Over the
last 20 years, hydrocarbons have helped the ruling families of the
Gulf consolidate and expand their political power. During the next
20 years, however, it is expected that competition from other global
suppliers of oil and the economic pressure to continue developing
the sector through privatization and denationalization will undermine
this political power.
The
political and economic structures of the Arab Gulf countries have
been surprisingly resistant to change. The resilience of the "old
political deal" between royal families and traditional elites--the
'ulema', tribal leaders, urban merchants and technocrats--can
be attributed to three main factors. First, the institutional, tribal
and commercial prominence of the traditional elites meant that they
have been able to "deliver" popular support to the ruling families.
Second, the Gulf monarchies have been able to shift from dependence
on domestic groups for military protection to a dependence on foreign
states. Treaties and military cooperation with the US and Britain
have protected them against land or resource grabs by their larger
and more populous neighbors. Third, oil revenues--the means to finance
patronage--have held the system together.
In order to ensure
the efficient distribution of these oil revenues, the ruling families
have created state institutions. Government expenditures as patronage
have flowed one way, while loyalty to the royal family has flowed
in the opposite direction. The size and nature of the oil revenues
have had other important consequences. They have given the ruling
families of the Gulf much greater economic power than taxes could
ever have produced. Massive state spending has made Gulf populations
dependent on government-financed social programs. Moreover, because
oil revenues are external to the system, they have made the ruling
families less dependent on other social forces in each country than
they had been before the development of the oil sectors. Finally,
new state institutions have strengthened internal security, while
oil revenues have given the Gulf states the means to buy external
protection.
The "old deal" is being
undermined on several fronts. The traditional elite is losing its
effectiveness as urbanization and the emergence of large welfare
states have diminished their authority.1 More
importantly, the financial resources which hold the patronage system
together have dwindled as revenues have been stagnant over the past
several years.
There is a widespread
recognition in the Gulf that the status quo is unsustainable. Piecemeal
attempts to shore up the political and economic system through selective
reforms will prevent radical changes. They will not, however, prevent
a gradual weakening of the economic power of the state and with
it the ruling families. Moreover, the reforms will gradually increase
the influence of the private sector, particularly if it is successful
in securing strategic footholds in areas where the state has so
far reigned supreme.
To prevent this shift
in relative economic, and ultimately political, power in the Gulf,
the ruling families will have to increase oil revenues substantially
in a short period. This is unlikely to happen because world oil
markets have become a hostile environment for Arab Gulf producers.
Oil prices have never recovered from the 1985-86 crash and Arab
Gulf oil producers have lost the "market share battle." In the short
run, even small supply increases from non-OPEC and OPEC countries
will force Arab Gulf exports to remain at current levels. Over the
long run, huge increases from Iraq and the Central Asian states
may rob Arab Gulf producers of the increments in increased global
demand they thought would accrue to them.
The smaller Arab Gulf
countries, notably the UAE, Qatar and Oman, have reacted to stagnating
oil exports by investing in gas production and exports. The larger
producers, however, have lagged behind in gas development either
because of a lack of gas reserves (Kuwait) or available financial
resources (Saudi Arabia). The development of Saudi Arabia's gas
resources is inevitable given its enormous appetite for electric
power, desalinated water and petrochemical feedstocks, all of which
require gas inputs. To do so, however, it will have to allow private
firms (Saudi and foreign) to enter this strategic sector of the
economy.
Developing gas is fundamentally
different from oil and has important domestic political implications.
Private sector involvement is needed, whether foreign or domestic,
to meet capital costs, to provide technological expertise and to
help secure markets. With this involvement comes exposure to international
standards of financial accountability, forcing a curtailment of
wasteful government expenditures. Moreover, because the payback
period for gas projects is longer than for oil projects, global
investors will continue to scrutinize this sector well into the
future.
Global Oil Markets
When oil prices crashed
in the mid-1980s, producers with a longer term outlook argued that
demand would rebound in the industrialized West and grow rapidly in
the industrializing East. Moreover, they believed that high-cost oil
producers that had flooded the market in the early 1980s, undermining
international prices, could not sustain their output at lower prices
and eventually would have to cut production. The large Arab producers
hoped that these developments would provide them with an ever-increasing
share of global demand.
In 1988, the collapse of the Soviet economy led to nearly a five
million barrel per day (b/d) decline in its crude oil production.
In 1990, the international embargo on Iraq after it invaded Kuwait
led to a decline of nearly three million b/d in crude oil on world
markets. But, even these two market-rocking developments did not
help large Arab Gulf producers preserve their market share. Saudi
Arabia was able to make up for part of the reserve loss by raising
its output by three million b/d. Kuwaiti output, also knocked out
by the UN embargo and later by Iraqi sabotage, rebounded to two
million b/d in the early 1990s, nearly 700,000 b/d higher than pre-invasion
levels. Adding small increases by the UAE, Qatar and Oman, the Gulf
has hiked its output by 4.8 million b/d since 1988. The region,
therefore, only took one-third of the incremental demand increases
of 12.1 million b/d between 1988 and 1996.
The remaining demand was met by two major sources: non-OPEC producers,
particularly the North Sea, and other OPEC producers, namely, Venezuela
and Algeria. A combination of technology and better terms offered
by the UK and Norway have kept North Sea crude oil output rates
rising.2 Developments within OPEC are more interesting.
In response to domestic financial constraints and given the prospect
of falling oil production and revenues, some of the poorer OPEC
countries invited foreign multinationals back to assist in raising
domestic production capacity. More than the intra-OPEC rivalries
over production quotas and prices, this was the most serious threat
to an organization created to provide a united front against the
major international oil companies. By the early 1990s, it was clear
that the non-Gulf OPEC members saw their future outside the organization,
particularly since Gulf producers dominate OPEC and often block
OPEC-mandated market share hikes for the smaller, more financially
constrained producers.
Algeria was one of the first OPEC member states to change its
foreign investment law. Despite the worsening political situation,
the large unexploited oil and gas resources in the south lured a
large number of foreign companies to invest in Algeria. An even
more threatening move was made by Venezuela. With little fanfare,
Petroleos de Venezuela (PdVSA) pushed through a phased domestic
restructuring program allowing for the reentry of foreign oil companies.
With new capital flowing in for the first time since the nationalizations
of the 1970s, the company was able to invest in refining capacity
in overseas markets. By 1997, PdVSA had become the largest refiner
in the US through its ownership of CITGO. It made similar moves
into the markets of other South and Central American countries.
World Market Shares
Even though they are linked through information networks that communicate
jitters, world oil markets are quite segmented by region. Countries
in the Atlantic Basin (including the Mediterranean) and the Asia/Pacific
regions are all net importers of crude oil. The Gulf is the major
exporting region in volume and until recently had been able to "swing"
between Asia and the Atlantic/Mediterranean. In the late 1980s, Arab
Gulf countries expected that steadily rising energy needs in both
regions would increase demand for Gulf oil. Increased demand in the
Atlantic Basin however was met by suppliers in the North Sea, Venezuela
and Colombia. In North America, PdVSA's purchases of refineries created
"dedicated buyers" of Venezualan crude and effectively shut out crude
originating in the Arab Gulf.
This left the Arab Gulf producers to concentrate on expanding
their share of the Asia/Pacific market. Rapid economic growth and
policy changes in Asian countries--particularly India and China--led
to an enormous increase in petroleum product consumption, much of
it met by Middle East supplies. Fine tuning supply according to
specific domestic needs, however, requires that refineries be closer
to the consumer than the producer. Asian policymakers, therefore,
have determined that Asia will need to add nearly five million b/d
of new refining capacity to meet rising demand.
Arab Gulf producers view these new Asian refining needs with great
interest. Buying into or building stable and protected markets from
scratch could secure for them a situation similar to that of the
Venezuelans in North America and minimize competition for markets
from Iraq (when the UN embargo is lifted) and the Central Asian
states (once export pipelines are built).
Kuwait had been eyeing Asian refineries after having developed
an extensive network of refineries and gas stations in Western Europe
under the brand name Q8. After the Iraqi invasion, however, the
Kuwait Petroleum Company was forced to divert funds earmarked for
Asian investments to rebuild the domestic oil sector. In the early
1990s, with Kuwait and Iraq temporarily out of the crude market,
Saudi Arabia rapidly picked up several pieces of Asian refining
capacity, namely a portion of the South Korean refiner Ssangyong
and outright ownership of the Petron refinery in the Philippines.
Saudi Arabia's attempts, however, to secure parts of the Japanese
refining industry--the real prize--failed, mainly for political
reasons. Likewise, it was unable to gain a foothold in China because
Sinochem, the government refining company, demanded that Saudi Aramco
pay for substantial social benefits for workers currently supported
by the Chinese company. In other Asian countries such as India,
subsidized domestic prices which render refining projects unprofitable,
have discouraged the Saudis and Kuwaitis from investing. As of mid-1997,
despite many announcements of Saudi, Kuwaiti and Omani joint-ventures
or investments in the Asian refining sector, no solid deals were
in the offing.
The pressure to secure market share for the Gulf Cooperation Council
(GCC) producers will mount in the next several years. Their greatest
competitor in the long-term is Iraq. On the eve of the invasion
of Kuwait, Iraq was pumping just over three million b/d. After the
Gulf War, its output fell to around 600,000 b/d, sufficient to meet
domestic consumption and a trickle of exports to Jordan and Turkey.
Since December 1996, Iraq increased its exports under UN Security
Council Resolution 986, which makes provisions for Iraq to sell
$2 billion worth of oil to pay for food and medicine imports after
deducting reparations and other payments.
This "humanitarian oil" was relatively easily absorbed into the
Mediterranean market early in 1997. In what may be a dress rehearsal
for the "bigger" return of Iraqi crude to the market, international
oil prices fell some $4 to $5 per barrel when Iraqi supplies returned
to the market. Moreover, Arab Gulf countries were once again restricted
to producing at levels they agreed to nearly three-and-a-half years
ago at the March 1994 OPEC meeting. Once sanctions are removed from
Iraq, it is not inconceivable that that country will be able to
produce around three million b/d almost immediately and export nearly
2.5 million b/d once port facilities at Um Qasr are upgraded or
rebuilt. Most of that crude will flow into the Asia Pacific region
and encroach upon Arab Gulf market share.
Competition for the Arab Gulf countries will also come from the
large oil producers of Central Asia and the Caucasus, once they
develop export routes to world markets. This is unlikely to happen
very soon. Russia has actively blocked exit routes from Azerbaijan
and Kazakhstan (the two largest potential oil producers of the region)
through its own territory and through Armenia and Georgia to Turkey.
The US has effectively banned US oil companies from investing in
Iran and threatened non-US oil companies with sanctions if they
build oil or gas pipelines through Iran, the most logical exit route
to the Asia/Pacific region.
Beyond the next five years, however, it is quite conceivable that
Central Asian and Iraqi oil will reach Asian markets, which could
force the Arab Gulf producers to limit their own production. Saudi
Arabia in particular could attempt to increase its market share
by raising output, thereby abandoning its role in global oil markets
as "swing producer." This could be dangerous for the kingdom because
it could mean having to live with lower oil prices. Although the
actual production costs for the Gulf producers may be extremely
low by international standards, if the socioeconomic costs of maintaining
an economy so dependent on oil revenues are factored in, these countries
become very "high cost" producers. Fears that an economic meltdown
would result from a rapid fall of oil prices have restrained Arab
Gulf countries from aggressively pursuing higher market shares.
In the medium to long term, since Gulf economies are unlikely
to reduce their dependence on oil revenues, cautious economic policies
will most likely restrain them from raising oil output. This means
stagnant oil revenues in nominal terms, falling oil revenues in
real terms and therefore a continued slide in oil expenditures per
capita. The reduced direct contribution of the Arab Gulf states
to the incomes of their citizens will decrease the ability of the
ruling families to maintain political loyalty.
Gas Development
Given the dim prospects
for raising oil revenues in the medium term, several Arab Gulf countries
have embarked on ambitious gas development projects to diversify their
export earnings. The UAE was the first to invite foreign gas companies
to build its Liquid Natural Gas (LNG) facilities in the 1970s and
was followed in the 1990s by Qatar, whose LNG shipments to Japan started
in 1997. Shell is building Oman's LNG facilities, while TOTAL is setting
up Yemen's LNG export program.
The economics of gas development are different from oil development.
Gas development requires substantial capital outlays mainly because
of the need to develop distribution and export facilities (liquefaction
units and/or pipelines). Given these capital costs, the period before
projects begin to generate net revenues can be long. Once they begin,
however, the income is steady--like a long-term annuity--unlike
oil revenues which peak rapidly and then decline as production falls.
Because of the high capital costs and long gestation period, such
projects require substantial gas reserves and creditworthy customers
who can pay for the gas over the long haul.3 The
capital costs associated with gas development have proven prohibitive
for some of the relatively poorer Gulf governments (namely Qatar
and Oman). As a result they have had to open up channels for multinational
investment.
Investment in gas development may produce unanticipated sociopolitical
consequences. Large foreign investments have exposed these countries,
for the first time, to international credit assessments. In order
to "live within their means" governments must cut expenditures,
which strikes at the heart of domestic politics. Just as important,
especially in Saudi Arabia, gas projects have opened up the hydrocarbon
sector to the prospect of domestic private investment. Large Gulf
companies with substantial capital resources are angling for a stake
in a sector that has traditionally been out of bounds to them. Although
not likely to affect significantly the smaller Gulf countries, it
will become a major factor in Saudi Arabia.
In strictly economic terms it might be easier for the Saudi government
to invite foreign companies in, as Shell, Agip and other multinationals
are suggesting. Three factors, however, are likely to lead to Saudi
private sector predominance. First, inviting foreign firms back
into the kingdom without the participation of the domestic private
sector could constitute a major political embarrassment for the
government. Second, the private sector has not enjoyed significant
lucrative opportunities since the boom years of the early 1980s.
Projects of this sort will be a major bonanza for a key constituency
of the ruling family. Moreover, from an economic point of view,
the repatriation of private capital it will produce will boost the
balance of payments and the overall economy. Third, there are a
number of new Saudi oil and gas companies that are joint-ventures
between merchant families and members of the royal family. These
companies have invested in hydrocarbons in Yemen, the Central Asian
republics and elsewhere. They view the opening of the domestic gas
sector as an excellent opportunity to turn political connections
into commercial success. Nimr and Delta, two such companies, are
lobbying for the opening of the gas sector, while other major companies
are gearing up to participate in the bonanza.
The idea of the "upstream" gas sector being opened up to private
capital is still considered radical in the Gulf, especially in Saudi
Arabia. Recent developments in the power sector, however, do point
in that direction. The Saudi industry and electricity minister recently
reclassified power generation as an industrial activity,4
thereby opening up enormous investment opportunities for private
sector firms. It is logical that the next step in this process of
denationalization will begin "downstream"--power generation in the
gas value chain--proceeding to "midstream" pipelines and gas distribution
and finally all the way "upstream" extracting resources from the
ground. The latter is the most lucrative part of the gas chain and
the most coveted by the private sector.
Changes in the international oil and gas industry do not portend
radical shifts in political power in the Arab Gulf states. A gradual
transfer of economic power, however, from financially constrained
states to their private sectors, which will gain control of key
economic sectors, will ultimately mean a broadening of the political
system. In the short run, this does not translate into popular politics.
It does, however, point to oligarchical rule rather than the monopoly
the ruling families of the region enjoyed after the rise in oil
prices during the early 1970s.
Fareed
Mohamediis managing director of the country and markets department
at the Petroleum Finance Company, Ltd. in Washington, DC.
Endnotes
1 See Fareed
Mohamedi, "State and Bourgeoisie in the Persian Gulf," Middle
East Report 179 and Fareed Mohamedi, "Saudi Arabia's Crunch,"
Middle East Report 185.
2 North Sea
output rose from 3.5 million b/d in 1988 to 5.9 million b/d in 1996.
Norway's oil production rose from 1.1 million b/d to 2.8 million
b/d, propelling it to the number two spot in the world in crude
oil exporting.
3 If commercial
banks and export credit agencies are financing these projects, they
require gas purchasing guarantees from the consumer to ensure that
the loan payments will be met.
4Middle
East Economic Digest (MEED), September 12, 1997.
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