Gulf prospects bleak for some

Subdued oil and gas prices are inhibiting infrastructure funding in the Gulf and only some of the region's clients will be equipped to ride out transformational market changes, says S&P Global Rating’s regional expert and associate director, Karim Nassif. 

Subdued prices of hydrocarbons, on which the Gulf Cooperation Council (GCC) region is heavily dependent for funding national operations, have contributed to rising fiscal deficits and depressed levels of investment. S&P Global Ratings estimates that deficits in the region are expected to reach 10% of GDP in Saudi Arabia, Bahrain, Kuwait, and Oman between 2016 and 2019. 

This has led GCC governments to implement expenditure reform – involving increased taxation and decreased subsidies for many corporate and infrastructure companies throughout the region. 

These fiscal reforms are also expected to have indirect effects on infrastructure companies and development in the GCC, including weaker economic growth and demand for goods and services. However, the extent of the impact will be heavily dependent on the types of company and its industry. 

Government backing will be key

Looking forward, larger government related entities (GREs) with special mandates are expected to perform best throughout – despite government fiscal reform and the region’s weakened economic state. GREs, additionally, account for the majority of corporate and infrastructure companies in the region.

However, while larger companies with government backing may be able maintain their credit profiles, smaller private companies remain highly exposed; unless however, they are leaders in their respective fields, have adopted conservative funding strategies, and are not dependent on government subsidies.

In terms of sectors, the oil and gas industries, together with construction, have been hit the hardest, due to project delays and lower investment throughout the GCC.

When it comes to the smaller private players, S&P placed Kuwait Energy on negative outlook in first-quarter 2016 following the revision of our oil price deck. S&P also lowered the rating on Dubai-headquartered oilfield services company Shelf Drilling Holdings Ltd. twice in 2016 to 'CCC' from 'B'.

The governments of the region are implementing reforms to energy subsidies. Notably, petrol prices have been revised so that they are set according to market indices in Dubai, Kuwait, and Qatar and gas prices charged to industry have been hiked in Saudi Arabia, Oman, Qatar, and Bahrain in recent years (reducing the gap to international market prices). 

However, depending on the country in question, the national champions still continue to receive important indirect subsidies either because feedstock prices remain low compared with global market prices, or because margins pertaining to their activities continue to be locked in by government concessions, irrespective of the prevailing market price of the product sold.

Although expected to remain stable, utilities and telecommunications will also have to navigate a tough operating environment. GCC utility companies, in particular, are heavily subsidised by governments. Yet, as many GCC governments cut energy subsidies and implement energy tariffs, as Saudi Arabia has already begun doing, stable utilities companies can be expected to face increased costs in the absence of full cost reflective tariffs.

Governments that are addressing deficits may also attempt to utilize the private sector for its infrastructure needs through increased public-private partnerships, which Dubai has been achieving more recently.

The risk of an increased tax rate is also high for the telecommunications sector. Recently, Saudi Arabia introduced a 5% profit tax on telecom companies’ profits, and Oman increased telecom operators’ tax rate from 12% to 15%. However, telecom companies in the region are offsetting low financial leverage by focusing on asset optimization, efficiency, and organic growth in existing markets rather than acquiring new debt-funded projects. 

Deficits may bring innovation

In the past, strong oil deposits supported cheaper corporate loans, which is why loans accounted for about 90% of total corporate and infrastructure funding (including bonds) in the first eight months of 2016. However as liquidity tightens in the GCC banking system, high infrastructure needs throughout the (estimated at US$50 billion from 2016 to 2019) could encourage alternative methods of financing as governments attempt to limit exposure to GCC banks.

More than likely the corporate and infrastructure capital market will expand, and alternative financing such as sukuk – bonds that do not infringe sharia law – are expected be developed as a medium for raising infrastructure funds in the medium- to long- term.  Indeed, with governments placing a greater onus on sharing the burden of infrastructure spending with the private sector, we can expect the capital markets to provide a form of funding suitable for public-private-partnership projects.