To stay or not to stay?
ME PoV Summer 2018 issue
The GCC energy reforms continuum
Energy reforms spark change but the question of how to proceed remains.
The energy industry plans underway in the Gulf, namely, Dubai Energy Strategy 2030, Oman’s Energy Master Plan, the National Transformation Program in Saudi Arabia and Vision 2030, among others, give the impression of significant and undeniable reforms. However, with OPEC’s decision to raise oil prices, there is the risk of systematic industry reforms being halted. This is especially true for the energy sector where the heightened urgency for reforms is viewed by many policy makers as a source of discomfort given the scale of change needed over a relatively short period of time. This author argues that reforms must continue (and at a fast pace due to foreseen budget deficits) to help shift and sustain healthier GCC energy economies and deliver on the adjacent national economic plans.
Significant progress has been made so far. The agreement between OPEC and leading oil producers from outside OPEC, particularly Russia, has led to higher prices and reduced a bloated inventory. There are now attempts to organize this agreement to a 10 to 20-year arrangement, as per Saudi Crown Prince Mohammed bin Salman.
In Saudi Arabia, the National Oil Company is undergoing a transformational change. One theme that has captured most of the headlines is the plan for the initial public offering (IPO) of 5 percent of Saudi Aramco. Even as the IPO is still in preparation, it has led to a thorough reform of the company's culture and organization.
The Abu Dhabi National Oil Company (ADNOC) has undergone additional transformation under a different restructuring model. The emirate’s Supreme Petroleum Council has decided to further diversify its upstream and downstream investments among western partners (the largest oil and gas companies, such as Shell and Exxon Mobil), Japanese buyers and key customers in growth markets such as China, India and South Korea. Markets have also witnessed ADNOC Distribution, its retail fuel arm, moving quickly to sell 10 percent of its shares in the local market in December 2017.
The sovereign wealth fund Mubadala, a major energy investor, has significantly expanded through its merger with the International Petroleum Investment Company (IPIC) in early 2017, adding a large refining and petrochemical portfolio. In parallel, the Abu Dhabi Investment Council (ADIC) has also become part of the Mubadala group, with a combined portfolio worth over US$200 billion. In March 2018, the Abu Dhabi Water and Electricity Authority (ADWEA) and the Office of Regulation and Control were subsequently merged with ADIC and brought under new management, consolidating three critical utilities arms.
In Kuwait, some major projects eventually offered improvements in the refining sector: a new LNG import terminal and deep sour gas production in northern Kuwait are two examples. BP and Shell have been giving discreet assistance as part of technical services agreements.
Qatar has merged its two gas companies to produce liquefied natural gas (LNG), gain efficiencies and move forward with the resumption of development in the North Field, widely recognized as the world's largest exporter of LNG by early 2020.
Bahrain has just announced a major discovery of crude oil and deep gasses at sea, although actual production will not begin until a few years later.
Reforms of energy subsidy models were another common step for the Gulf states. Fuel, electricity and water prices have been raised throughout the GCC, although in some cases at very low levels, and still need to move to parity with prices in the global market. Natural gas prices for energy and industry uses have risen in Saudi Arabia, Bahrain and Oman. The Saudi and UAE governments have eased the impact of rising energy bills on low-income Saudi citizens through payments under the Citizen Account, in many ways, similar to the cash aid provided by Iran after energy price increases in 2010.
In Abu Dhabi, small increases were imposed on citizens and the biggest increases were imposed on expatriates. Gas prices are still far from international levels in all GCC countries, except Kuwait. Diesel prices are still heavily subsidized in Saudi Arabia and below global levels in Kuwait, Bahrain and Qatar.
Renewable energy has also been introduced in the UAE and is accelerating elsewhere with 300-megawatt solar power plants in Saudi Arabia, as well as further tenders for 3.3 gigawatts of solar and other energy renewable sources. Similar renewables-focused projects exist in Bahrain, Kuwait and Oman. Solar energy programs have been implemented on rooftops. Riyadh’s 200-gigawatt project plans—with Softbank—have attracted a lot of attention. The gas-rich state of Qatar has so far made little progress in this area.
In the wider GCC economies, a variety of budget cuts were made and new resources introduced to fill the deficit, including a 5 percent VAT in Saudi Arabia and the UAE. Saudi taxes increased on unused land, soft drinks, expatriate residences and their families.
All this seems to be a great effort. But rising oil prices have weakened the dire need for reform, with a widespread feeling among policymakers that the worst is over. Saudi Arabia's Minister of Energy, Industry and Mineral Resources Khalid Al-Faleh commented that continued production cuts would keep the market “stable,” while Brent prices rose from a low of US$45 a barrel in June 2017 to about US$78 a barrel in May of this year. The idea of a long-term OPEC deal involves a strategy aimed at raising prices and limiting production growth in the short- and medium-term, at the expense of losing market share and accelerating the transition to non-oil technologies in the long-term. This makes diversification more urgent. Conversely, if the agreement collapses, or if strong U.S. shale oil growth continues, or a global economic slowdown occurs, it could lead to increased supply in the market, driving a decline in recent price gains and thus giving new impetus for reform.
The GCC–including Bahrain and Oman, which do not have large oil reserves–has faced debt-raising challenges. In the face of stagnation in the non-oil economy and purported public resentment, Saudi Arabia has benefited from recent gains in oil prices, Saudi Arabia has loosened its austerity program, recouped bonuses, reduced salary cuts and made one-off payments to Saudi students abroad, costing the budget approximately US$13 billion. The plan to balance the budget from 2020 to 2023 has been postponed. It requires oil production of 11.03 million barrels per day and oil prices to reach US$75 per barrel.
It is not clear how these figures are consistent with the continued commitment to restrain OPEC, the agreement with non-OPEC countries, or the potential impact of rising prices on global demand and competition for supply.
Kuwait and Oman have provided extensive lists of privatizations, including refining, petrochemicals, drilling, oil field services, fuel trading and power generation, and it is this author’s view that they need to act on them. Similarly, it would be beneficial for Saudi Arabia to move ahead with its plans to split the Saudi Electricity Company and sell it to local companies.
Other energy-intensive or extractive industries, such as petrochemicals, steel, cement, aluminum and mining, continued to expand, sometimes reaching more sophisticated products, but they still largely depend on state support and often described as quasi-government in terms of their organizational agility. Further privatization and encouragement of small and medium enterprises and international arrivals would reduce the GCC countries’ vulnerability to energy and commodity price fluctuations while boosting private sector production and job creation.
To bear the fruits in full, reforms must be viewed as a perpetual, fast-paced effort across policy making, planning, and executive branches. The downside for potential disruption of the current effort is likely to carry unbearable costs to fiscal budgets and deceleration in attracting private sector investment. Higher oil prices, coupled with the expedited continuum of reforms, will undoubtedly reinforce a faster shift to non-oil based revenue and boost delivery on industrialization plans.
by Salam Awawdeh, Partner, Consulting, Energy & Resources Leader, Deloitte Middle East