June 11, 2019/Fitch Ratings
Elevated tensions between the US and Iran have raised the prospect of disruptions to oil and gas shipments in the Gulf region. Fitch Ratings views a conflict that causes serious disruptions as a tail risk that would have a significant negative impact on budgets in the region, although large buffers would cushion the impact for the richer sovereigns. An escalation could also affect ratings if it caused us to reassess geopolitical risks for the sovereigns.
In the event of a complete month-long halt of oil and gas shipments through the Strait of Hormuz, we estimate that annual fiscal deficits would rise by 1pp-3pp of GDP in most Gulf-based oil exporting countries rated by Fitch. The highest impact would be on Kuwait, Qatar and the Iraqi federal government, which would have little capacity to divert their exports.
Saudi Arabia and Abu Dhabi could continue some exports through pipelines that bypass the Strait, reducing the fiscal impact. Oman’s export infrastructure is located outside the Strait.
Higher oil prices could offset some of the fiscal effect of lower export volumes for Saudi Arabia and Abu Dhabi. We estimate that oil prices would have to rise by USD50-80/bbl to offset the budget impact for each month the Strait were closed. However, in a broader military conflict, Iran and its proxies would likely target Saudi exports through the Red Sea pipeline and the UAE’s exports from Fujairah.
Meanwhile, any sustained rise in oil prices would strain the fiscal and external finances of the oil importers in the MENA region, including Lebanon (B-/Negative) and Tunisia (B+/Negative).
All sides will be wary of the costs of outright conflict and a lengthy closure of the Strait, and neither is our base case. Action by Iran to disrupt commercial oil and gas trade would risk overwhelming military response, and escalation risk comes primarily from the possibility of miscalculation. This is magnified by the Iranian establishment’s tenuous control over its proxies including the Yemeni Houthis. Economic weakness from US sanctions could constrain Iran’s ability to fund its proxies, but a hardline response by the regime cannot be ruled out if it feels it has no alternative. How far a conflict would disrupt shipments is unclear – they continued through the Strait when tankers were targeted in the 1980s Iran-Iraq war.
Increased tensions falling short of outright conflict could still have negative subsidiary impacts. Vulnerabilities include the tourism and logistics sectors in the UAE, airline hubs in the UAE and Qatar, and non-resident funding for Qatar’s banking sector. Higher tensions could inflame sectarian conflicts and undermine governance in Bahrain, Iraq and Lebanon while increasing the risk of war between Hizbollah and Israel.
A temporary loss of exports or such subsidiary impacts have the biggest potential to affect the ratings of sovereigns with weaker balance sheets and budgetary positions. Kuwait and Abu Dhabi would be the most resilient, with vast external assets, little debt and projected fiscal surpluses in our baseline. Qatar has a smaller asset position, high debt and large potential contingent liabilities, mainly from the banking sector.
Saudi Arabia has even smaller buffers and is already set to run sizeable fiscal deficits under our baseline forecasts, leading to a gradual build-up of debt and drawdown of assets. Bahrain could require further financial and security support.
Sovereign ratings could also be affected by a broader reassessment of geopolitical risks in the region. These are partly reflected in the low scores of Gulf oil exporters on World Bank Governance Indicators (which have the highest weight of all indicators in Fitch’s Sovereign Rating Model).
In accordance with our sovereign rating criteria, Fitch can reflect a qualitative adjustment to ratings for particularly large geopolitical risks, for example in the one-notch adjustments for latent conflicts in Israel (A+/Stable), Taiwan (AA-/Stable), and South Korea (AA-/Stable). Currently, no GCC sovereign is subject to a notch adjustment due to geopolitics, but this could change if we felt a conflict was becoming materially more likely.