Middle East: clean energy sources and the diversification of the oil economies ? / By Giacomo Luciani

After many years spent pressing the brake on climate negotiations, the major oil producers in the Gulf appear to have changed their strategy, accepting climate change as a serious threat which needs to be addressed. This has led to the formulation of what seems to be a complex strategy, which can be summarized in a set of five principles:

This article explains these five guiding priorities in turn and discusses the geopolitical implications of the resulting change for the global posture of major ME producers. As always, a caveat is necessary: not all major Middle East oil producers are the same. The new tendency highlighted here is especially visible in Saudi Arabia and the United Arab Emirates (UAE), less so elsewhere. When it comes to Iran or Iraq, policies are driven by short-term, rather than strategic, preoccupations. One should therefore beware of generalisations, although the fact that Saudi Arabia is the main producer in the region, and necessary partner of any Organization of the Petroleum Exporting Countries (OPEC) joint action, limits the leeway of the remaining producing countries.

A continuing role for oil

In the universe of energy scenarios there is almost complete convergence on the conclusion that oil will continue to be in use for decades to come. Very few scenarios propose a rapid abandonment of oil, by 2050 or soon thereafter – an example being the Energy Revolution scenario proposed by Greenpeace [1].

The ultimate horizon for most scenarios is 2035 or 2040; in most of them oil demand increases throughout, albeit at a slower pace. The “450” scenario of the International Energy Agency [2], which is meant to propose a path towards maintaining the increase in global temperature within the 2 °C limit, envisages oil demand peaking in 2020 and declining from 93 to 74 million barrels per day in 2040. As the name indicates, this is a normative scenario, i.e. one built starting from the desired result and working out all that is needed to reach that result: there is no pretension of political realism. Alternative scenarios, e.g. based on the Intended Nationally Determined Contributions (INDCs) that participant countries have put forward at COP21, are very far from yielding the intended result.

A decline in oil demand is possible if oil is systematically substituted for in those remaining uses for which it is easily substitutable: heating, power generation and some industrial uses. But when it comes to transportation, substitution is extremely difficult – especially in a world in which billions of people in the emerging countries still have not achieved car ownership. There is a lot of enthusiasm about the future of electricity use in ground transportation; but progress, especially when measured at the global level, is minimal. In any case, substitution of oil products in other transportation modes, especially aviation, is very challenging.

The major producers of the Middle East know that they can count on several decades of oil sales. What they are afraid of is not that demand for oil will suddenly disappear, but that policies may be adopted that would restrict oil usage more than it is necessary for containing greenhouse gas emissions. They oppose discriminatory policies, such as subsidization of specific renewable sources, and favour market-based policies, which envisage putting a price on carbon and limiting emissions through market response.

Lower oil prices

Although oil will continue to be in use for decades to come, it is clear that, on the one hand, resources are much more abundant that we used to believe even ten years ago and, on the other hand, demand may not grow exponentially, as expected in the past. The combination of these two elements radically changes the strategic perspective: while it was thought until very recently that oil would inevitably fetch a higher and higher price in the future, it is clear today that the price may remain low for a very extended period of time and even far into the more distant future. High prices encourage production out of more expensive plays, while technological progress, improved know-how and more selective management succeed in reducing the cost and break-even price of developing so-called unconventional sources.

In the new situation, the strategic perspective of major producers has completely changed. A country like Saudi Arabia had a policy of limiting the rate of exploitation of its reserves to no more than 2% per year in order to be able to produce at a steady level for at least fifty years. In contrast, international oil companies normally adopt a much more aggressive depletion rate of around 10%, which results in an early production peak and shorter plateau, followed by decline. The Saudi approach has not been shared by all major producers: most of them in fact always aimed at maximizing production in the short term. But the Saudi and Emirati “restraint” was sufficient to sustain oil prices at a higher level, based on the theory that OPEC was a residual producer – the “call on OPEC” [3] – and Saudi Arabia and the UAE were the residual (swing) producers within OPEC.

However, this strategy only makes sense if future prices are expected to be higher than today’s – compensating, or more than compensating, for the loss in net present value that pushing production into the future inevitably entails. If we believe that terms of trade will systematically evolve in favour of oil, and revenue is not urgently needed, then it makes good sense to keep oil in the ground and produce it later. But in the new environment, priorities have changed: since 2014 the Saudi authorities have frequently underlined that it does not make sense to produce expensive oil from high-cost resources while keeping cheap oil in the ground: cheap oil must be produced first. This is the new rationale that underpins Saudi Arabia’s determination to defend its global market share, and let prices be determined by market forces at a level that will discourage excessive production from more expensive sources.

The consequences of this shift are momentous. While it is likely that oil prices will consolidate the modest gains they have recorded since the very low levels registered at the beginning of 2016, they are unlikely to go much higher than the cost of the marginal barrel in the richer US tight oil plays. The latter has significantly declined and may be not higher than $50 per barrel.

In the new environment, the major producers will devote growing diplomatic attention to their best customers, China first and foremost, closely followed by India. Saudi Arabia is currently reinforcing its trading position in the US by taking full ownership of Motiva – until now a joint venture with Shell – and perhaps acquiring further refining assets. This would allow Saudi Aramco to consolidate exports of some one million barrels per day, selling refined products rather than crude oil directly within the United States.

Preparing for the post-oil era: economic diversification

The expectation that oil prices may remain at a relatively low level for an extended period of time adds urgency to the quest for diversification of the oil economies and preparing the future beyond oil. The drive to diversify has always been prominent in the countries of the Gulf – with the possible exception of Kuwait –, and considerable transformation has taken place. Nevertheless dependency from oil revenue remains overwhelming with respect to government revenue and exports.

The imperative of diversification is hindered by the fact that the major Arab oil producers enjoy extremely limited comparative advantage outside of hydrocarbons. The ultimate goal is diversification away from oil, in view of the fact that it is an exhaustible resource; but in fact the best opportunities are based on oil and gas availability. The latter means integrating upstream and downstream in the value chain: developing a capability to produce goods and services for the oil industry, and adding value to crude oil through refining, petrochemicals and other industries that are highly energy intensive – such as aluminium. But the pursuit of these opportunities also inevitably brings about very high levels of energy or emissions intensity per unit of gross domestic product (GDP).

At the same time, the availability of domestically low-priced oil products and electricity has led to a pattern of consumption, which is wasteful and unsustainable in the long run. The outcome has been very fast growth in demand for electricity, which in turn is generated almost exclusively in gas and oil-fired plants. When combined with very high consumption of liquid fuels in transportation, the outcome has been that all countries in the Gulf region are faced with the perspective of devoting a growing share of their output to meeting domestic demand, and a dwindling share is available for export.

In the new environment it is widely recognized that this posture is untenable and should be addressed urgently. This implies curbing demand by increasing consumer prices to a level that is closer to international prices and effectively encourages a culture of greater efficiency and avoidance of waste; and at the same time also moving in the direction of diversification of the generation fleet through the introduction of solar, wind and nuclear power generation.

Energy diversification has become part of the official discourse since at least the middle of the past decade, but it has been pursued with variable determination in different countries. The United Arab Emirates stand out as the country that has invested the most in the direction of energy diversification, initially with initiatives that involved more appearances than substance, such as attracting the headquarters of the International Renewable Energy Agency (IRENA) to Abu Dhabi; however progressively the substance has followed suit. Today the UAE is pursuing an ambitious nuclear program, with four nuclear reactors under construction in association with South Korea. The first of these is expected to be connected to the grid in 2017, and the others to follow in subsequent years. So far this program has progressed on time and within budget. If these achievements will be confirmed until all four reactors are started, it will be a major success and a vindication of the pragmatic approach adopted by the UAE – which contrasts in particular with the Iranian posture.

At the same time, several tenders have been launched in Abu Dhabi and Dubai to stimulate investment in solar power. These have led to rapidly decreasing prices, even to the point of defying credibility. The latest development is the adjudication in October 2016 of a 350 megawatt (MW) solar photovoltaic (PV) plant at Sweihan, East of Abu Dhabi, to a yet unnamed bidder that proposed a price of 2.42 US cents per kilowatt-hour (kWh), which is extremely low. This tender was launched by Abu Dhabi Water & Electricity Authority (ADWEA), which is the major state-owned electricity company in Abu Dhabi; previous tenders had been launched by Masdar in Abu Dhabi or Dubai Electricity & Water Authority (DEWA) – the state owned electricity company – in Dubai, and have seen progressively decreasing prices. This trend will inevitably come to an end, because even if the cost of photovoltaic panels continues to decrease, other cost components will eventually play a greater role. Nevertheless, it is extremely important that the United Arab Emirates has demonstrated that renewable sources can be extremely competitive in the region. This outcome is the result of a combination of factors, among which the very high insolation and the business-friendly approach of the tenderers are prominent. The UAE has a goal of generating 7% of its power from green sources – which include nuclear – by 2020, and may well be able to attain it.

Elsewhere, not as much progress has been made. The difference highlights the importance of institutional arrangements and clarity of vision. Several other governments in the region have not displayed serious commitment to pursuing energy diversification, and only a few token initiatives have been recorded. In the case of Saudi Arabia, in partial contrast, the interest and the vision are present, but the institutional set up for implementation has not been favourable.

In April 2010 the late King Abdullah established the King Abdullah City for Atomic and Renewable Energy (K.A.Care) with a complex mission including regulation, investment at home and abroad, strategy design and implementation. K.A.Care elaborated a long-term vision to 2032, which envisages that hydrocarbons will remain a prime element in the likely energy mix, and recommends supporting it with nuclear, solar, wind, waste-to-energy, and geothermal on the following basis: hydrocarbons – 60 gigawatt (GW); nuclear – 17.6 GW; solar – 41 GW, of which 16 GW will be generated through the use of photovoltaic cells and the balance of 25 GW by concentrated solar power; wind –9 GW; waste-to-energy – 3 GW; and geothermal – 1 GW.

Implementation of this ambitious vision has however lagged behind, largely because of the hybrid nature of K.A.Care and of multiple conflicts between the mission that has been entrusted to it and those of other institutions such as the main state-owned Saudi Electricity Company (SEC), the electricity sector regulator EMRA, the King Abdulaziz City for Science and Technology (KACST) and so on. In a recent cabinet reshuffle the responsibility of all energy issues has been unified under a single Ministry led by Khalid Al-Falih, who is a key protagonist of the Kingdom’s drive to diversify its economy. It is therefore possible that implementation will now move ahead more decisively, but doubts remain.

With respect to solar energy, the envisaged expansion requires very significant administrative capacity to identify, launch and adjudicate projects numbering probably in excess of one hundred, and it is not at all clear that such capacity exists. As for nuclear, which is the second most important component, Saudi Arabia does not have an equivalent pragmatic approach to that of the UAE: it will not accept renouncing the right to enrich uranium or reprocess spent fuel, as the United States request to extend their cooperation; and will not rely on a single supplier, as the UAE did with Korea, nor accept that most key position in the industry be staffed by experienced foreigners. Saudi Arabia has been courted by several potential suppliers of nuclear power plants – notably Chinese, Russian and French – but has yet to define basic parameters such as location of potential projects, timing, intended financing and so on. The idea that the country might succeed in having 15-16 large power plants in operation by 2032 seems quite challenging.

The threat of global warming

There is also growing realisation that global warming is a threat for the viability of the region. The effects of global warming at the regional level are not quite clear, but rising sea level would encroach on significant low lying areas and crucial economic assets which are concentrated along the shores of the Gulf. It is sufficient to think of what may happen with major residential and industrial developments in Bahrain, Qatar and the UAE, many located on land that has been reclaimed from the sea to expand the originally available surface, to conclude that a significant increase in the level of the water would spell disaster. Furthermore, temperatures in the region already are intolerable for several months of the year, and water resources critically scarce. Any increase in average temperatures would lead to higher energy demand for air conditioning or desalination. Already today the provision of energy for desalination is a critical security concern, because any shortfall in the availability of desalinated water may render large metropolises uninhabitable in a few days’ time.

Awareness of these challenges has not yet percolated to the masses, and in any case the fact that the challenge is global does not encourage departing from the wasteful energy consumption habits. Nevertheless, it is to be expected that the governments and technocratic elites of the major Gulf oil producers will not shift back to being an obstacle to concerted global action for containing emissions. Their position will be to favour those measures that directly target emissions, rather than discriminating between energy sources with less than coherent focus on emissions. This entails favouring market-based approaches, i.e. either a carbon tax or a system of emissions trading, rather than administrative measures aimed at discouraging or encouraging specific sources. At the same time, they will insist on global optimisation of decarbonisation investment, meaning that often one may more easily reduce emissions by investing in emerging countries rather than in the advanced industrial ones. The former category includes all major importing countries but also the major oil and gas producers in the Gulf, for whom global decarbonisation may turn out to be an opportunity rather than just a threat.

Decarbonisation: from threat to opportunity?

It is possible for the major Gulf producers to turn decarbonisation from threat to opportunity if emissions are minimized globally – rather than country by country – concentrating investment where it may yield the best results. The Gulf countries enjoy two key advantages: the first is the potential to capture and store vast amounts of CO2, and the second is possible large-scale development of solar energy, including for export to neighbouring countries and farther beyond. Both opportunities are clear in the mind of some of the regional leaders, such as the former Oil Minister of Saudi Arabia, Ali Naimi, and his successor, Khalid Al-Falih.

Carbon capture and sequestration (CCS) is almost unanimously considered as an essential component of the drive to contain emissions, because fossil fuels will continue to be in use, and CO2 will need to be prevented from entering the atmosphere to the maximum extent possible. The difficulty of CCS lies in finding appropriate geological formations where the CO2 can be sequestered in large volumes. The best candidates are, not surprisingly, the known oil and gas fields, which have stored hydrocarbons for ages, and offer the appropriate conditions for CO2 to be stored safely. In addition, injection of CO2 in oil and gas fields still in production is a method of enhanced recovery, and contributes to maximizing availability of fossil fuels.

If importing countries will accept to import oil and petrochemical products rather than crude oil, refining and petrochemical industries might progressively be shifted to today’s oil exporting countries, where CCS would be possible at lowest cost. Some other energy intensive industries might also be displaced with the same rationale. This shift would give an important contribution to emissions reduction globally, but requires the acceptance of greater specialisation in international trade.

As for solar energy, it may be almost banal to note that desert countries enjoy a higher insolation than any or most of the advanced industrial countries, and can in due course of time become exporters of large volumes of electricity. This was the inspiring intuition of the now-defunct DESERTEC project, and is a perspective that former Saudi minister Naimi has evoked several times.

Would this evolution entail increased dependence of the industrial countries on the major oil producers? The answer is not clear-cut. Today these countries depend on oil exporters for their supply of crude oil, and this is perceived as a potential security weakness. Tomorrow they may depend for an array of different products, each of which would not be as strategically important if considered individually, but the total would nevertheless be very important. However, this is true of all international trade: in a globalizing world countries are increasingly interdependent.

Geopolitical implications

It is frequently argued that decarbonisation may lead to decreasing strategic importance of the major oil producers and marginalisation of the Middle East in the global context. This view is much too simplistic: fossil fuels will remain in use for decades to come, and the major oil producers have an important stake and role to play in the decarbonisation process.

What may happen is that their economic and therefore strategic profile will change. If further downstream integration in the oil refining and petrochemical industry as well as in other energy intensive industries will take place, we could soon reach the point where major oil producers in the Gulf will barely export crude oil at all: they will rather export oil products such as gasoline or diesel, and petrochemical products or even manufactured products made out of petrochemicals. Such a process of diversification of exports would change the strategic profile, because while everybody perceives crude oil as being a strategic commodity, few would say the same of linear low-density polyethylene or polybutadiene – or even aluminium ingots, iron bars or cement.

Furthermore, today’s major oil exporters need to make further decisive progress towards diversification of energy sources and carbon capture and sequestration. For the latter, it is interesting to note that in a study published by the King Abdullah Petroleum Studies and Research Centre (KAPSARC) [4], it was concluded that Saudi Arabia would need to import CO2 from other countries if it were to adopt CCS as major technology for enhanced oil recovery. In this line, in the future, the oil producing countries of the Gulf might become more important for their storage and sequestration capacity than for exporting crude oil.

Finally, the major oil producers of the Gulf will remain strategic investors of global importance through their sovereign funds. The latest announcement in October 2016 that Saudi Arabia will invest $45 billion into a $100 billion fund managed by Japan’s Softbank targeting high technology ventures is a harbinger of things to follow: it is a risky strategy but one that may bring about major gains and economic power. The industrial states have long ago renounced their role as investors and promoters of advanced technology – perhaps rightly so, time will tell.

That said, the transformation of the Gulf oil economies requires peace and stability in the region. Today, the region is ablaze and tensions increasingly lead to armed confrontation. Conflicts encourage short-termism and discourage investment everywhere. So far, the countries of the Gulf Cooperation Council (GCC) have avoided direct involvement in regional conflicts and succeeded in attracting international investment. However lately such prudence has been cast aside and the UAE and Saudi Arabia have intervened militarily in Yemen and Libya, and indirectly in Syria, Iraq and other countries. Tensions between and within Arab countries are increasing, and no conflict has ever been resolved: neither the Israeli-Palestinian conflict, nor the Lebanese civil war, nor the conflict with Iran. Lower oil prices mean reduced financial resources, including to engage or persist in conflicts: thus maybe greater readiness to compromise may become apparent in due course of time. It is however not at all visible at the moment.

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• [1] Greenpeace International, Global Wind Energy Council and SolarPowerEurope, Energy [R]evolution. A Sustainable World Energy Outlook 2015. 100% Renewable Energy for All, Hamburg, September 2015.
• [2] The International Energy Agency’s “World Energy Outlook”, published yearly in November, is based on three scenarios: a “current policies” scenario, a “new policies” scenario, and a “450” scenario.
• [3] This expression is based on the assumption that all non-OPEC countries maximize their crude oil production, and OPEC modulates production to satisfy global demand on top of non-OPEC supply. As the OPEC member countries have in practice not at all coherently followed this strategy, Saudi Arabia has been viewed as the “swing producer” within OPEC, although it has officially abandoned this role already in 1985 and de facto not followed the production policy that it would entail.
• [4] Saud M. Al-Fattah, Murad Barghouty and Bashir Dabbousi, Carbon Capture and Storage: Technologies, Policies, Economics, and Implementation Strategies, KAPSARC – CRC Press, 2011.