Best oil investment trusts. The $2 Trillion Threat To Middle East Oil

Best oil investment trusts. The $2 Trillion Threat To Middle East Oil

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The global drive to mitigate the impact of climate change and boost renewable energy is threatening the immense wealth that the Arab Gulf oil producers have accumulated from crude oil over the past decades.

In less than a decade and a half, the six members of the Gulf Cooperation Council (GCC)—Bahrain, Kuwait, Oman, Qatar, Saudi Arabia, and the United Arab Emirates (UAE)—could see their combined US$2 trillion wealth wiped out, if they do not significantly accelerate fiscal reforms and raise their non-oil revenues and non-oil share of their respective economies to be ready for a world of peak oil demand.   

This warning came from the International Monetary Fund (IMF), which said in a report last week that the GCC countries urgently need deeper reforms in their economies, revenues, and the way they are spending in order to preserve their net financial wealth over the next two decades, in which global oil demand is expected to peak.  

The Threat To Middle East’s Oil Wealth

At the current pace of fiscal reforms, income, and spending, the six oil producers will see their current US$2-trillion wealth exhausted by 2034, the IMF said.

The fundamental change in oil markets, with increased attention to climate policies and potential carbon taxes, poses a huge challenge to the GCC countries, which collectively produce over one-fifth of global oil supply.

Some countries in the region have already started to implement some reforms, including cutting subsidies for fuel and water, or charging non-nationals the market prices of gasoline as compared to subsidized prices for nationals.

Yet, the current reforms across GCC will not be enough, the IMF said. The mere economic diversification away from oil—a difficult goal to achieve in itself—will not be sufficient to stop the wealth erosion in the key oil producers in the Middle East; GCC countries need a significant increase of their non-oil revenues, according to the fund.

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But then even higher non-oil revenues may not be enough—governments will likely be forced to downsize in order to rein in public spending, the IMF said.

“[T]here remains significant scope for rational­izing other categories of spending, including reforming the region’s large civil service and reducing public wage bills which are high by international standards,” the IMF’s paper reads.   Related: Could This Be The Decade Of Green Hydrogen?

“Besides strengthening public finances, these reforms would also reduce labor market distortions and facilitate private sector development,” the fund noted.

But The Middle East Is Not Kicking Its Oil Addiction

The petrostates in the Middle East have started to implement some reforms after the oil price crash of 2014-2015 plunged most of the government budgets into deficits, as oil revenues—the key source of income and government spending to support the economies—halved.

The biggest producer in the region and the world’s top oil exporter, Saudi Arabia, continues to run massive deficits five years after the oil price collapse. Although it has its Vision 2030 plan to diversify the economy away from oil, including funding part of the plan with proceeds from the Saudi Aramco IPO, the Kingdom continues to struggle to attract foreign direct investment.  

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So it continues to bet big on locking in future demand for its oil with joint ventures in the key oil growth market, Asia. Aramco continues to strike downstream deals in China and India, looking to become a global leader in refining and marketing. 

Saudi Arabia’s oil and gas sector accounts for about 50 percent of its gross domestic product (GDP), and about 70 percent of export earnings, as per OPEC figures.

In other words, oil makes up half of Saudi Arabia’s economy, and Vision 2030 or not, the Kingdom will have a hard time kicking the oil habit, even if it were earnestly trying to do so.

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The dilemma for the Saudis here is that without oil, Saudi Arabia is losing a key leverage in regional and international politics. It’s the Kingdom’s vast oil reserves that have paid for and continue to pay for the lavish lifestyle of the House of Saud, the family ruling the absolute monarchy which is the only country in the world bearing the name of its rulers.

The United Arab Emirates, one of the three OPEC members in the GCC alongside Saudi Arabia and Kuwait, has a mode modest exposure to oil—around 30 percent of the UAE’s economy is directly based on oil and gas production. Abu Dhabi is the emirate most exposed to oil demand and oil prices, while Dubai, for example, is a top luxury tourist destination and is doing quite fine without oil reserves.

Kuwait has a huge sovereign wealth fund, which could help it stave off the total wealth depletion until 2052, according to the IMF.

But Kuwait is heavily dependent on oil, too—the oil and gas sector accounts for about 40 percent of its GDP and a whopping 92 percent of export revenues, according to OPEC.

“Weaning the economy off oil hinges on the emergence of a vibrant non-oil sector that creates jobs for the growing labor force,” the IMF said in a report on Kuwait last month, noting that “The current conjuncture and the exhaustible nature of oil underscore the need to diversify the economy and ensure adequate savings for future generations.”   Related: 5 Weird Ways To Generate Renewable Energy

Oman and Bahrain of the GCC (but not OPEC members) are the most vulnerable producers to the looming peak oil demand, while Qatar—thanks to its huge natural gas reserves and the expected continued rise in global gas demand—could be spared some of the fiscal pressure that its neighbors may feel over the next two decades, the fund says.

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Climate Change Dilemma  

Increased efforts to combat climate change have reached the largest oil producing companies in the Middle East—Saudi Aramco and the Abu Dhabi National Oil Company (ADNOC). Aramco is now openly talking about climate change, touting research on lowering emissions, while ADNOC prides itself on being among the top five lowest GHG emitters in the oil and gas industry.  

The irony is that due to their geographical position, oil producers in the Middle East would be more affected by climate change in the coming years than oil producers further north.  

Jim Krane, Wallace S. Wilson Fellow for Energy Studies at Rice University’s Baker Institute, wrote in a paper last month the Gulf oil producers “would benefit most from reducing ongoing accumulations of carbon in the atmosphere and associated adaptation costs.”

“The petro-states of the Gulf should view climate change with more alarm than northern oil producers like Russia, Canada and Norway, which would experience milder short-run damage — or even benefits — from a warming climate,” Krane wrote in the paper published in the British Journal of Middle Eastern Studies.

“A creeping risk to the Gulf oil windfall is materializing in the form of climate action,” Krane wrote, while the IMF said in its report last week that “oil-exporting countries may need to be ready for a post-oil future sooner rather than later.”

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