The silver lining to cheap oil in the Middle East

Landscape of oil refinery industry
Anek Suwannaphoom | Getty Images

Cheap oil is widely expected to hurt Middle Eastern economies, but a new report highlights unexpected benefits the selloff may bring to the region.

Further declines in global crude oil prices could see nations step up their efforts to diversify away from oil and increase the chances of a nuclear agreement with Iran, according to Citi.

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Reforms to intensify

Crude's steep fall could motivate nations to reduce their economic dependence on oil and diversify their economies through investments in the non-oil sector. Oil revenues finance the majority of government spending for exporting nations and as a result of the selloff, Citi sees exporters slashing expenditure growth from a historical 13 percent in 2010-2014 to 5 percent in 2015-2018.

"With revenue pressures promising to constrain government spending growth for the foreseeable future, breaking the link between oil revenues and economic growth moves towards the top of the economic policy agenda. We expect governments to move in parallel paths to achieve this," said Farouk Soussa, chief economist for the Middle East at Citi.

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Soussa expects governments to achieve this by promoting the private sector through corporate and tax reforms as well as increased public-private partnerships. This could result in greater privatization overall and harmonizes with financial market reforms to improve the mobilization of private capital towards investments, he said.

He also anticipates officials to raise non-oil revenues to reduce the budget's vulnerability to oil prices: "These aims necessitate austerity measures similar to those which destabilized the social and political balance on Europe's fringes in recent years...but these are inevitable feature of sustainable economies."

High chances of an Iran deal

The slide in oil prices makes chances of a deal between the P5+1 countries and Iran more likely by the new June 2015 deadline, according to Citi.

"Projected Iranian revenues for next year will have fallen by almost a quarter since the 24 November deadline passed, putting substantial pressure on Iran's already sanction-battered and fragile economy. This is likely to give further negotiating space to President Rouhani and his team, and less influence to Tehran's hardliners who oppose any sort of deal with the United States," Soussa said.

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However, Citi notes that a deal with Iran is two-sided as it could also hurt regional oil exporters. If sanctions against Tehran were rolled back, increased quantities of Iranian oil could surface in international markets, depressing crude prices even further.

The bigger picture

Citi's two benefits are a tiny silver lining to the plethora of negative consequences faced by the resource-rich region from Brent crude's 45 percent year-to-date decline. Most analysts see lower prices doing more harm than good for both exporters and importers alike.

"Most Middle Eastern governments are not going to get the revenues they require for their budgets, so it [cheap oil] could put political and domestic pressure on them, especially with the ISIS issues in Syria and Iraq," said Barry Dawes, head of resources at Paradigm Securities.

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The argument is that the headwinds faced by exporting nations in the Gulf will also hurt importers like Egypt in the form of diminished aid and investment.

"Prices at these levels are not geopolitically sustainable. If you look at the break-even fiscal budget for most OEPC nations, all but two are well above $80 and several are above $100. That's what it takes to keep the Arab Spring and civil unrest at bay. Even Saudi Arabia, with their large fiscal reserves, won't be able to handle current prices for too long," Gina Sanchez, chairwoman and founder of Chantico Global told CNBC earlier this month.