The pace of change across Gulf states from oil-dependency to a reduced role for energy is still incremental. But with climate change and alternate energy core focus areas for investors, that pace needs an acceleration. File picture from the late 1990s of a site operated by Saudi Aramco. Image Credit: AP

Dubai: The transition towards a lower-carbon world economy is likely to result in reduced demand for hydrocarbon and other fossil fuels, which in turn will have a lasting impact on Gulf states, according to Standard & Poor’s (S&P).

“The hydrocarbon-exporting economies of the Middle East will remain reliant on oil and gas as the primary source of economic activity well into the next decade,” said Benjamin J. Young an analyst at S&P.. “One of the most frequently asked questions we receive from investors is what will be the longer-term impact for GCC countries and to what extent our ratings on these sovereigns account for this risk.”

Currently, hydrocarbons contribute, on average, 81 per cent of government revenues in the Gulf. S&P analysts expect the pace of economic diversification to remain gradual, thus exposing these countries to a decline in investor appetite.


“As global investors get to grips with the implications of climate change for their portfolios, they are likely to reappraise their appetite for investment in sectors and regions they perceive as most at risk from de-carbonization initiatives,” said Young.

Investor concerns stem to a large extent from the 2016 Paris Agreement goal to maintain global warming below 2 degree celsius. Climate change is also driving political backing for more public investments in alternative energy across Europe, Asia, and the Americas. The economic and political incentives for large hydrocarbon importers to find a sustainable substitute have never been greater.

Carbon scare

One gauge of a country’s exposure to energy transition risk is the contribution to GDP from sectors related to oil and gas activity (upstream and downstream). The hydrocarbon sector contributes on average about 40 per cent to the GDP of Gulf countries plus Iraq. This primarily relates to upstream activities (oil and gas extraction).

Adding downstream activity, such as petrochemical refining and other sectors indirectly dependent on hydrocarbon revenues, the contribution is even higher.

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According to S&P, on a per capita basis, the Gulf states’ greenhouse gas emissions are among the highest globally, at 27.2 tons per capita. This compares with the 7.6 tons average for the EU (including the UK), 5.9 tons for the 15 largest economies in Asia-Pacific, and above 16.3 tons per capita average for North America.

Slow pace of diversification

Although Gulf economies have made some progress in diversifying away from oil since 2012, oil-related activities remain dominant. S&P estimates that the non-oil private sector’s share in Gulf economies’ real GDP will reach an average of 36.8 per cent by 2022, up from 29.2 per cent in 2012.

GCC governments have also begun to diversify public revenue away from a near total reliance on oil. Average central government revenue (excluding investment income estimates) at the end of 2018 was about 25 per cent below 2012 levels, which reflects a 36 per cent decline in oil prices.

Over the same period, non-oil revenues increased by 81 per cent on average, largely reflecting the introduction of value-added tax.

“The move away from a lucrative carbon-emitting industry toward still nascent and expensive-to-develop carbon-neutral sectors is core to carbon transition in the region,” said Dhruv Roy, an analyst at S&P.

“Based on what we know today, global hydrocarbon demand is yet to peak and GCC governments have many decades of reserves.”

The low cost of hydrocarbon production provides GCC states some resilience to energy transition risk, helping buy time for diversification. Analysts said although alternative scenarios could put hydrocarbon demand on a steeper downward trajectory, thus placing pressure on oil prices, oil is seen as much more entrenched in the global economy. The energy transition and electrification trend will thus be more gradual.