While oil prices have rebounded before soaring since the depths of collapse in the spring of 2020 — with Brent crude prices skyrocketing from $19 per barrel in April 2020 to a three-year high of $86 per barrel in October 2021 — the prospects for a sustained high oil price for Gulf producers is unlikely. As oil demand rebounded in late 2021, the confluence of difficulty in supplying other kinds of energy products from natural gas to coal has inflated energy prices globally and marched alongside inflationary pressures on everything from food to consumer products. In fact, many analysts and OPEC+ member oil ministers expect a more balanced market by mid-2022 and a decline in prices, perhaps in the $55 range within next year.
We are in a temporary period of adjustment as the global economy recovers from the effects of lockdowns and restricted mobility during the Covid-19 pandemic. But the definition of "temporary" within a broader energy transition is less well understood. And while the longer-term trajectory of global oil demand is likely to decline over the next decade, current global oil demand matches its pre-Covid levels of over 100 million barrels per day. The cooperation agreement among major producers — the OPEC+ agreement in place since December 2016 — continues to hold. Yet, there is a widening gap among these members in their production capacity agility. Some producers, including Russia and Nigeria, are less able to ramp up production of spare capacity. The rupture between the UAE and Saudi Arabia in July 2021 showed some of the incongruities among major producers in their spare capacities as well as their oil exports strategies within a timeline that sees the global energy mix less reliant on oil. Moreover, OPEC's own assessment of oil demand in 2022 continues to be sluggish, begging the question of whether they know something the rest of us do not. The rising pressure of price inflation, questions of continued waves of infection and variants in Asia and elsewhere, and the US’ sluggish rebound may lead to a global economy that is not yet in good health. Added to that uncertainty is Iran’s ability to increase its exports (including key sales to China even under sanctions) and possibly new production, if sanctions relief and a return of the JCPOA emerge in early 2022.
There is a growing disconnect in the politics of energy demand whereby both the US and Europe underestimate their reliance on oil and gas while overestimating their aspirations for a greener economy. As a result, the Gulf’s oil producers, and Saudi Arabia in particular, try to calibrate production to revenue generation expectations and fiscal policy. For Saudi Arabia, the fiscal outlook for 2022 is quite positive: oil revenues are rising, the government has been disciplined in its spending, and the reform agenda persisted even during the pandemic when the pressure to increase stimulus and social outlays was substantial. Non-oil revenue has increased, though not necessarily from new business growth but rather from new tax implementation and a healthy market for petrochemicals (the materials that are the base for many plastics and most of the protective gear from masks to gloves that we all have used daily in the last two years of the pandemic). The Saudi government classifies petrochemicals as a non-oil export, though they are made from oil. Saudi Arabia recorded a budget surplus of SAR6.7bn ($1.8 billion) in the third quarter of 2021. The year-on-year increase in oil revenues has been significant, rising to 60 percent over 2020. Non-oil government revenues increased 30 percent year-on-year in the first three quarters of 2021. The tripling of the value-added tax to 15 percent in May of 2020 along with growth in domestic demand for goods and services (especially strong given travel restrictions on citizens during the pandemic), generated revenues for the state close to SAR 88 billion, or according to Jadwa Investment bank, VAT revenue generated over 70 percent of government non-oil revenue in the third quarter of 2021.
The upswing in oil prices in late 2021 could certainly put pressure on the government to loosen its fiscal restraint and start spending, particularly on large projects. But the Public Investment Fund is now under a mandate to direct $40 billion per year in domestic development spending and those projects, such as megaprojects in Neom, are likely to gain speed. There is also the concern that the current tax rate will be reduced, especially if the government feels pressure from citizens and businesses to implement relief policies after a difficult pandemic recovery and now flush with oil export receipts. The Crown Prince, Mohammed bin Salman described the VAT as "temporary" in an April 2021 interview, increasing pressure for him to show support for relief measures. The pro-cyclical nature of oil exporters, especially the Saudi economy, will be difficult to undo.
Overall, 2022 should bring some fiscal relief for Saudi Arabia, albeit temporary. The real challenge will be a global economy that is both recovering from the pandemic, but also somewhat ambivalent about its energy needs. The prospect of growing inflation, across all kinds of products, does not bode well for growth or for access to capital, as the cost of borrowing for many countries, including oil exports, is likely to increase. The ability of governments to be flexible in their fiscal policy and disciplined on necessary reforms — especially among oil exporters in subsidy reforms in energy and water and collection of taxes — will all become increasingly difficult. Saudi Arabia's answer to this problem is to slowly calibrate oil production, careful to watch for an oversupply in markets in late 2022. Second, the kingdom will be laser focused on its non-oil revenue generation, not just from tax but from the ability to attract investment into new tourism and renewable energy projects. Energy markets’ volatility and global threats against growth prospects — whether from a resurgent pandemic and its variants or growing inflationary pressure — all make 2022 look like a very challenging year.