The impact of lower oil prices
The oil industry is a very dynamic sector constantly confronting challenges of expansions and contractions in production and price levels. Expert practitioner Nour Amache explores the current landscape.
The decrease in oil prices
Since June 2014, the price of a barrel of oil has been plummeting reaching low levels last witnessed during the 2009 recession. Currently the price of Brent Crude, which is used as an international benchmark, is $49 a barrel after having recorded a price as high as $105 a barrel during the past decade. What makes the oil industry volatile and drives the price of oil to fluctuate?
This recent decrease in the price of oil can be attributed to a multitude of factors but most importantly to the forces that govern the market of any commodity: supply and demand. The supply of oil is increasing as the United States production levels have nearly doubled during the past six years, making them more self-reliant and hence pushing the previous oil exporters to find different markets. Canada, Iraq and Russia have been increasing their production levels as well, hence a higher supply. Looking at the other side of the coin, we see a dwindling demand as the economies of Europe and the developing countries suffer and as people are shifting toward more energy efficient vehicles. In addition, China’s recent devaluation of its currency has led to a decrease in their demand for oil and that has a substantial effect as China is considered the biggest oil importer in the world. Hence, we have and increasing supply and a decreasing demand, thus lower prices.
Effect of lower oil prices
While many households benefit from lower gasoline prices as the share they spend on energy decreases, governments as well as the oil companies and firms, who are usually benefiting from high oil prices, now face challenges: several oil and gas production companies are decreasing dividends, selling assets and reducing salaries and benefits. Furthermore, this drop in oil prices, if not managed by OPEC that is currently refusing to cut production levels, will lead to a significant drop up to $300 billion in the revenues of Saudi Arabia and its Persian Gulf allies, according to the International Monetary Fund.
As the governments of the GCC countries encounter lower revenues and profits from the oil industry, their ability to support SMEs that rely strongly on funds from government and support endowments will hence decrease. Although the GCC countries, apart from the UAE that has cut off its federal budget by 4.2 per cent and removed the subsidies on diesel and petrol, have not yet undertaken serious measures to overcome the decreasing revenues, they will nonetheless have to react soon if oil prices maintain this downturn.
According to Abdul Baset Al Janahi, CEO of Dubai SME, the current status of oil prices is healthy for the economy in terms of re-adjusting policies and expectations at the overall macro level.
He affirms that in the short-run, businesses should not be impacted due to this lower oil price level, yet there will be a significant effect if the oil price level remains low for more than two years. He is optimistic in what concerns SMEs since they are more nimble and can adjust faster to changes compared to larger enterprises, especially when there is a strong commitment from the government to these SMEs and entrepreneurs.
A report on Mideast Debt published by Reuters on the 28th of April reassured that the six rich nations of the GCC are easily coping with the current prevalent low oil prices, where strong state expenditures are keeping economies growing strongly.
Saudi Arabia, for instance, is covering much of the budget deficits caused due to low oil prices, by transferring funds saved abroad into the country, rather than borrowing domestically or using their deposits at local banks, hence maintaining an abundant liquidity level in GCC banking system, where deposits are continuing to grow even if at slower rates. So for many companies in the Gulf credit is still easily available at low rates but not to SMEs that lack the advantage of shareholding links to governments.
Financing possibilities to SMEs
SMEs are facing challenges in borrowing and when they are able to secure loans, the banks in turn are setting strict conditions such as more collateral and tough documentation and shorter repayment periods. According to Vikram Venkataraman, Managing Director at Vianta Advsiors, which works with smaller companies around the region to raise bank finance, “They are tightening credit lending norms because of the overall impact of low oil prices and the consequent freeze on oil industry capex-heavy projects…”
The volume of banks’ loans to SMEs in the GCC remains low, where they only comprise two per cent of the total loans given, which leads these SMEs to rely heavily on other funding sources, such as non-bank financial companies.
There are a multitude of factors for why banks are hesitant and cautious when it comes to lending SMEs: One factor is the lack of progress among SMEs in building proper financial infrastructure. Another factor is the lack of coverage of credit registries and bureaus that cannot give credit scores and hence there is very little information on credit worthiness of SMEs which is an obstacle that creditors face.
A third factor that limits banks’ lending to SMEs is the lack of a good collateral registry which is according to Robert Rocha, a senior advisor to the World Bank, “a centralised, electronic, easy to access database where a creditor, when they receive a loan application, can see whether that SME has some collateral to offer either in the case of inventories or receivables”. This in turn makes the process of lending to SMEs a difficult and tiresome process altogether. Moreover, the cost of enforcing the collateral is very high which does not make it very feasible in the case of low volume of loans to SMEs, especially that SMEs usually do not have a lot of fixed assets.
This is in addition to the banks’ caution in lending to SMEs due to their belief that low oil prices could deprive these businesses of access to fresh business opportunities.
As a result of the tight funding possibilities for SMEs from the banking sector, entrepreneurs rely heavily on private funding from their savings and on funds from establishments founded to assist in the development of SMEs, as it is estimated that SMEs comprise 80-90 per cent of the total volume of business in the majority of the Arab countries.
The major funds established to assist SME development include the Khalifa Fund initiative that has provided 904 million AED by the end of 2013 to support 608 SMEs and the Mohammed Bin Rashid Establishment for SME development that was able to support around 13,000 entrepreneurs to launch their projects and has 3000 registered SMEs that have benefited with loans reaching 215 million AED.
Challenges of SMEs in non-oil production Arab countries
We cannot shield any country from the effect of changes occurring around the world, let alone neighbouring countries with which there are strong economic ties. The Arab world countries are strongly connected economically, whether in their dependence on the Arab oil and assistance funds or in their dependence on each other in the economic sectors, specifically the agriculture and the services sectors.
This is in addition to the fact that the oil producing countries, specifically Saudi Arabia, United Arab Emirates, Qatar and Bahrain employ millions of Arabs from their Arab neighbours, which creates an additional strong link between oil and non-oil producing countries and hence makes them mvore susceptible to the economic changes occurring in the GCC as a result of the fluctuations in the prices of oil.
With the above in perspective, and considering the fragility of most Arab non-oil producing countries due to the political unrest and the fact that most are import and service-based economies such as Lebanon, Jordan and Tunisia, we can thus comprehend why SMEs face many challenges in these countries. This is especially that the governments in these countries are lost amid the wind of change as a result of the so-called Arab Spring, leaving them burdened and hence not planning or planning but not implementing policies designed to support the development of SMEs.
SMEs across the Arab World rely heavily on endowments or specific funds established to assist them since the banking sector across the Arab world tends to be very strict in policies related to lending small and medium enterprises for mainly the same reasons.
As a final thought, it is crucial to note the urgency and imperativeness for the governments of all the Arab countries support SMEs as they comprise 90 per cent of the total number of enterprises in the Arab World and employ 60 per cent of the workforce. This is necessary for the economic development of the Arab countries and mainly the non-oil producing countries.
Hence, all the Arab countries should implement policies that call for assisting SMEs, primarily by establishing funds and development programs for these SMEs, similar to the initiatives undertaken by Dubai and Abu Dhabi.
