On October 18, 2018, the Arab Gulf States Institute in Washington convened its fourth annual Petro Diplomacy conference, “Back to the Future – Oil and Gas at the Center of New Growth in the GCC States.”
Grand reform plans underway in the Gulf region, typified by Saudi Arabia’s National Transformation Program and Vision 2030, give an impression of fast movement. Important changes are undeniably underway. But, with the success so far of the OPEC pact to lift oil prices, there is a danger that systemic reform grinds to a halt as the sense of urgency for uncomfortable changes ebbs. This applies in particular to the all-important energy sector.
First, there has been notable progress so far. The pact between OPEC and leading non-OPEC oil producing countries, notably Russia, and including Gulf Cooperation Council members Oman and Bahrain, has increased prices and cut swollen stockpiles. There are now attempts to systematize this into a long-term arrangement, with Saudi Crown Prince Mohammed bin Salman talking of a “10 to 20 year agreement.”
National oil companies have been restructured. Most headline grabbing has been the drawn-out plans for the initial public offering of 5 percent of Saudi Aramco. Even while this remains in preparation, it has led to an overhaul of the company’s culture and organization.
More transformational change has come to the Abu Dhabi National Oil Company, for long a staid and slow-moving organization. The coincidental expiration of its main concessions from 2014-18 meant that renewal was required, but the emirate’s Supreme Petroleum Council has taken the opportunity to diversify its spread of partners from the Western supermajors (largest publicly traded oil and gas companies, such as Shell and ExxonMobil) and long-time Japanese buyers, to boost the representation of its major customers and growth markets in China, India, and South Korea. ADNOC Distribution, its fuel retail arm, moved quickly to sell 10 percent of its shares on the local exchange in December 2017.
Sovereign wealth company Mubadala, itself a major energy investor, has been greatly expanded by its merger in early 2017 with the International Petroleum Investment Corporation, including a large refining and petrochemical portfolio, and in March 2018 when it was combined with the Abu Dhabi Investment Council. And the Abu Dhabi Water and Electricity Authority and the Regulation and Supervision Bureau have been folded under a new Department of Energy.
In Kuwait, long an investor’s graveyard, some major projects have finally moved ahead – upgrades to the refining sector, a new liquefied natural gas import terminal, heavy oil developments, and production of deep, sour gas in north Kuwait. BP and Shell have been rather quietly assisting under technical service agreements. Qatar has merged its two LNG companies to gain efficiencies and moved ahead with a resumption of development at the North Field that will regain its position as the world’s largest LNG exporter in the early 2020s. Bahrain just announced a large discovery of offshore tight oil and deep gas, though commerciality is yet to be established.
Energy subsidy reform has also been a widespread theme. Fuel, electricity, and water prices have been raised across the GCC states, though in some cases from very low levels, and still not always to world market parity. Natural gas prices for power and industry have been bumped upward in Saudi Arabia, Bahrain, and Oman. The impact of rising energy bills on low-income Saudi citizens has been cushioned by payments under the Citizen’s Accounts, somewhat similar to, though more targeted than, the cash handouts Iran introduced in its 2010 energy price rises. In Abu Dhabi, increases have still left electricity and water prices for citizens at less than a third of those for expatriates. Gasoline prices are now around international levels in all GCC countries except Kuwait, while diesel prices remain heavily subsidized in Saudi Arabia and below world levels in Kuwait, Bahrain, and Qatar.
Renewable energy deployment, already well underway in the United Arab Emirates, has begun to accelerate elsewhere, with the award of Saudi Arabia’s 300-megawatt Sakaka solar photovoltaic project, further tenders in the works amounting to 3.3 gigawatts of solar, and other solar and wind projects in Bahrain, Kuwait, and Oman. Rooftop solar programs, providing regulations and usually net-metering (the offset of self-generated against consumed electricity) for businesses and residences, have been rolled out in Oman, Dubai, and Abu Dhabi, and have been planned for this year in Saudi Arabia. Riyadh’s 200-gigawatt solar venture with Softbank has attracted much attention, but its near-term steps are more tangible signs of commitment. Gas-rich Qatar has progressed little in this arena so far.
And in the wider economy, a variety of budget cuts and revenue-raising measures have been introduced to narrow deficits, including a 5 percent value-added tax in Saudi Arabia and the UAE, and Saudi taxes on unused land, soft drinks, and expatriate dependents.
This all sounds like a lot. But the higher oil prices have undercut the urgency for reform, with a widespread feeling among policymakers that the worst is behind them. Saudi Minister of Energy, Industry, and Mineral Resources Khalid al-Falih has commented that the continuation of production cuts will keep the market “stable,” while Brent crude prices have risen from a low of $45 per barrel in June 2017 to around $67 per barrel in April. The idea of a long-term OPEC and non-OPEC pact implies a strategy aiming at high prices and limited growth in output in the short and medium term, at the cost of losing markets and accelerating the transition to non-oil technologies in the longer term. That makes diversification now even more urgent. Conversely, if the pact falls apart or if strong growth in U.S. shale oil or a global economic slowdown leads back to market oversupply, the recent price gains may slip back, and give reform renewed impetus.
The GCC countries, even junk-rated Bahrain and Oman, have encountered little trouble in raising cheaply-priced debt. Faced with a recession in the non-oil economy and public discontent, and buoyed by the recent oil price gains, Saudi Arabia has relaxed its austerity program, reinstating bonuses, undoing salary cuts, and making one-off payments to students abroad, with announcements in January costing around $13 billion. The plan for a balanced budget by 2020 has been pushed back to 2023, and even this relies on oil production growing to 11.03 million barrels per day and oil prices reaching $75 per barrel. It is not clear how these two figures are compatible with a continuing commitment to restraint in the OPEC and non-OPEC pact, or the likely effect of higher prices on global demand and competing supply.
Really fundamental reform, to ensure robustness both against a recurrence of low oil prices and a longer-term erosion of oil’s importance in the world economy, would have several components.
It is now pretty much acknowledged officially that the IPO of Saudi Aramco will not take place before 2019. Decisions need to be made soon to ensure this can take place on a leading international exchange, probably London, alongside the Tadawul, in process of being upgraded to emerging market status. Recent license awards in Abu Dhabi and Qatar have not changed the upstream structure, but simply introduced a reshuffled set of likely long-term incumbents. But plans in Abu Dhabi, and the much smaller Ras Al Khaimah, for open bid rounds for new exploration acreage are encouraging.
Privatization so far has been minimal and limited to minority stakes. Both Kuwait and Oman have made extensive lists of companies slated for privatization, including refining, petrochemicals, drilling, oil services, tankers, fuel retail, and power generation, and need to push ahead. Similarly, it is time to move on plans to split up Saudi Electricity Company and sell it to local citizens or corporate partners. Power grids and pipelines are ideal candidates for outside investors throughout the region.
Other energy-intensive or extractive industries, such as petrochemicals, steel, cement, aluminum, and mining, have continued to expand, and sometimes into more sophisticated products, but still largely on the same state-guided lines. Further privatization and encouragement of small- and medium-sized enterprises and international entrants would reduce the state’s exposure to volatile energy and commodity prices, while boosting private sector spinoffs and job creation.
The increases in natural gas and local fuel and electricity prices have not yet established anything like a free market in energy across the Gulf states. The next step would be to link key prices to international benchmarks, then gradually to liberalize the price, trade, import, and export of the main energy products. Political and commercial barriers prevent the full extension of gas and electricity trade within the GCC and with its near neighbors, but wherever possible these should be encouraged, with wider use for instance of the GCC electricity grid, and more gas interconnections.
The recent period of low oil prices has led to important and continuing restructuring of the energy sector across the GCC states, in some countries more than others. Now, a radical rethinking of the energy economy’s functioning is required, to make the most of the current OPEC strategy. Unlike previous episodes of oil producer reform, this time the urgency needs to remain even if prices for now rebound.
Looking to boost oil prices, OPEC and its non-OPEC allies have agreed to curtail oil production by 1.2 million barrels per day, but the volume of barrels taken off the market may prove to be much higher.
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