Over reliance on Chindia a danger for GCC oil revenues

Posted on 20 September 2010 with 2 comments from readers

The majority of growth in demand for energy has come from emerging market economies like India and China over the past couple of years with the developed world in a major slump. But there is a danger in relying on notoriously cyclical emerging markets for growth moving forward.

As this month’s GCC Economic Bulletin from the National Commerical Bank, Saudi Arabia’s largest bank, reports: ‘The economic profile of the GCC region leaves it heavily exposed to commodity price fluctuations’.

Risks to the oil price

The bank’s economists go on to warn about possible food price inflation as the global economy recovers. But there is an even bigger risk from a deflationary bust in oil prices. That would certainly follow the bursting of the economic bubble now growing in China.

House prices in some Chinese cities are up 100 times in a decade. Construction and real estate accounts for 50 per cent of GDP. New plans for a $500 billion high speed train network look like hubris. The GCC has only to look at Dubai for an example of what happens when real estate and construction gets into a bubble.

First, inflation lifts off and salaries begin to rocket. Then eventually property prices go so high that there are few buyers left. Then something happens to prick the bubble. For Dubai it was a sudden stop to credit in the global financial crisis that brought this party to an end. China is presently the place which seems to have unlimited credit and record IPOs, a sure danger signal.

The Chinese central bank has been reigning in credit this year. Can it organize a gradual and orderly unwinding of the boom? History does not offer many examples of bubbles that have slowly deflated. That is why the analogy of a bubble is a good one for this type of economic phenomenon.

$750bn oil revenues

As the NCB report points out annual GCC oil revenues have recovered sharply from $570 billion in 2009 to $750 billion this year. Some 30 per cent of this increase came from China which is now the biggest customer for oil from the Middle East.

Any problems in the Chinese economy will therefore impact sharply on GCC oil revenues. That said the longer term situation does appear to be a permanently raised demand for energy. All those new car owners in China will have to buy petrol. And with a higher demand for oil coming up against major supply constraints, the stage is set for higher oil price levels.

This is what we already see with the old Opec $22-28 price band of the early 2000s long since cast into market history. Indeed, the oil price uptrend did not break until $147 in July 2008 and recovered from its December 2008 low of $33 relatively quickly to today’s $70-85 range.

But whereas the NCB Economic Bulletin this month is all about the threat of food price inflation, and house price inflation in the Kingdom, the bigger threat on the horizon to national prosperity may be a second dip in the oil price as the Asian bubble led by China pops. History is full of national economic miracles that strangely vanished in the face of economic forces.

GCC hardly broke

However, the GCC economy will hardly be sunk with $180 billion in additonal oil revenues this year and the prospect of a quick resumption of higher oil prices later as in 2009. For if nothing else a faltering China would force the developed nations into more monetary stimulus that would drive up commodity prices, including oil.

Buying commodities on any market weakness would therefore be eminently sensible, and a lot safer than stocks and bonds.