It has been another turbulent year for the Middle East and, in particular, for Saudi Arabia. The Kingdom started 2015 with the succession to King Salman, which has hastened the transition of power to the third generation of the royal family. Saudi Arabia has launched a military intervention in neighbouring Yemen and remained involved in the Syrian conflict. And throughout the year it has been drawing heavily on foreign reserves, to offset the impact of much lower oil revenues on the government budget.
In our first chapter, All change in Saudi Arabia?, we examine the main policy decisions facing Saudi rulers. Faced with a trade-off between maximising short-term revenues and maintaining market share, the Saudis remain firmly committed to the latter. With the recent OPEC meeting underlining the lack of cohesion within the group, we expect the Kingdom to endure low oil prices until a slowdown in non-OPEC supplies rebalances the market. This is not to say the Saudis, and by extension OPEC, will never cut production again—rather, they want to be sure they will influence the market when they do.
Large financial reserves built up in recent years, together with a low debt/GDP ratio, provide a buffer during a period of low prices. But with the IMF forecasting a budget deficit of around 20% of GDP this year and next, Saudi rulers cannot completely avoid considering spending cuts. Public sector salaries and subsidies make up a large share of overall spending however, limiting the options for cuts unless infrastructure projects are scaled back. Senior royals have raised the need for structural reforms to reduce the dependence on oil revenues, but as with previous periods of low energy prices, this talk has yet to translate into action.
Meanwhile, the military intervention in Yemen is the most visible element of a far more assertive Saudi foreign policy that has emerged this year. There has already been a significant financial and human cost to the campaign, without achieving Saudi goals. Concerns about the influence of Iran are a main driver for the more interventionist approach to regional conflicts now emerging. This is likely to result in further confrontations in the coming years, although we do not expect either side to allow these to escalate into a direct conflict.
Turning to the other major conflict in the Middle East, the battle against the self-titled Islamic State (IS) group continues in both Syria and Iraq. Coalition airstrikes have helped local forces retake some territory in Iraq, but the militants remain a potent force. The Iraqi Kurds have an extended frontline with IS, which is stretching their Peshmerga forces thinly. The continued threat from IS adds to the financial and political challenges facing the Kurds.
In our second focus piece, Running to stand still, we consider the progress made by the Kurdish oil sector over the last two years. Production has risen from 0.20 mb/d at the end of 2013 to around 0.85 mb/d, with exports at around 0.6 mb/d. But most of the gains are due to the Kurds taking over fields formerly controlled by Baghdad. Projects being developed under contracts awarded by the Kurdistan Regional Government (KRG) have ramped up much slower than planned. With the KRG owing IOCs substantial amounts in arrears, Capex has been slashed and we expect growth to stall in 2016, leaving exports at current levels.