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The Gulf is an indispensable oil region

For the world’s essential energy-producing region, weak oil prices are an opportunity

As long as the world needs oil, it will need the Gulf.

Bahrain, Kuwait, Oman, Qatar, Saudi Arabia and the United Arab Emirates (UAE), the six members of the Gulf Cooperation Council (GCC), sit atop 405 billion barrels of recoverable oil, almost a quarter of the world’s total. In 2013 they accounted for about the same share of its supply. For all the glamour in North America’s energy sector, Saudi Arabia, the GCC’s dominant member, remains the market’s crucial oil exporter, with unrivalled influence over global crude prices and therefore over the world’s economy. Its decision at the November 2014 Opec meeting to adopt a passive role in the market – to take its “hand off the tiller”, in the words of one senior Saudi official – has not lessened this market power. Oil prices are weak because Saudi Arabia wants them to be.  

The region is not just a global upstream powerhouse. Gulf countries have built up networks of refineries and petrochemicals facilities that stretch from Ras Tanura to Texas and Seoul. More plants are being built. After adding almost 1 million barrels a day (b/d) of refining capacity in the Middle East in the past two years, another 1.7 million is due on stream by 2020, according to the International Energy Agency. Between 2015 and 2020, Gulf states will be able to export 1m b/d.

Yet as Petroleum Economist’s survey of the Gulf this month shows, big problems, some of them long in the making, are looming across the region.

The Gulf’s Opec members – Saudi Arabia, Kuwait, the UAE and Qatar – may have engineered the fall in oil prices, but the strategy was necessary: relentless market strength in recent years had weakened global oil-demand growth and spurred the startling rise in production elsewhere. The Gulf exporters, whose oil can be extracted at a fraction of the cost needed in unconventional, deep-water and maturing basins elsewhere, could no longer accept their ever-shrinking share of a market that was no longer expanding as quickly as before. The lower oil price, believes Ali Naimi, Saudi Arabia’s oil minister, will solve this, by forcing these rivals out of the market. “Others will be harmed greatly before we feel any pain,” Naimi said in an interview earlier this year with Mees, an industry newsletter.

He’s half right. Others – fellow Opec members Venezuela, Iran, Algeria, Nigeria, as well as Russia, the North Sea’s producers, Norway, marginal Canadian oil sands developers and the least efficient US tight oil players – are being harmed by prices that have slumped from around $113 a barrel in mid-2014 to about $50/b now. But the Gulf’s pain threshold is nearing too. In January, Oman’s oil minister Mohammed Al-Ruhmy used a speech at a Petroleum Economist conference in Kuwait City to tell his Gulf peers that they had got their strategy wrong. “This is not business. This is politics that I don’t understand – this is your politics that I don’t understand.”

Chain reaction

Oman will run a deficit this year because of the fall in oil prices. But the damage of plummeting revenue will be felt in its neighbours, too. Profligate spending, especially in the years since the Arab uprisings of 2011 – in that year alone GCC states upped public spending by $150bn, or 12.8% of GDP, according to a report from Chatham House, a think tank – pushed up fiscal break-even prices across the Gulf (see Table 1). Robust sovereign reserves mean these countries have firepower to withstand a prolonged slump. But even Saudi Arabia, admits Naimi, may be forced to borrow money or run deficits. In Gulf newspapers columnists are asking if it is time to start taxing citizens.

That hardly seems likely. But the Gulf could use this period of fiscal tightening to end wasteful energy subsidies. The argument against doing so is that the Gulf’s monarchies don’t want to hit their restive populations in the pocket.

This is short-term nonsense. Energy demand growth in the Gulf, where per capita consumption is the highest in the world, demands an ever-greater share of countries’ budgets to pay for the subsidies while taking a larger slice of the energy that could be sold at international prices to the world. Pricing energy so cheaply that Gulf residents leave the air-conditioning running when they’re on holiday is in no one’s interests.

The subsidies have contributed to another problem, as our articles on the Gulf’s gas and power sectors show. Aside from Qatar, the world’s biggest liquefied natural gas (LNG) exporter, none of the other Gulf states has a thriving natural gas sector capable of quenching its own rising thirst for electricity. Low domestic gas prices and lack of access to international markets has discouraged upstream activity targeting natural gas. In combination with soaring power demand and internal GCC political frictions – which have stymied cross-border gas trade in the region – this has created a situation in which gas-poor Gulf states like Kuwait, less than 600 km away from gas-rich Qatar, will buy LNG from Shell, which may source the LNG from Qatar. A pipeline between the two countries would be far cheaper. Bahrain, even closer to Qatar, may buy its LNG from Russia.

Absurdities like that also reflect some of the Gulf’s fraternal rivalries. A pipeline from Qatar to Kuwait and Bahrain, for example, can’t happen until Saudi Arabia lifts its objections to the infrastructure passing through its maritime borders. Indeed, in recent years, much of the intra-Gulf antagonism has focused on Qatar, whose adventurism elsewhere in the Middle East – supporting the Muslim Brotherhood in Egypt and Islamists in Syria and Libya – has angered the UAE and Saudi Arabia.

GCC members have chafed against each other recently in other ways too. Saudi Arabia’s unilateral shutting down of the Khafji oilfield in the Neutral Zone it shares with Kuwait has left Kuwaitis seething – mainly in private – about Riyadh’s arrogance. In turn, Saudi Arabia and others in the Gulf have been angered by Kuwait’s discounting of its crude sold to Asia – a mini intra-Gulf price war that has rumbled in the background of the wider price collapse.

Whatever the oil price, meanwhile, the Gulf states face other fundamental changes. A common view of the unrest across the Middle East and North Africa in recent years is that the republics – Tunisia, Egypt, Libya, Syria, Iraq – have been vulnerable where the monarchies have not. But this is debatable. Well-armed police states prone to showering their people with oil-funded social programmes may offer these monarchies security for now. But the longer-term picture could be different. 

“The current economic bargain between state and citizen in the Gulf states is unsustainable as they all prepare for a post-oil era, albeit with different timescales,” wrote Jane Kinninmont, a Gulf expert at Chatham House think tank, in a recent report on the region. In four of the GCC’s states, hydrocarbons resources will run out in the lifetime of citizens born today. “Generational change, with 60% of the (GCC’s) population under the age of 30, is placing strain on traditional political structures.” Saudi Arabia’s new king, Salman, seems to have recognised some of this. His Western-oriented son, Mohammad, is thought to have been behind the reshuffle of the kingdom’s government. He is just 34 – a radical age to be wielding power in the kingdom. Whether the ruling family can move deftly enough to keep up with its youthful population in the long term remains to be seen. Younger, better educated citizens will increasingly demand more of a say in how their countries are governed, says Kinninmont. She expects more republican movements to emerge in the coming years, if the rulers don’t accommodate changing popular expectations. How the monarchies deal with their youth will be key to the region’s stability.

Upstream delays

In the meantime, the global oil market will fix its attention on the GCC’s oil sector. The weaker oil price may make costly upstream expansion plans – such as those under way in Kuwait and the UAE – less urgent. If the rise in non-Opec production is short-lived, as some analysts expect, the world will increasingly rely on the Gulf again, and will rue any decisions to delay development now while prices are low. If Opec’s Gulf members truly believe that low oil prices will win them back a bigger slice of the oil market, they should be pushing ahead in the upstream.

The lower price offers the Gulf other opportunities. The big state oil companies still crave the knowledge and technology transfer that better relations with international oil companies (IOCs) could offer. As the lower oil price cuts their margins, their state masters should use the opportunity to open the field to other investors. This cannot happen in name only. Kuwait wants majors to help develop its upstream, but investors complain about red tape, political interference and poor terms – an impression Gulf states need to address if they are to win capital from investors that must now be choosier about where to place their money. Competition from Iraq and Iran, which are both considering new contracts to secure more IOC investment, is another reason for the GCC members to act. The prospect of a post-sanctions Iranian oil sector bustling with foreign investors – a distant but ever less likely prospect – should spur Gulf countries to be more welcoming. The Gulf’s own private sector also needs nourishing. The IMF says strong economic growth in the GCC in recent years has relied too much on state spending, while private-sector growth has been weak and concentrated in low-skill jobs (especially foreign labour). Most nationals work for the state, whose wage bill will rise sharply as more of them enter the work force. Lower oil prices mean this model is no longer viable, says the fund. Nurturing a genuine private sector would create jobs.

In short, a period of low oil prices will test the Gulf. But it could also be cathartic. Straitened finances are a chance to make broader changes – to subsidies, foreign investment terms, intra-Gulf energy infrastructure, and the rampant profligacy that has made too many citizens depend on governments that depend too heavily on oil revenue. Doing so would make the world’s most important energy-producing region stronger and more stable, whatever the price of oil.

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