JIME International Symposium 

Sustainable Economic Growth, Energy Needs
and Policy Implications in the GCC



Fareed Mohamedi
Partner, PFC Energy
  (11/11/2010)

A Brand New Day

The global financial crisis and the fall in oil prices in 2008 again focused attention on the economic situation in Gulf. Since the Gulf economies took off in 2003 and the period of high growth stretched into 2008 there had been growing worries that this was a massive investment bubble built on high oil prices and cheap credit. The speculation on the nature of this boom was largely focused on Dubai given the magnitude of its expansion but news of delays in region-wide mega construction projects, private bank failures and merchant family business collapses all raised concerns that a bust was rippling through most of the Gulf Cooperation Council member states.

Undoubtedly, the Gulf faced the aftermath effects of the investment boom and regional financial sector expansion. Moreover, since inflows of capital by local businesses and foreign investors helped spur growth rates to new heights, especially after 2005, the global contraction exacerbated regional problems. As is typical of most commodity price and credit based booms, this will take a number of years to work through so the region faces another period of slower growth.

However, the doom and gloom predictions that the Gulf is going to suffer through another “lost decade” as it did after the oil price collapse in 1986 fundamentally miss the changes that have taken place in the region. The structural changes on the political and economic front have put the Gulf on a very different trajectory than the situation the countries faced in the mid 1980s. Most importantly, the options faced by the states are more numerous and their capacity to deal with the economic problems is materially larger.

In 1986, the oil price decline exposed the fragility of the political economy of the region on four levels: the inability to control the global oil price; the lack of prowess of the public sector to regulate and stimulate growth; the unwillingness of the private sector to commit funds to the local economy, and the lack of commitment of the population in general to support their ruling families. Since the mid-1980s, in varying ways, the Gulf States and regimes have restructured their political economies to their advantage, more or less creating sustainable structures. There are certainly new problems being created but they pale in comparison to the problems faced in the 1980s.

An unexpected long term constraint to growth is the unrestrained use of power by residential, commercial and industrial use and hydrocarbons in general. The key reason for this is the high level of subsidization of all forms of energy. Apart from the high subsidy bill paid by the exchequer, underinvestment in power capacity has led to periodic power supply disruptions. Moreover, several states are starting to suffer from environmental damage. As a result, governments across the GCC have started to source gas from overseas in the form of LNG, develop alternative energy programs and even consider the construction of nuclear plants. All these moves are triggering a number of policy initiatives which could have long term implication on the domestic political and geopolitical level.

Oil: A New Paradigm

The price of oil, the lifeblood of the Gulf, is easier to control today than it was in the mid-1990s. The prospects for the Gulf countries, especially Saudi Arabia, of continuing to maintain control over oil prices are also much better than it was in the 1980 and the 1990s. Two fundamental factors have changed: there are no hawks or doves in OPEC with all members aligned on prices; and, the threat of non-OPEC oil producers has disappeared. Even the worst oil demand conditions in the last several decades have not offset the global supply side constraints as evidenced by the ability of OPEC to bring prices back up from recent lows of $35/b to a steady range of $70/b to $85/b.

In the 1980s, OPEC had deep policy divisions about the conduct of oil markets and oil price objectives. The hawks, more populous member countries (Nigeria, Algeria, Iran, and Indonesia), wanted higher oil prices. The doves, the smaller states, particularly of the GCC, were content with lower prices. The latter had a low “absorptive capacity” and generated surpluses at lower prices. For Saudi Arabia, the most important OPEC state in the Gulf, this price objective also had an important long term strategic and geo-strategic underpinning. Before the Iranian Revolution, Saudi Arabia’s oil minister Zaki Yamani wanted lower prices so the world would comfortably remain addicted to oil and Saudi Arabia could continue to be its primary supplier. After the Iranian Revolution, the Saudis under King Fahd grew closer to the US and felt obliged, in return for the security umbrella, to provide the world’s largest consumer with lower priced oil. Saudi Arabia’s role within OPEC was one of price modifier and since it held so much of the organization’s excess capacity it could adjust its production to dampen prices.

Today, after the economic ravages of the 1980s and 1990s, even richer countries like Saudi Arabia and the UAE need higher oil prices. The fundamental divide over what each country needs to balance their books still exist (Venezuela is estimated to need around $85/b while Qatar needs $10/b and the Saudis somewhere in the middle with $50/b) but the memories of uncontrollably lower prices have created an unprecedented unity in OPEC. The lower price threshold countries are content with higher prices and are more than happy to bank their surpluses. As a result, Saudi Arabia has around $500 billion in foreign reserves, the UAE is estimated at around $600 billion, Kuwait at $300 billion and even poorer Venezuela has assets of $45 billion. In balancing these needs of various producers (and even with a nod to important consuming countries like the US and increasingly China) King Abdullah stated that the fair price of oil was around $75/b. This would meet most producers revenue needs and not scuttle the economies of the consuming countries. The question then comes down to whether OPEC can influence crude oil markets and maintain this price.

Most oil market analysts believe this target is entirely feasible over the medium term and in fact may be the low end of the range. This is because of what is happening in the non-OPEC countries. The first oil price shock i.e. the price spike of the 1970s and 1980s led to sharp supply response in most parts of the world with huge supply increases coming from the North Sea, Russia, Mexico and even smaller producers in Asia. These non-OPEC producers pushed production up and seized market share from OPEC as consuming countries – even the US --implemented efficiency and conservation drives. As the residual producer, OPEC was forced to cut output. This pattern was repeated as recently as the late 1990s during the Asian crisis when Asian demand collapsed while North Sea output continued to climb.

Looking into the future today, non-OPEC’s output days are numbered. Around the world production from most oil basins has either plateaued or is in terminal decline. Select non-OPEC producers, notably Brazil, may buck this trend but overall flat or declining non-OPEC production leaves OPEC with any incremental demand that may be created in the world economy. In 2008 and 2009, global demand shrunk due to the recession but with developing Asia continuing to grow economically it and the rest of the non-OECD will support an upward climb for oil demand even if OECD markets falter. This growth will diminish competition from non-OPEC crudes, leaving oil markets firmly in the hands of OPEC. With members aligned on the need for $75/b or higher and Saudi Arabia, again the main holder of excess capacity, as well as not particularly eager to dampen prices, it is highly feasible that such a floor price is achievable over the next 3-5 years. One can envisage a number of risks to this forecast – a faster than expected rise in Iraqi output, competition from alternative fuel sources, and even steeper declines in demand due to weaker economics etc. – but with minor adjustments to Saudi production prices can remain in this range.

While price objectives have aligned OPEC members, is also a lack of regional rivalries spilling over into OPEC decision making. In the 1980s, Iran and Iraq were at war and the GCC was arrayed against Iran. The US was a major force in the region and OPEC doves were willing to listen to its dictates. Today, member states are not in a position to attack each other and the US is increasingly becoming irrelevant to the power relations between major countries even though it maintains the only serious armed force in the region except for Iran. The US is a spent force in the region and is spending much of its time extricating itself from Iraq and ultimately Afghanistan. From an oil markets point of view, unlike in the past, Saudi Arabia is unwilling to be influenced by the US on where oil prices should be. That does not, however, preclude it from attempting to temper prices from time to time in order to be seen as a responsible member of the global economic community.

A New Economic Growth Model Saves the Day, At least for Now

By the mid-1990s, after a decade of low oil prices, huge budget deficits, domestic debt accumulation, falling real income levels, rising unemployment (exacerbated by a demographic boom) and economic policy paralysis, the poorer gulf regimes were confronted with the specter of political revolt. In Bahrain, 1994 saw widespread demonstrations, riots and attacks on public institutions. The Saudi monarchy faced demonstrations in its ancestral heartland led by individuals it had lavished money and support during the Sahwah (religious awakening) of the 1980s. Qatar had yet another contentious succession (every one of the last five had been) and then attempts at a counter coup amid external interference and even a mini-war. Hundreds were arrested in Oman for anti-government activities while in Kuwait the government progressively lost power as popular support shifted to the Islamist parties. In total, the economic deterioration was taking its toll leaving the regimes scrambling to find a new economic model to revitalize their economies and save their rule.

The Asian miracle was a potential model. Since the early 1980s, the ruling families of Bahrain and Dubai had wanted to emulate Singapore. The rapid growth of the Southeast Asian economies beyond Singapore, notably Malaysia, Indonesia and Thailand, after the mid-1980s showed that the Singapore model could be applied everywhere. Malaysian Prime Minister, Mohammad Mahatir’s dictum “Growth is like a river in flood, it obscures the rocks below” had a real resonance in the politicallt volatile Gulf of the mid-1990s. Most notably, Saudi Arabia’s Foreign Minister Saud Al Faisal and the Emir in Qatar (after the coup) started to talk of emulating the Asian economies. Oman came out with its vision 2020 modeled after a similar strategy from Malaysia.

The big problem the Gulf States faced was that they did not have any of the necessary assets to implement the Asian Model. That effort required state of the art public infrastructure, a skilled populuce, internationally competitive wages and a public bureaucracy that was efficient, flexible and far sighted. While the Gulf countries had invested in infrastructure in the past, by the mid-1990s it was nearly 20 years old and was no longer adequate. Access to cheap foreign labor, poor public education, unearned government largesse and skewed expectations for high salaries left most Gulf citizens globally uncompetitive. Plus, the local bureaucracies from top to bottom were slothful, venal and ignorant.

Leaving these problems aside, most critically to get the growth engine running the Asian Model required foreign private investment. A combination of circumstances hindered foreign investment in the GCC countries despite a pretense that these economies were open for business. Local merchants sought protection from foreign competition through the Agencies Law (only they could import certain registered goods). Government’s restricted investment in a whole slew of areas even beyond the recently nationalized hydrocarbon’s sector. Ruling family members built up private monopolies in certain areas and would not allow local businessmen into those sector let alone foreigners. Ironically, overseas the Gulf was not seen as a place to invest even though it had a middle to high income market. None of the competitive attributes prevailed to attract FDI and as a result most international businesses shunned the Gulf and serviced it through exports from Southeast and North Asia and from Europe.

Moreover, since the mid-1980s, with the decline in the price of oil, but with continued high government spending, most of the Gulf economies had little macroeconomic stability. Saudi Arabia ran budget deficits averaging close to 16% of GDP from 1985 to 2000 every year. It ran down over $140 billion in foreign reserves to fund these deficits and built up nearly $150 billion in domestic debt. There were periodic runs on the riyal during this period. The situation was similar in Bahrain, Oman and Qatar. Even after the coup in 1995 and after the initial development of LNG supplies, Qatar borrowed heavily – roughly 50% of its foreign debt went to buy domestic patronage while the rest funded its share of the LNG development. As a result of this instability most local and foreign businesses chose not to invest in the region.

Nonetheless, by the mid to late 1990s, lacking any alternatives, and after a long period of economic stagnation and threatening politics, the Gulf regimes started to make tentative attempts to acquire some of the necessary attributes to implement the Asian model. Dubai was clearly the leader of the pack and began transforming itself from being the smuggling entrepot servicing Iran and South Asia to a globally competitive business/tourism center. Government companies built up the public infrastructure, state of the art public services, transportation networks (airlines and telecoms) and began a huge international publicity campaign to attract tourists and businessmen. By 2000, Dubai became the local embodiment of Singapore and heartened local promoters of the model because it appeared it could be indigenized.

Its poorer cousin, but as much an economic pioneer, Bahrain began building on some of its strengths. It spawned an offshore banking sector in the late 1970s, which stagnated in the 1980s and 1990s because of the liquidity squeeze caused by low oil prices. The sector stopped being able to channel money out of the region because in general these were not surplus countries anymore and it could not facilitate lending because of local financial problems and due to anti-creditor regulations, particularly in Saudi Arabia. A parallel banking system was also spawned in Kuwait for political reasons in the form of Islamic banking. However, because of a more seasoned regulatory system in Bahrain, Islamic banking migrated to the island. Then with more innovations in regulation, the creation of a new accounting system more suited to the industry and new rating practices, Bahrain was able to rapidly grow an industry. It could be argued this was the only real locally grown economic innovation of the entire region.

When Saudi Arabia started the accession process to the World Trade Organization (WTO) in the late 1990s, it became quite clear that the Kingdom was starting to signal it was open for business. WTO membership served several political and economic purposes. Externally, it protected the Kingdom from discriminatory trade practices. In this regard, the Saudis were most concerned about tariffs and restrictions on their burgeoning petrochemical industry. It provided a formal means to settle disputes and in general Saudi exports would be given Most Favored Nation Status. Internally, WTO was seen by local proponents, particularly the more progressive technocrats, as a means to control the venal Royals and their monopolies and reinvigorate the parasitic private sector through competition. Moreover, those technocrats committed to making more politically difficult reforms could blame them on the WTO negotiations. As a result, this led to a new foreign investment law, the creation of the Saudi Arabia General Investment Authority, a new insurance law and early attempts to partially privatize a number of large government institutions. When then Crown Prince Abdullah called for the opening of the Saudi gas sector to foreign investment keen observers knew that the ruling family was serious about economic restructuring.

Oman also sought to kick-start growth in its economy through the globalized services, mainly tourism, and to use natural gas to fuel energy intensive industries. Vision 2020 articulated these policies and sought to direct the necessary government agencies and private sector players towards this end. In the late 1990s, Emir Hamad’s vision of Qatar becoming the world’s largest exporter of liquefied natural gas was well underway in partnership with ExxonMobil. Then as the revenues from these exports were spent on infrastructure, transportation and public services (Education City was the Emir’s wife’s pet project), Hamad started to see Doha becoming another Dubai.

Two emirates remained relatively quiet in the late 1990s, Kuwait and Abu Dhabi. Both enjoyed huge surpluses at $10 a barrel of oil and were unfazed by the low oil prices of the era. In the case of the former though, the ruling family was bogged down in endless parliamentary battles with a widespread opposition and concentrated on survival by buying patronage.

By 2000, despite these unprecedented policy moves, with the possible exception of Dubai, the Gulf was mired in the same problems of the previous two decades. Oil prices were still low although the OPEC meeting of March 1999 had put a floor under prices and they had somewhat rebounded. This provided some relief to government budgets, but for the most part they had reconciled themselves to spending at a lower level and keeping their budget balanced. Fiscal probity, however, did nothing for growth. Worse still, the new regulations were not putting the region on the world’s list of priority destinations for new investment.] Again, Dubai was the exception but it too was constrained by the drag of the past and was a mere shadow of what it would become.

Several factors came together to change the situation and put the Gulf on the extremely high growth rate path from 2001 to 2008. First, oil prices started to rise after 2001 spurred by stronger demand from China and later by problems in Venezuela, the invasion of Iraq destroying the Iraqi oil sector and the lack of new supplies despite rising prices. Initially, Gulf governments didn’t believe the permanence of these high prices and remained quite conservative on the spending front, preferring to rebuild their foreign assets.

Regional governments only started to spend after 2003 and this was only after the local private sector regained confidence in their economies, partly because of higher oil prices, and began an almost unprecedented private sector led boom. This second factor behind the boom, the prodigal private sector, received a massive boost after September 11 as large local companies feared their investments in the West would be scrutinized and it was safer to repatriate funds in their home economies.

Private sector repatriation of funds was also helped along by two innovations undertaken by governments. Better and new regulations opened up new industries. For example, in Saudi Arabia a new insurance law led to the creation of the insurance industry. New Islamic banking regulations spurred growth in this sector. But the creation of new commercially run government companies partly financed by private sector funding was a very important innovation on a number of levels. Governments could now undertake projects of massive scale which neither governments or the private sector could attempt by themselves. This would lighten the burden on the government budgets and leave them focused on public welfare. Private funds would not be lost to foreign banks but deployed in hopefully constructive projects at home. These commercially run companies were seen as able to reproduce themselves and not degrade into wasteful public bureaucracies. The buzz created by this so-called private sector activity even attracted the attention of foreign companies and banks that wanted to participate in the growth of the region. Suddenly, after trying so hard to attract foreign funds in the late 1990s, the Gulf became a destination for fund managers, property managers, banks and industrial companies from around the world.

But most importantly, from a political economy viewpoint, most of the principals behind these new public private partnerships were ruling family individuals. The potentially independent minded private sector entities could be controlled and subordinated to ruling family entities while both profited from their investments. In fact, this was a masterful reversal of the situation some of the ruling families found themselves in the 1990s where they faced the prospect of borrowing through the public exchequer from the private sector who undoubtedly would have extracted political concessions from the ruling families. In these new ventures, key individuals from the regimes were in charge and allowed access to those that were deemed sufficiently loyal and worthy of this new form of largesse.

New Politics: Better governance, More Engagement, More Divide and Rule

Higher oil prices always improve the standing of the Gulf ruling families. There is more money to put through the patronage networks and tribal, merchant and other kinship groups are more than happy to fall into line. Nonetheless, the Gulf’s rulers have put in place more sophisticated political institutions or revived older ones from the 1960s and 1970s which are allowing for greater political engagement and accountability with the populace at large.

One manifestation of this is simply better governance and provision of public services. Since the mid-1990s, the Al-Saud have strived hard to improve the quality of their ministers. The appointment of Ali Al-Nuami, Ibrahim Al-Assaf, Gazi Al Gosabi and Mohammad Al Jasser to the ministries of oil, finance, labor and the Saudi Arabian Monetary Agency, respectively, was a clear indication of their desire to hire competence given the more challenging economic environment they faced. King Abdullah has also attempted to control some of the corrupt practices of ruling family members and demand that they pay for public services they use.

Similar moves were apparent in other Gulf countries although in Kuwait and Bahrain the appointment of ministers was more complicated by the rise of parliamentary politics. Under the tutelage of the Crown Prince in Bahrain, economic policymaking was given greater prominence. Management of the state was complicated by the divisions in the ruling family but new institutions like the Economic Development Board and the National Oil and Gas Authority were designed to bypass patronage networks embedded in the old ministries and controlled by the Prime Minster in order to spur development. In Qatar, where the talent pool is quite shallow the Emir has relied on the oil minister, finance minister and his wife to implement huge and complicated projects. The Al Maktoum of Dubai and Al Nahyan have created technocratic structures to show their citizen and foreign businesses that their city states are run efficiently and without corruption and, at least in Duba,i several technocrats were prosecuted for alleged corruption. The Sultan of Oman used a combination of trusted aides and technocrats to focus on economic development after the release of his 2020 Vision.

In the last decade, the ruling families of the Gulf have put in place formal and informal institutions to engage their populations. Far from being electoral bodies with real legislative power or ability to sanction the executive, these institutions nonetheless were an acknowledgement that the ruling families had lost much real power in the 1990s, needed to curb their arbitrary rule and that the populations needed to be listened to. These institutions were also designed to reinforce other measures taken to improve governance. On a less formal and ad hoc level other moves have been taken by the ruling families to lessen societal cleavages. In Saudi Arabia, King Abdullah initiated the National Dialogue designed to improve relations with the Shi’a community. Similar moves were made in Bahrain.

While these moves helped dampen tensions, the regimes also stepped up efforts to divide and rule and also masterfully exploited mistakes made by the opposition. The use of terrorism in Saudi Arabia played into the hands of the ruling family as they moved fast to discredit more radical elements of the Sahwah or returning jihadis from Afghanistan. By playing the National Dialogue card, King Abdullah clearly showed who the principal political power broker in the Kingdom was since none of the various regional and ethnic groups dealt with each other and all came through the Al Saud to negotiate politics in the Kingdom. In Kuwait, tribal disenchantment with the urban Islamists have put the ruling family back into the driver’s seat of Kuwaiti politics. Former nationalist and leftist opponents in Kuwait would prefer dealing with the ruling family then with the Islamists. Bahrain’s principal opposition group, the Al Wifak boycotted the first parliamentary elections and essentially excused themselves from Bahraini politics for four years. Upon their return other groups had taken some of their power although more recent heavy handed politics by the ruling family (and the wholesale importation of Sunnis from around the Middle East to rebalance the demographic mix) have led to a strong showing of the Al Wifak in the 2010 parliamentary elections.

George W Bush’s objective was to destabilize the Middle East. Ironically, it actually stabilized it in two important ways. First, it raised the specter of an external threat from a country that was perceived in the region to be doing Israel’s bidding. After King Abdullah and the aftermath of September 11, 2001 ended the Special Relationship and US troops withdrew from the Kingdom the Al Saud were better positioned politically at home. They did appear to their opposition as the best alternative to external rule. As a result, the Al Saud were able to recruit some of their most vociferous critics to their cause against domestic radicals and terrorists. Second, the regimes were able to point to Iraq as an example of domestic instability and chaos. Most opposition movements became more than willing to have the negotiated and limited politics of the pacific southern Gulf than the violent and tumultuous politics of Iraq and even more recently Iran.

The Future: Peaceful for Now, Some Problems Ahead

These financial, economic and institutional changes have created more stable systems in the Gulf. But the future depends on the ability of the economies to reproduce and grow over the medium term. Also, a lot depends on the distribution of income and opportunities. The Gulf regimes have found the means to generate incomes but they have not totally been able to spread these through their populations, especially through growing employment in these new companies. Many of their companies still primarily hire foreigners. In the downturn, many of these companies have been protected by their governments. The governments have used the state’s resources to shore up balance sheets of the banks once some of these companies have rescheduled their loans. They have also prevented some private sector companies from competing against these entities ? for example in the real estate market several development plans have been scuttled because of government restrictions so that the public-private partnerships can unload their inventories without worrying about new competition. The governments have not been so generous about private sector companies going under due to financial irregularities and lack of adequate supervision. Given the well know brand names of some of these companies, the lack of government support and perception of poorer than expected bank supervision has created some resentment among the private sector. This combined with perceptions of worsening income distribution will have political consequences if the recession persists for more than a few years. It will lead to even more resentment if the Gulf rulers do not continue to broaden participation beyond some of the pretend democratic institutions that they created in the last two decades.

The Energy Needs of the GCC: The Achilles Heel?

The ability of the Gulf governments to create a sustainable growth model and a relatively stable political system has vastly improved the growth prospects in the region. However, the prospect of high economic growth has raised a key threat to the system ? a shortage of energy. This is particularly surprising given the substantial oil and gas reserves in the region. A number of factors are coming together to create dislocations and constraints that the GCC faces. GCC governments have provided free or cheap electricity to their citizens as part of the social contract of patronage and political loyalty. Demographic expansion, urbanization and strong economic growth (plus higher temperatures) have led to rapid expansion in power demand.

GCC Power Needs

Middle Eastern energy demand is expanding in all ways but it is electricity demand that is the source of the bulk of this demand expansion. Aside from the often-discussed air conditioning demand in the region, electricity is also needed by the vast industrial complexes springing up around the province. The rapid urbanization and industrialization drive is afforded by sufficient oil revenues being leveraged to support the needs of a population averaging four or more children per family. Despite the demographic pressures and the sufficient financing available, brownouts and blackouts are still events that occur, particularly in the hot summertime months as demand peaks and the electrical system is unable to handle the load.

The push to build generation facilities as quickly as possible has taxed the traditional electricity companies, with many countries now encouraging companies to also build generation facilities to boost reserve margins above the largely inadequate levels. These business structures known as independent power projects (IPPs) allow private companies to build power plants and then sell the output under guaranteed prices or price benchmarks back to the electric companies. This opening has allowed more megawatts to be brought online, often faster and at less cost than what the local or national utility could have accomplished, helping to reduce the number of blackouts and brownouts that occurred last summer when temperatures were even hotter than usual.

Most of these facilities will be fueled by crude, diesel, HFO, or natural gas, with many facilities able to run on more than one type of fuel, allowing fuel choice to be made on economic or availability basis. Despite this, other fuels now have the option to gain a foothold. While they will never be the dominant fuel source, coal, nuclear, and renewable options have all been examined by different governments around the region. The reasons for the sudden interest in non-traditional fuels for the region is multi-fold and only partially due to the rapid rise in power demand. The power demand growth is an issue for governments and companies concerned about the long-term prospects for maintaining export levels. This issue has begun to be tackled by some with increases in power costs, but in many parts of the market the processes and procedures for credibly creating and paying electric bills do not even exist, and the prospects of dramatically turning down energy growth by efficient stewardship of the electrons is unlikely to occur in either the short or long term.

And the energy demand growth has not just hit the power sector; it has hit the petrochemical sector as well. With many of these companies preferring methane and natural gas liquids to naphtha or another oil-based fuel, this places another pressure on gas supply, and makes natural gas for power generation an increasingly scarce commodity. With more crude, diesel and HFO facilities operating, the region has the second worst air pollution in the world, just behind Southeast Asia. Unlike Southeast Asia, whose high pollution rates can be blamed on Indonesia’s forest fire burning policy, the problems of poor quality air in the Middle East can be blamed on all of the countries. While coal power could reduce the dependence on local fuels, it would only exacerbate these pollution issues.

In addition to expanding electricity beyond the traditional fuels, another option is to approach the problem of power supply on a regional basis. By tying together the different power grids of the region, efficiencies can be gained, and power can be shifted from one area to another as demand dictates. Inter-political squabbles have prevented this from occurring in the past, but gains have recently been made with the GCC grid now linking together five countries, with the line through the UAE to Oman on the drawing board. Right now this larger grid provides value only on the margins, allowing system operators to balance load, ensure adequate reactive power and other ancillary services. But because most of the linked countries still have inadequate reserve margins, as well as peak demands that occur often at the same time, the full value of the GCC grid is largely unrealized. Prospects for this to change over time are unlikely, as adequate electric supply created within the borders will be viewed as an energy security issue. And unlike oil and gas reserves, building up an adequate electricity reserve margin is more attainable. Barring a financial disaster for one or more of the countries, (and minding the control the Israelis hold over Palestinian electric supply) it is unlikely that any country in the region would allow another to be a primary supplier of electricity. However as a region, the GCC grid holds the potential to provide a pathway to export electricity into the Maghreb and potential Europe if efficient HVDC transmission lines can be economically constructed.

GCC Oil and Gas Supplies

The expansion of upstream capacity has been mixed in the region. Saudi Arabia and the UAE have expanded their crude oil capacity. Bahrain, Qatar and Oman face resource constraints given the maturity of their crude oil sector. Kuwait’s crude oil sector expansion plans have been mired in political problems as the Parliament constrains its national oil company’s dealings with foreign oil companies and the lack of domestic skill prevent a go it alone strategy. Ultimately, over the next several years, oil production from Saudi Arabia and the UAE will be constrained by global demand.

Saudi Arabia has seen the largest capacity increase in the region and one of the largest single increases in the world recently. Saudi Aramco has been increasing capacity since 2004 with the Qatif/Abu Safah expansion that added 650 mb/d in 2004, Harad III in 2006 that added 300 mb/d of Arab Light, and the 500 mb/d Khursaniyah field that came partially on line in the fall of 2008. The company in mid 2009 has commissioned three addition projects: Shaybah expansion (250 mb/d of Arab Extra Light) and Nuayyim (100 mb/d of Arab Super Light); and, Khurais (1.2 mmb/d of Arab Light). The 900 mb/d Manifa heavy oil field offshore development has been delayed from 2011 to 2014 by Saudi Aramcofs decision to re-negotiate with contractors to obtain lower costs and accompanying delays in construction schedules for the refineries that would use the crude. Part of the delays were due to the expected lack of demand over the next several years.

Another factor that will constrain Saudi Arabia’s oil production is the development of Iraq’s oil sector. With the awards of 10 contracts to foreign oil and gas companies, Iraqi oil production is likely to expand from around 2 million barrels per day to 6 sometime over the next decade. There are two key factors that motivate companies to rapidly increase output, suggesting significant capacity additions in the near term: firms awarded for rapid output increases to interim production targets that trigger fees and cost recovery payments and limited spare export capacity gives advantage to first movers who can secure the remaining capacity. PFC Energy forecasts a roughly 380 mb/d increase in production by end-2011 over end-2010, and an additional 460 mb/d by the end of 2012, primarily in southern Iraq. Risks are entirely to the downside, but existing infrastructure should allow an expansion of production through end-2012. By end-2012, infrastructure and logical capacity constraints will begin to impact the production outlook significantly, and politics?or at least the government’s capacity to take important inter-ministerial decisions?will become far more of a potential limit on the pace of additional output increases.

The Saudis, the swing producer in OPEC, have figured that this will lead to an increase of around 500,000 barrels per day of Iraqi crude per annum on average, which essentially will account for a large portion of the increase in global demand for crude oil. The Saudis have a long memory of the disorder that the re-entry of Kuwaiti (and later Iraqi) crude to world markets brought in the 1990s and want to prevent any destabilization of oil prices due to market share battles or disunity within OPEC. This accommodation will keep Saudi production at around 8-8.3 million barrels a day for the foreseeable future. As a result, Saudi associated gas production will be constrained by its stable crude oil production and given high power demand rates the Saudis will have to use direct crude burning or other oil products to fuel its electricity output.

Saudi Aramco is rapidly shifting its investment dollars to explore for more gas. After forcing foreign companies into limited gas deals and reserving certain areas for itself, all of which yielded insufficient supplies, the Saudi national oil company is now in a mad dash to find more supplies. Success thus far has been limited, although a commercial discovery has been made at one of the Rub al-Khali (RAK) ventures (possible one led by Lukoil), which has given Riyadh some hope. S. Aramco has also apparently made another independent discovery. For now the major output of non-associated gas will come from the Kuran gas field in the Gulf along with onshore gas from around Ghawar. This is also forcing Saudis to consider imports of gas, possibly from Qatar or from Iraq. The latter has as much to do with improving political ties with Baghdad as it does to meeting local energy needs.

To increase oil production, UAE will need to develop reserves held in undeveloped fields. The only increases in oil production will come in Abu Dhabi. ADNOC is awarding several onshore oilfield service contracts to boost output above currently forecasted levels. ADNOC is slated to spend $50-60 billion over next decade to increase capacity. In the UAE, until 2008, energy demand surged due to Dubai’s rapid growth. Dubai’s own crude production has been in precipitous decline while its ability to source gas from Abu Dhabi was limited by that Emirates domestic needs and desire to export LNG. This shortage led to Mubadalla (the arms offset fund which was fashioned into an asset development company) investing in the Dolphin project which brought gas by pipeline from Qatar. Volumes of gas from Qatar were limited due to the extremely advantageous price provided by Qatar to the project and due to Qatar’s own massive export needs. Attempts by Dubai to import gas from Iran were thwarted by US pressure and disapproval by Abu Dhabi which views Iran with great suspicion. The gas demand pressures in Dubai self corrected at least temporarily because of the financial bust in 2008 although cargoes of LNG have been delivered to Dubai recently. Energy supply pressures have eased but for the UAE they are reemerging because of Abu Dhabi’s desire to spend enormous amount on development. Here Abu Dhabi envisages power shortages (despite an early attempt to mobilize private capital to fund its projects) and gas feedstock shortages. As a result, it has become one of the most active explorers of developing alternative energies.

The situation in Qatar is the opposite of the rest of the Gulf. The world’s largest gas field has been developed to produce around 77 million tons of LNG annually by 2011. Several years ago the Oil Minister Atiyeh ordered a moratorium on further export contracts for LNG. Problems with the field and the need to stretch out resources were behind the decision. Therefore, not only were new LNG opportunities restricted in Qatar but the emirates ability to meet the region’s needs (beyond its own) was curtailed. It has positioned itself to provide competitively priced gas to external industrial investors. The gas project investment has been paired with a generation build out that, with the completion of the 1GW Mesaieed power plant, has afforded it reserve margins sufficient enough to export power, in addition to the gas made available to UAE and others.

In Kuwait, production will remain flat to declining until former projects under Project Kuwait are brought on stream. Heavy oil projects in the north are not expected to bring as much production on stream as previously expected. They are now expected to reach just 170 mb/d by 2020. As a result, the outlook for an increase in associated gas remains poor. Previous plans to import pipeline gas from Qatar have been blocked by Saudi Arabia following a Qatari-Saudi spat over Al Jazeera. While relations have improved, the availability of gas has once again become an issue. Kuwait, whose oil development, has stagnated has already started importing LNG cargoes which look set to become a permanent feature. Gas from Iraq, which Kuwait imported until August 1990, is also a possibility.

Alternatives

Despite its now pressing need for power, and its lack of coal resources, a common base load fuel for developing and developed economies alike, the region has depended almost completely on oil and gas. Another common base load power type, hydro resources is only available in workable quantities in Iran. The sole focus on gas and oil is understandable given the resource base but the pressures from rapid growth point to the need to both diversify and expand power sources. Moreover, environmental issues are becoming important and troubling. The Middle East region is surpassed only by South Asia in Particulate Matter (PM), a key indicator of air quality. Air quality varies widely across the region but the GCC, particularly UAE, Saudi Arabia, Oman and Kuwait (and Egypt and Iraq) are at double or higher than the global average. Qatar, Jordan, Lebanon, Tunisia, Morocco are near or below the global average. Concerns about air quality and pollution are becoming a concern for quality of life and health factors, creating a driver for increased usage of low-emissions power generation to fuel new and growing cities. Relative to the rest of the world, the Middle East, including the GCC, has lagged far behind in clean energy investments. As the global petroleum supplier, there has been little reason to not use local oil/gas to meet energy needs. While NOCs are getting involved in clean energy efforts, the opportunities for private sector investment will remain open, with increasing openness in the general electricity sector. Renewables targets will cause this investment level to rise. These targets are shown for the region in Table 1.

Table 1
Renwables Targets in the Middle East



While investments in clean energy for the region have lagged, much is still being done. The concept city of Masdar in Abu Dhabi, provides a forum for new sustainable energy ideas to be tested, as well as old techniques refurbished for modern living (angling streets to accommodate sun and wind patterns, building materials, and other techniques). The aim is to ultimately create an economic cluster which will attract high tech companies from around the world and attract talent to support it. The UAE will also be the global headquarters of the International Renewable Energy Agency (IRENA) set up in Abu Dhabi. While Abu Dhabi is getting the lion share of the alternatives publicity, Saudi Arabia has set up several centers focused on energy efficiency, renewables, and nuclear power. Two institutions are going to take the research and development lead: King Abdullah University of Science and Technology and Kapsarc. The former will take the lead on the science and technology of alternatives and renewables, while the latter will focus on making the appropriate policy recommendations to the government, particularly on the issue of subsidies, conservation and efficiency of oil and gas use but also on policies to promote the investment in renewables.

The Nuclear Option

Despite the focus on renewable energy globally, it continues to play a minor role, with “advanced” renewable energy such as solar, wind, and wave providing just 0.25% of global supplies. Coal’s emissions profile and fuel needs makes it unsuitable for large scale use in the gulf, leaving nuclear as a potent option that can provide needed base load. Renewable power will be the focus of significant investments, particularly as Abu Dhabi and others seek to be global leaders on renewable energy and sustainable development. Regional applications will be heavily skewed to utilize the substantial solar resources of the region, helping to meet peak demand and reducing investment requirements. But renewable power will not be enough to meet the substantial power needs of the region, with many turning to nuclear power.

In December 2006, the GCC states announce a study on nuclear energy’s “peaceful uses”. France agreed to work with them. In February 2007 the GCC agreed with the IAEA to cooperate on a feasibility study for a regional nuclear power and desalination program, with a plan emerging by around 2009. The effort fails. All six countries are signatories of the nuclear Non-Proliferation Treaty (NPT). While most countries in the region have at least examined the potential for nuclear power, the UAE has made the most progress, signing a $20+ billion deal for a Korean-led consortium to build four reactors. Kuwait and Saudi Arabia have also moved ahead with preliminary studies. States without substantial oil/gas reserves to power their economies have a greater incentive to build out nuclear power, but financing such expensive projects is more difficult.

It is useful to look the specific case of the UAE to see how nuclear plans have developed in the GCC. Although other developments will not follow Abu Dhabi’s path exactly, it is informs us of all the specific issues that had to be dealt with. The UAE ratified a safeguards agreement with the IAEA in 2003 and appointed an ambassador to the Vienna agency in 2008. In that year the UAE published a comprehensive policy on nuclear energy. It was seen as “proven, environmentally promising and commercially competitive option which could make a significant base-load contribution to the UAE’s economy and future energy security.” The report envisaged 20 GWe nuclear from about 14 reactors, with nearly one quarter operating by 2020. Also, in 2008 The Emirates Nuclear Energy Corporation (ENEC) was set up as an Abu Dhabi public entity, initially funded with $100m. Most importantly from a geopolitical level, the UAE agrees to forgo domestic uranium enrichment and spent fuel reprocessing (to allay proliferation concerns), and "to conclude long-term arrangements …. for the secure supply of nuclear fuel, as well as the safe and secure transportation and, if available, the disposal of spent fuel via fuel leasing or other emerging fuel supply arrangements."

It was in 2009 that Abu Dhabi started to implement its plans. Nine bidders were invited but reduced to three consortiums led by Areva/EDF, GE-Hitachi and Kepco. Priority was placed on speed -- the program model is based on contracting outside expertise, including safety experts for regulatory purposes, with local expertise to be developed over time. CH2M Hill was appointed to oversee nuclear power program implementation. The Kepco consortium was selected in December for 4 APR-1400s (pressurized water reactors), with the first unit expected to be online by 2017. The contract value was placed at approximately $20.4 billion for 4 units. The consortium is comprised of Kepco’s subsidiaries and Samsung, Hyundai Engineering & Construction, Doosan Heavy Industries, and Westinghouse (US-certified System 80+ design developed into the APR-1400). For the nuclear industry it was an unusual contract in that Kepco will also operate the plant. It expects to earn $20 billion by operating the reactors for 60 years. The fuel supply arrangements are unclear and will be contracted separately. Spent fuel disposal plans are also uncertain.

Kepco won the contract for several reasons. It had the following advantages: lower price, flexibility, and proven track record (at least on the domestic level); it had also earned the status as a one-time emerging market that succeeded in building its own nuclear program. But its competitors also had key disadvantages: their prices were too high – although not announced, they were presumably 1/3 or more higher than the Kepco bid since equivalent projects in US were estimated at $6-$10 billion per reactor; other factors included bad track records in constructing reactors on time and within the budget and lack of adequate experience-- Areva EPR (Evolutionary Power Reactor) projects in France and Finland (at Flamanville and Okiluoto, respectively) are both well over time and budget and the GE-Hitachi is trailing Westinghouse and Areva in reactor sales in the US with only only three (1 in Japan, 2 in Taiwan) of its Advanced Boiling Water Reactors (ABWR) under construction worldwide. Construction on ABWR in Taiwan began in 1999 and is behind schedule.

In assessing the deal, Abu Dhabi’s strong financial position (ENEC is likely to take substantial stake in the project and/or in Kepco consortium), clear and decisive government-decision making which is unlikely to be challenged internally, and strong support by IAEA were strengths of the deal. Some of the challenges include: Kepco is new to an export role, the UAE is a first time builder and there will likely be construction delays, cost overruns, and regulatory obstacles (Federal Authority of Nuclear Regulation (FANR); Abu Dhabi’s Environmental Agency). Longer term the challenges are likely to be more serious:

In other parts of the GCC, early stages of nuclear plans have materialized. In Saudi Arabia, an April 2010 royal decree stated that nuclear energy is “essential to meet the Kingdom's growing requirements for energy to generate electricity, produce desalinated water and reduce reliance on depleting hydrocarbon resources.” As noted above the science technology university and the policy think tank in addition to King Abdullah City for Nuclear and Renewable Energy (KACARE) is being set up in Riyadh to advance the nuclear agenda. In July 2010, Shaw Group announced joint initiative to design, build and operate reactors in Saudi in partnership with Toshiba/ Westinghouse and Exelon. US firms will be unable to proceed with technology experts unless the US signs a nuclear cooperation agreement with Saudi Arabia under Section 123 of the US Atomic Energy Act ? this will be problematic given likely Congressional opposition, though this has not stopped the Saudis from employing a former US Nuclear Regulatory Commission Director to oversee some aspects of the program. In Kuwait in March 2009 the government moved to set up a national nuclear energy commission, in cooperation with the IAEA. In April 2010 it signed a nuclear cooperation agreement with France covering electricity generation, water desalination, research, agronomy, biology, earth sciences and medicine. It also signed a nuclear cooperation agreements with USA, Russia and Japan. This September 2010 the government announced plans for four 1000 MWe reactors by 2022.

Jordan is the other country in the region that has expressed an interest in nuclear energy. The government hopes that nuclear power will provide 30% of electricity by 2030-2040. The Jordan Atomic Energy Commission (JAEC) is evaluating three vendors and designs (Kepco was not chosen). They are: Atmea-1 from Areva-MHI (Mitsubishi Heavy Industries); AECL EC6 (Enhanced Candu-6 by Atomic Energy of Canada Ltd.); VVER-1000 from Atomstroyexport (Russian). Japan has signed a nuclear cooperation agreement with Jordan (paving the way export approval for Atmea) September 2010. The JAEC expects to start building a 750-1100 MWe nuclear power plant in 2013 for operation by 2020 and a second one for operation by 2025. Longer-term, four nuclear reactors are envisaged. Further nuclear projects will involve desalination given the country's water deficit of some 500 cubic meters/yr. Uranium Resources Areva and JAEC have set up a joint venture in October 2008.

The UAE-Kepco deal will not be completely mimicked in these other developments. The UAE has promised to forego uranium enrichment and reprocessing in nuclear cooperation agreement with US (under Section 123 of US Atomic Energy Act). While the United States sees this as “role model” for the rest of the region, Jordan and Saudi Arabia have both indicated an unwillingness to hew to this precedent. Despite the advances, no other country in the region has advanced to a bidding stage.

Implications of Alternatives Development in the GCC

It is unlikely that the Gulf will make much progress in meeting its targets for renewables. Solar will see an increase in development but nuclear will likely take the lead as a source of alternative power – the governments are good at turnkey projects and with their financial strength can ensure that foreign contractors deliver on-time or close to it. There are several long term political and economic implications/considerations in developing nuclear power:

   JIME Center.All rights reserved.