The rise of the Mid-East 'INOC'
State-controlled Mid-East Gulf oil and gas firms are evolving in a changing world
Uncertainty over long-term oil demand, sustained lower prices and the energy transition pose challenges for the entire industry. But perhaps no group of players feel these headwinds more keenly than the Mid-East Gulf’s national oil companies (NOCs), as they butt up against the very essence of their traditional business models.
These firms are developing strategies to meet these challenges and reshape themselves for a lower-carbon future—be it seeking outside investment, partnerships, a sharper trading focus or an aggressive push in the downstream. And the trend has been given a name, international NOCs, or INOCs
Petroleum Economist spoke to Edward Bell, senior director, market economics at Dubai bank Emirates NBD during London’s IP week to get his views on the INOC phenomenon.
What do you see as the major challenges for the Mid-East Gulf NOCs at present?
Bell: The NOCs are agents of oil market policy rather than being the determinants of it. So, for instance, it is the oil or energy ministers that will meet at Opec, not the CEOs of Adnoc or Aramco. So, they are always going to have to balance meeting geopolitical demands from the Opec level at a more commercial, engineering and technical level.
I think, by and large, they have been pretty good at doing that, while any international company that operates in the region—anybody who has ever done a deal with any of these firms—is aware that oil market policy is dictated by factors that are not necessarily commercially driven, but subject to Opec decision making.
Even when one looked at the prospectus for the Aramco IPO, it was very explicit that Aramco does not set oil production targets, the government does. So, I do not know if that is necessarily a challenge, but it remains a theme that I do not see going away anytime soon.
“It would have been a struggle for anybody to imagine Aramco doing a group level IPO five or 10 years ago”
What we have seen in the last couple of years is NOCs responding to volatility and downward price moves to try to figure out ways to maximise revenue from all of the infrastructure and all of the knowhow they already have in place. In particular, there has been innovation in financing techniques on the part of the NOCs which we had not really seen up until the last couple of years.
The Aramco IPO is obviously the most high-profile—I really think it would have been a struggle for anybody to imagine Aramco doing a group level IPO five or 10 years ago. But it is not the only one we have seen. For instance, Adnoc has gone down a different route, with not a group level IPO, but at the company function levels. The distribution company is now listed, and it might be on the cards for other companies to list on an exchange or to open up some of its midstream functions to outside investment as well.
So, innovation in the way companies finance themselves or raise capital will be a trend that we continue to see. The UAE and Saudi Arabia have led it, but Oman has also talked a lot about doing an IPO for Oman Oil, if not yet on the PDO side—so where the government has complete control—to raise revenue and raise capital for the company.
On top of that, there is the big push that we have seen into trading by all the NOCs. ATI was set up a couple of years ago by Aramco, Adnoc is going through a similar process now. I think that is a reflection of the desire to transform into a sort of ‘international’ national oil company.
We might see more a trend in the Gulf region that just relying on basically being a price taker or a price receiver of what the market is saying the oil price should be is not enough anymore. The NOCs have to become more actively involved in making all of their assets, infrastructure and knowhow work for them.
And when they enter into JVs, are they choosing the right partners for the right reasons all the time? Or are there geopolitical criteria that go alongside the economic?
Bell: I think there are politics there, but partnership decisions are largely informed by the economics first. I see that as the driver. If you look, for example, at when Adnoc’s concessions came up for renewal, they went to companies from countries where there is a trading relationship.
That makes sense. If you are Adnoc or you are Aramco and you are selling crude into Asia, why not do a JV with a company in China so you can have greater visibility over the market you are selling into and some greater security of offtake for your crude or your products? It makes more sense than partnering up with a European company that might be motivated by shareholder or regulatory pressures that do not necessarily affect you in the same kind of way.
It reflects an attitude of, we will look at where our products are going and do business with those jurisdictions, more than we want the prestige of doing business with a top-tier IOC.
While that is logical, will it not always be the case that a Mid-East Gulf NOC is balancing its commercial strategy with its commitments to provide revenue to the state coffers?
Bell: I do not think there is going to be any change in terms of shareholder demands on NOCs. The shareholders are the governments, which use the income generated to finance the socio-economic costs of the region. If there is this push to internationalising, to more innovation etc., it comes back to the firms figuring out that they cannot just rely on taking the price that the market gives them. It is imperative that they expand their own sources of income—whether through trading, refining or petrochemicals—to ensure that they can continue to meet the demands of the shareholder.
“Gas is the area where most of the exciting investment is going”
It is actually kind of analogous to what you see with Shell or ExxonMobil, but the demands of the shareholder are not necessarily quarterly returns but are much more long-term.
That seems like a good juncture to ask about the new shareholders in Aramco. How do you see the prospects for a successful expansion of the IPO to non-domestic investors?
Bell: Aramco, in terms of attracting potential IPO investors into its long-term story, has been very clear that they want to make themselves a big gas player as well. If you look at the financials of the company, it is enormously profitable. But that is within the context of a very headline-driven, “oil demand is going to peak, oil is bad, oil is too carbon intensive” story.
So, for attracting longer-term Aramco investors, a pivot to gas makes sense.
When you look at the region more broadly, it is, on aggregate, gas short. You have exceptions like Qatar that are big exporters but, by and large, it is a region that still needs an enormous amount of gas, particularly for power generation. And if you have an expansion of the population, its economies are going to have more and more demand for power, hence the gas story makes sense and would be the compelling hook to attract investors into Aramco.
Given that most of the NOCs in the region have profited mainly from their access to high-quality, low-cost crude reserves, how much of a challenge, though, is going to be any pivot towards gas?
Bell: The fact that these countries are not as big gas producers as reserves would imply. shows that there is a technical challenge. There have also been issues around gas pricing and around getting it to port infrastructure.
But, looking at the region from a top-down view, gas still is the area where most of the exciting investment is going, rather than in upstream oil production. We have had a couple of big discoveries made in the UAE in recent weeks. That is testament to a desire to try to maximise gas production going forward.
Which is not to say that it will be immediate and have a major impact on countries’ energy mix in the next couple of years. But, on a 2025-30 time horizon or beyond, I would expect to see gas as a much more significant part of the hydrocarbon growth story in the GCC economies than crude, albeit alongside refined products and petrochemicals as well.
Although they have talked up gas, have the approaches of some of the Mid-East Gulf NOCs to energy transition challenges, e.g. Aramco’s narrative that its crude has a very low carbon footprint, risked bordering on complacency?
Bell: I think they will react to a couple of things. One is whether the global energy demand profile changes significantly so that oil loses material market share in the overall global energy mix. There would obviously be some material economic consequences for the Gulf NOCs as a result of that over the next few decades—even if it is not necessarily climate issue-driven, but rather, say, the world just becomes much more efficient in its use of oil. That is a long-term structural risk to the region’s economies.
The availability of gas reserves in the region should allow firms, if they are able to exploit and develop them, to continue to be an important energy raw materials supplier to the world—if gas is that transition fuel, which is still very much up for debate. But that, again, comes back to what actually does the global energy mix look like in 2030 or 2040.
Where I do not necessarily yet see the push for a ‘greener’ profile for these companies is from the investment side of things. Traditionally, the NOCs have been reliant on financing from export credit partners—e.g. the Japanese export credit agencies have spent a lot with Adnoc to develop upstream projects—or, for Aramco in particular, have been largely self-financing.
If there is a shift to relying more on capital markets and public bond markets to finance projects, and we see a more entrenched environmental risk rating on oil companies from investors, then that might be more of a catalyst to push for a greener profile. So far, we are not seeing that.
It will become quickly apparent if an NOC says, “We are going to issue a bond that is exclusively going to be for CCS or another green initiative,” and there is a lower cost to that capital, there is a tangible positive impact. Again, though, we are not at that point yet.
As I said earlier, the firms are taking these initial financial innovation steps—Aramco issues bonds, Adnoc’s pipeline company has issued bonds—which they had not done before. I expect that trend to persist, and, particularly as NOCs try to market themselves outside of the region to an international investor base that is more driven by environmental and ESG considerations, that might see a push to alter their asset mix.
So, is it fair to say the Middle East energy investment environment is putting less store in ESG at present?
Bell: That may be true, but I do not think it is exclusive to the Middle East region. Asian markets may be in a similar position. Europe, really, stands apart as an outlier on this. That being said, we have seen some companies issuing green bonds in the Middle East, so it is not a completely foreign concept.
And, given that it is a segment of finance that is relatively new, you can maybe give the region a bit of a bit of space and see how it develops. But, certainly, we have not seen a significant uptake of ESG themes from the domestic investor base.