only beginning," says the report, "with signs that strong oil prices and revenues will last many years, a government fiscal position that can support growth in spending for years, and megaprojects just getting underway that will carry high growth through 2010 and beyond."
Saudi Arabia is not the only beneficiary of the oil boom. With the United Arab Emirates and Kuwait accounting for a further 16.6% of global reserves between them, growth elsewhere in the six nation Gulf Co-operation Council (GCC) has also been powering ahead. That is clear enough from the procession of glowing research reports produced by the ratings agencies in recent months.
Qatar, for example, which has the world's third highest reserves of natural gas, can now boast per capita GDP of more than $61,000, according to a recent report by Standard & Poor's. In Qatar, "real economic growth is expected to maintain its impressive pace, at about 10% in 2007," says the report, "and will average 14% in 2008-2009, as heavy investment in the LNG (liquefied natural gas) industry expands production capacity."
Along with the five other members of the GCC — Bahrain, Saudi Arabia, Kuwait, Oman and the UAE — Qatar was upgraded by Moody's at the start of October to Aa3 from A1. "Given the GCC governments' large net asset positions and low levels of gross debt, it would take a severe and sustained adverse political scenario to cause a government bond default either in local of foreign currency," advised the ratings agency at the time. "The growing reliance of the world economy on oil exports from the Gulf suggests that the international community will strive to prevent such scenarios from occurring. Gulf governments' net asset positions also provide a significant cushion against any severe fall in oil prices, which is in any case not expected."
Of greater importance than the headline growth figures, however, has been the way in which GCC governments have managed the windfalls that they have received from runaway oil prices. As S&P observes, "the authorities have not responded to the current oil boom with a propensity to squander windfalls through unproductive expenditures."
That represents an important departure from previous global oil cycles in two ways. First, it is in marked contrast to the method espoused by policymakers in the past. "When you travel around the region and talk to clients, especially to those that were around in the 1970s and 1980s, it is clear that they are absolutely determined not to blow the money on iconic buildings, Ferraris and yachts," says Peter Burnett, executive chairman of UBS Middle East operations.
Second, this time around high oil prices and excess liquidity are not being used as an excuse to delay or defer much needed economic reform programmes. "Traditionally when the oil price has been down, everybody in the region has talked enthusiastically about economic reform, privatisation, promoting private sector investment and so on," says Merrill Lynch's Culpepper. "Then when the oil price has gone up again, all that has been put on the back burner. All of a sudden the state has become the sugar daddy again and started throwing money around. In this present cycle, it is different. Governments in countries like Saudi Arabia are still sticking to their original plans of economic liberalisation and making them work."
Beyond the Gulf
So too are certain other Middle Eastern governments outside the Gulf. After more false starts than its more progressive policymakers care to remember, Egypt appears to be grasping the nettle of public sector reform more decisively than ever before, pushing ahead, for example, with bank privatisation. "Egypt now has a reform-minded government which is focusing on cutting the costs of doing business and reducing the role of the state in the economy," says Dr Nasser Saïdi, chief economist at the Dubai International Financial Centre (DIFC). "The Egyptian government has recognised that if it is to adopt a UAE-style of economic development it has to take the government out of the business of production, which is a major barrier to competition and investment."
Further along the North African coast are more enigmatic economies. Algeria is described as the region's "wild card" by Dr Georges Makhoul, president, Middle East and North Africa region, at Morgan Stanley in Dubai. "If you look at the size of its population and the wealth of its natural resources, Algeria could be a very exciting market."
On this basis, Libya too has great potential. At present, however, it is the judicious and strategic management of liquidity that is being generated by the big oil and gas exporters in the region that is absorbing the attention of international banks committed to their Middle Eastern franchises.
There are some parallels between the opportunities being created in the Gulf region and those that characterised the high growth economies of Asia in the 1980s and 1990s. But there are also important differences between the Middle East financial market today and that of Asia a decade or so ago. Peter Burnett spent 10 years in Asia before taking on his new role in UBS's Middle Eastern operation, and he says that the key difference between Asia a decade ago and the Middle East today is the need for capital. "When we started building up our presence in markets such as Korea and Taiwan we led with our equities business," he says. "We can't do that in the Middle East because it has so much capital. According to some estimates, the region is generating cash liquidity of $300bn per annum based on current oil prices. So instead of needing new capital, what clients in the Middle East need is advice on how to manage and spend that capital." The result, says Burnett, is that UBS will be focusing largely on advisory and asset management in the region.
Others agree that providing advice on the management of surplus liquidity will be an important growth area for banks developing a presence in the Gulf, which is why so many countries in the region are courting foreign banks so enthusiastically. "What has really changed is not just that the Middle East has become such an important source of capital," says Kenneth Borda, chief executive officer for the Middle East and North Africa at Deutsche Bank in Dubai. "In the past, much of the liquidity generated here tended to flow outside the Middle East, which is why bankers servicing the region did so as suitcase bankers. Because so much of the wealth that is being generated locally is now being reinvested in the region, governments are committed to encouraging the development of sustainable financial communities."
There are, inevitably, caveats to the Middle East's success story. One is that while the oil rich nations of the GCC are managing their wealth responsibly, many other economies throughout the broader region that have fewer natural resources do not have the same luxury.
Lebanon is an example of a country that has seen its economy struggle and its creditworthiness decline in 2006, as a result of the Israeli bombardment. With its debt amounting to some 175% of GDP, its economic recovery was fragile enough before the Israeli bombs started to rain down on Beirut. The Lebanese government was in the process of executing a series of reforms that were intended to boost the domestic capital markets. But now, after the ceasefire, the government estimates that the conflict may have cost the country $6.5bn. And although official financial assistance from Kuwait and Saudi Arabia has helped to offset much of the $2bn that, according to S&P, has flowed out of the banking system in recent months, that has not been enough to prevent the agency from revising its outlook on Lebanon to negative.
Another regional economy that has not been reaping the rewards of higher oil prices is Morocco. As the IMF observed in a recent analysis of the region, negative influences holding back the Moroccan economy have included adverse weather which has hit agriculture, and the termination of the WTO's Agreement on Textiles and Clothing (ATC) which has hurt Moroccan textile exports.
As the economic fizz in the region is being generated chiefly by the Gulf, international bankers' main focus is inevitably on the opportunities arising in the countries of the GCC. "Markets like Egypt may well offer more in the way of traditional privatisation-type transactions," says Burnett at UBS. "And it will be important for us to have a certain critical mass in countries outside the Gulf because our clients in the GCC will want to be kept informed about opportunities arising elsewhere in the wider region. But for most banks, the main focus will be on the Gulf."