On June 13th, the Central Bank of Kuwait (CBK) announced the publication of its annual Economic Report, which revealed, among other things, that Kuwait's GDP at constant prices fell by an average of 9.9% in 2020. At current prices, this amounted to a fall of almost 23.2%, mainly driven by "a drop in the average price of Kuwait's Export Crude [Oil] (KEC) per barrel to USD 41.5 in 2020, slipping 35.2%". In response, CBK adopted "extraordinarily accommodative policies" to prop up the economy, including lowering the Discount Rate - the interest rate at which the central bank lends to commercial banks - to a historic low of 1.5%.
It should come as no surprise that a country such as Kuwait, with its high economic dependence on oil exports, should have suffered such a setback in 2020. After all, the year was one that saw global oil markets convulsed by chaos, driven by the pandemic and the collapse in demand that accompanied it. As such, the public finances of oil producers worldwide took a hit, not least of all the Arab Gulf states.
The spot price (immediate delivery price) over time of West Texas Intermediate (WTI), a benchmark oil grade customarily traded in Cushing, Oklahoma. This chart reflects the vicissitudes of world oil markets over the years, from the Gulf Crisis (1990-1991) to the rise of Asian emerging economies (early 2000s) to the global financial crisis (2007-2008), and finally, the oil price collapses of 2014-2016 and 2020.
That is the big picture, but how did the particular circumstances of Kuwait affect its experience of the oil crisis? With rather good timing, Dr Manal Shehabi of the Oxford Institute for Energy Studies has very recently published a report that endeavours to answer this very question. Let's explore some of what it has to say.
A Hydrocarbon Economy
Shehabi notes that Kuwait has long depended on abundant hydrocarbon resources as its "main engine of economic activity, exports and government budget", facilitated by "low production costs relative to other regions thanks to favourable geological circumstances". These oil rents have "supported the distribution of very generous welfare redistributive measures (such as energy and other subsidies) to citizens and local industries as well as guaranteed public employment to Kuwaiti citizens in the public sector with generous salaries and benefits". Because Kuwait's hydrocarbon production is fully managed by the public sector, its oil industry has facilitated the emergence and maintenance of a welfare state, with negligible taxes and high subsidies.
Kuwait's efficiency of hydrocarbon production is reflected in this table of breakeven oil prices by country (the oil price required for a state to balance its budget, while meeting expected spending needs). Kuwait's low breakeven price (the lowest in the region throughout 2000-2016, and the third lowest in 2019) grants it a significant degree of resilience to fluctuations in world oil prices. Data shown is for the MENAP (Middle East, North Africa, Afghanistan and Pakistan) region.
As such, oil continued to dominate the Kuwaiti economy. However, questions about the sustainability of Kuwait's oil-dependence began to be raised after oil prices collapsed precipitously from mid-2014 to early 2016 (with WTI falling from $107.52 per barrel in June 16th 2014 to a mere $29.71 per barrel by February 8th 2016). Financial analyst Evan Tarver contributes this drop to a strong US dollar (which pushes down oil prices denominated in US dollars), in addition to weak performance in the European and developing economies, and finally, the adoption of the Iran nuclear deal, which raised the spectre of oversupply as Iranian oil became available to world markets. World Bank analysts also point to rising US shale oil production as "play[ing] a significant role in the oil price plunge from mid-2014 to early 2016". Whatever its causes, the crash was disastrous for Kuwait's public finances, with the state "experienc[ing] its first fiscal deficits in years, a trend that continued to deteriorate since".
Sectoral breakdown of the Kuwaiti economy in 2015. "Crude oil", "gas and petro-services" and "oil refining" combined account for 83.6% of total exports and 47.77% of GDP at factor cost.
The events of 2014-2016 spurred Kuwait to "advance the country’s economic transformation policies and plans to transform away from hydrocarbons", according to Shehabi. Foremost among its announced goals were "expanding renewable projects; improving the country's business environment to attract foreign direct investment; increasing productivity and growth of the non-energy sectors ... [and] reducing carbon emissions in line with Kuwait’s National Determined Commitments (NDC) to the [UN Framework Convention on Climate Change]". In other words, the goal was economic diversification away from dependence on hydrocarbons.
However, five years later, oil "continued to dominate the economy, exposing it to ongoing oil price volatility challenges", a vulnerability keenly felt during the oil crises of 2020. Why have these reform efforts proven less than successful? Shehabi attributes this failure to five structural characteristics of the Kuwaiti economy.
Shehabi outlines five key features that have "been shown to largely constrain Kuwait’s economy and its non-oil pro-export diversification potential", which I have interpreted as:
Structural rigidities: The dominance of hydrocarbons in the economy's output, trade and budget has led to specialisation and dependence - as such, it may be difficult to achieve a non-disruptive transition.
Fiscal rigidities: The state has committed itself to negligible taxes and high subsidies; these committed expenditures may limit the state's ability to invest in new sectors of the economy.
Labour market rigidities: 77% of all Kuwaiti nationals are employed in a bloated (and dominant) public sector, while in the private sector, over 90% of workers are non-Kuwaiti. This complicates the development of durable non-oil industries, given the strong association between the oil industry, the public sector, and the domestic workforce.
Sovereign wealth fund savings: The Kuwait Investment Authority is the fifth largest sovereign wealth fund in the world, with USD 533 billion in total assets. These funds may act as a "financing alternative to oil revenue shortages and a means to smooth out short-run governmental expenditures during deficits". With this back-stop in the place, the state may feel comfortable enough to delay the diversification process in the short-term.
Oligopolies and Monopolies: The private sector is dominated by oligopolies, while state-owned enterprises act as monopolies. Their entrenched power and sustained rents may stifle "growth-enhancing innovation", such as that required to develop infant industries.
To make matters worse, the response of the Kuwaiti state to the pandemic has helped to exacerbate some of these rigidities. This is particularly so with regard to the state's enormous fiscal stimulus, which, according to Shehabi, has widened fiscal deficits to "the largest for Kuwait since the Gulf War in 1990-1991". This spending, which partly manifests itself in increased budgets for government ministries and the maintenance of a minimum income for workers, has been "funded through relocation of committed funds for long-term diversification, energy transitions, or other environmental projects". The result is the continuation of Kuwait's welfare-state model, along with the weakening of efforts to diversify away from a reliance on oil.
Thus Shehabi reaches the rather sombre conclusion that "in the existing economic structure and policy regime and foreseeable oil market dynamics, Kuwait will not be able to weather the effects of another future pandemic or accelerated energy transitions and decarbonization the way it survived this pandemic."
As the world appears to march toward that fabled "energy transition" - the shift away from fossil-fuel-based systems of production and consumption - oil-dependent economies such as that of Kuwait will have to chart a new path forward. One of Shehabi's contributions in the report is to highlight some features of those economies - not just that of Kuwait - that could hold them back. The late Ahmed Zaki Yamani, who served as the oil minister of Saudi Arabia for twenty-four years, once claimed that “the Stone Age did not end for lack of stone, and the Oil Age will end long before the world runs out of oil.” The question is, who will try to hold on until it is too late?