RaboResearch - Economic Research

Dit artikel is ook beschikbaar in het Nederlands

The GCC: going cold turkey on oil?


  • The oil-rich Gulf Cooperation Council (GCC) countries have been severely affected by the oil price slump and are trying to diversify away from oil
  • Diversification is a particularly acute priority for Oman, which has a mere 15 years of reserves left
  • Past diversification efforts have proven unsuccessful; most GCC countries have made very little progress and consequently still lag far behind more industrialized peers
  • The combination of a mediocre institutional environment, coupled with distorted labour markets skewed towards public employment, will make diversification hard
  • In the short-run, necessary budgetary consolidation in particularly Oman, Bahrain and Saudi Arabia, will weigh on political and social risk in these countries

Saudi Arabia recently announced a comprehensive economic reform plan to move away from the current oil centered economy. Earlier in 2016 several GCC countries announced that they will install value added taxes, a novelty in this wealthy part of the world. These moves are clearly a response to the low oil price environment, which has an effect on the oil rich GCC countries. To appreciate the challenges ahead, we need to thoroughly understand the problems an oil-based economy faces and where countries stand in terms of diversification and managing the budgetary impact of the oil price slump. 

Why diversify?

There are two reasons to diversify away from oil. Countries like Oman, and to some extent Qatar are faced with depleting reserves relative to production (figure 1). At current production levels, Oman’s proven reserves last around 15 years (BP, 2015). Qatar is in a more benign position with reserves of around 35 years. A looming deadline creates a clear impetus for countries to act. Diversification should help countries sustaining their current spending patterns by replacing oil-related economic wealth with other sources of economic activity. Hesse (2006) shows that diversification and per capita income are positively correlated for a 96 country sample. Spatafora et. al. (2012) shed some light of how that process works. They conclude that an increasing sophistication of exports (goods and services) can be an important contributor to overall economic growth. This is because some products offer knowledge spillovers, backward and forward linkages in the value chain or allow for the production of products with similar characteristics, all of which are needed to grow future industries.

The other reason to diversify is to enhance macroeconomic stability. The volatility of GDP growth in the GCC countries is around three times higher than for developed economies in 2000’s (figure 2)[1]. When an economy has multiple sectors, an adverse shock to one sector is typically dampened by developments in other sectors, with implications for both government budgets and wider economic aggregates such as employment. We see that the GCC countries are very oil dependent in terms of government revenue. Qatar is an outlier with just 59% of revenue stemming from oil and gas. The other GCC countries derive well of 70% of their revenue from oil with Saudi Arabia and Kuwait topping 90%[2]. Growing other taxable sectors should help these countries achieve a greater degree of stability of their economy and government finances.

Figure 1: Depleting oil reserves for some
Figure 1: Depleting oil reserves for someSource: BP statistical review
Figure 2: Impact of low prices GCC countries
Figure 2: Impact of low prices GCC countriesSource: IMF WEO, Rabobank

Little progress so far

If diversification is key, where do countries stand currently? When we compare the GCC countries to some of their emerging market peers and developed economies, we see that despite all the emphasis on diversification, most GCC countries actually lag in terms of export sophistication (figure 3). Aside from Bahrain, which also exports more refined oil and manufactured aluminum products in addition to crude oil exports, all countries have a long way to go if they want to produce higher value products in the future.

Figure 3: GCC lags in export sophistication
Figure 3: GCC lags in export sophisticationSource: World Bank
Figure 4: Little progress on diversification
Figure 4: Little progress on diversificationSource: World Bank

When we compare export sophistication between 2000 and 2014, we see that most countries have achieved very little progress in terms of diversifying their exports (figure 4). Only Bahrain, Kuwait and Oman achieved an improvement in their export diversification while the United Arab Emirates, Qatar and Oman actually became less diversified. Considering that all countries have pursued a plethora of diversification plans in the past, this does not bode well for future plans. Of all the GCC countries, the position of Oman is particularly concerning as it has the lowest remaining reserves and a very low degree of diversification.

Explaining the lack of progress

There are broadly two reasons why GCC countries have found it difficult to attract other industries. The first reason is lagging institutional quality. According to the IMF “businesses across the GCC report restrictive labor regulations, an inadequately educated workforce, inefficient government bureaucracy, and, to some extent, lack of access to finance as key factors inhibiting private sector activity” (Callen et al., 2014). We actually see broader institutional issues as the GCC countries barely perform better than the global average in terms of institutions (figure 5), though these outcomes are very skewed by Qatar and the UAE on the positive side and Yemen on the negative side (figure 6).

In particular, the countries lag behind the global average in terms of voice and accountability, indicators that show to what extent the population can show grievances and hold its government accountable (figure 5). This allows current elites to capture economic rents and retain political as well as economic control of a country. However, it also inhibits economic development. Acemoglu and Robinson (2005) note that: “economic institutions encouraging economic growth emerge when political institutions allocate power to groups with interests in broad-based property rights enforcement, when they create effective constraints on power-holders, and when there are relatively few rents to be captured by power-holders”. In the GCC countries, the current political structure inhibits economic growth of the non-oil sector and therefore acts as a drag on any ambition towards diversification.

Figure 5: GCC mostly around world average
Figure 5: GCC mostly around world averageSource: World Bank
Figure 6: Differences in institutional strength
Figure 6: Differences in institutional strengthSource: World Bank

The other possible explanation pertains to the incentive structure of the economy. Domestic firms are incentivized to focus on the non-tradable sector, where they can obtain attractive government contracts at low risk (Callen et al., 2014). Domestic workers are incentivized to work in the public sector as it boasts higher wages and better non-wage benefits. The ratio of minimum wages in the public relative to the private sector stands at a factor 2 in Saudi Arabia and 3 in the UAE (Soto, 2014). Though data is generally hard to come by, Soto (2014) estimates that over two-thirds of workers in Saudi Arabia work in the public sector. This creates a high reservation wage for workers and disincentivizes workers to work in the private sector. To really diversify, the GCC countries will need to completely overhaul the current system which provides cushy public sector jobs, benefits and profits for a large part of the native population. However, this will prove extremely difficult politically.

Box 1: Oil prices outlook – low prices here to stay

Last year, oil prices fell to a thirteen year low hitting 27 USD/bbl. Oil prices had been on the decline since mid-2014, as a result of shifting oil price fundamentals (Dumitru, 2016), such as rising US supply from the shale oil industry and a subsequent aggressive push for market share by Saudi Arabia. Early 2016 saw the temporary dive below 30 USD/bbl which was largely driven by a stronger USD and higher risk perception in financial markets, factors which have since been partly reversed. Fundamentals tell us that low prices are here to stay.

The International Energy Agency forecasts a tightening of the oil market as oversupply falls from 1.6mbpd in 2016Q1 to 0.1mbod in 2016Q4 (figure 7). We expect oil prices to stay around 40 USD/bbl mark nevertheless, as inventories are at record highs and OPEC production is expected to increase. A fall in US supply is partly offset by increasing production in the Gulf of Mexico and a possible reactivation of a backlog of drilled but uncompleted tight oil wells and rising Iranian supply. By 2017, the oil market should reach an inflexion point as sharp capital expenditure cuts in 2015 (-23%) and 2016 (estimate of -15%) start hurting supply. That said, declining cost of the much more flexible shale oil, will act as a ceiling on the oil price. That ceiling is now around 71 USD/bbl (Rystad) but could come down further. Going forward oil prices will be increasingly volatile as a result of the higher market share of flexible shale.

Figure 7: Oil supply forecast to decline second half 2016
Figure 7: Oil supply forecast to decline second half 2016Source: EIA, Macrobond

Two years ahead

As should be clear from the above, the benefits of diversifications, if achieved at all, will hardly do anything in the short run to address the challenges of lower growth and rising budget deficits as a result of low oil prices (box 1). Under financial pressure most countries will have to reduce spending and boost tax receipts to balance their budgets (figure 8). Oman and Bahrain face particularly large fiscal deficits in the next two years. All GCC countries have announced they will cut subsidies and raise taxes but according to the IMF, the current budgetary consolidation plans are not enough to balance the budget. This is not surprising as all countries rely for over half of their revenue on oil with Saudi Arabia and Kuwait topping the list with over 90% (figure 9).

Figure 8: Deficits will stay without action
Figure 8: Deficits will stay without actionSource: IMF WEO
Figure 9: Oil dependence 2010-2014
Figure 9: Oil dependence 2010-2014Source: Macrobond

However, some countries have more leeway than others in adjusting the budget as they have built up significant reserves. Figure 10 plots the years a sovereign wealth will last (assuming a 0% return), when a country maintains a budget deficit equal to that of 2016/2017. This analysis shows that Oman, Bahrain and Saudi Arabia are the most vulnerable as they have a lowest reserves relative to their budget deficits. Kuwait, Qatar and the UAE are in a much more comfortable position with reserves that will last decades yet with current fiscal deficits.

Figure 10: Lifetime of sovereign wealth fund
Figure 10: Lifetime of sovereign wealth fundSource: SWI institute, PWC, Rabobank
Figure 11: Relatively low political risk
Figure 11: Relatively low political riskSource: IHS

Political and social risks going forward

Despite the need for budgetary consolidation, we see the risk of riots and protest and political risk are relatively low, except in war-torn Yemen (figure 11). This can partly be explained by the fact that countries have not yet implemented the required reforms and budgetary consolidation. Going forward, we see the risk of protests and riots increasing when people’s purchasing power is affected by policy. That risk may be exacerbated by the lack of a “safety valve” in the form of elections and democratic participation, attested by the low voice and accountability score in the world governance indicators (figure 5).

The political risk will be largely tied to the pace of budgetary consolidation, meaning that Oman, Saudi Arabia and Bahrain will be most vulnerable while Kuwait, Qatar and the UAE look much more stable in the short and medium run.

Another risk particular to the region is the persecution of minorities. Many GCC countries have sizeable Shia populations, most of which are of persecuted by their Sunni rulers. Their circumstances have spawned protests in and after the Arab Spring and in many countries have led to occasional militant activity. Increasing economic malaise could strengthen their activity. Particularly Saudi Arabia and Bahrain are vulnerable to this kind of activity as both host sizeable Shia populations, which in the case of Saudi Arabia, live largely in the oil producing areas. A factor of importance is the rise of Iran as will gradually reintegrate into the world economy. As the most populous Shia country in the region, increased influence of Iran increasingly puts the country on a collision course with the Sunni-ruled GCC countries. 


[1] Note that the high GDP volatility for Kuwait in the 1990’s was primarily caused by the Gulf War.

[2] We have no data for the United Arab Emirates.


Acemoglu, D., Johnson, S., & Robinson, J. A. (2005). Institutions as a fundamental cause of long-run growth. Handbook of economic growth1, 385-472.

BP (2016). Oil reserves. Retrieved from: http://www.bp.com/

Callen, M. T., Cherif, R., Hasanov, F., Hegazy, M. A., & Khandelwal, P. (2014).Economic Diversification in the GCC: Past, Present, and Future. International Monetary Fund.

Hesse, H. (2006). Export diversification and economic growth. World Bank, Washington, DC.

Soto, R. (2014). Labor market structures in Arab countries: what role for minimum wages? [Powerpoint slides]. Retrieved from: www.ilo.org.

Spatafora, M. N., Anand, R., & Mishra, M. S. (2012). Structural Transformation and the sophistication of Production (No. 12-59). International Monetary Fund.

Dumitru, A. (2015). Behind the curtains of the oil price plunge

Jurriaan Kalf
RaboResearch Netherlands, Economics and Sustainability Rabobank KEO
Alexandra Dumitru
RaboResearch Netherlands, Economics and Sustainability Rabobank KEO

naar boven