Despite Wealthy Appearances, the Middle East’s Oil and Gas Exporters Worry about the Future of Energy

One of the great lamentations of the Western world is that its economy is being held hostage to Middle Eastern oligarchies, that the nations of the Middle East and North Africa are becoming richer and richer from monies the United States and the rest of the developed world lay at their feet.

Yet at a recent panel at the first Wharton Middle East and North Africa Business Conference, experts who have spent years looking at the oil industry, often first hand from those oil countries themselves, painted a different picture. It is one of worry about the future of oil, and a move in many places toward not only different industries, but completely different kinds of energy production.

"The challenges in the Middle East transcend oil," said Morten Klumb, a partner at McKinsey & Company, who has spent the last six years for the firm in the Middle East, often focusing on infrastructure and real estate, not solely the oil business. The World Bank, said Klumb, estimates that the region has to spend billions of dollars on infrastructure just to get up to speed.

Fifty percent of the populace, he said, does not have adequate access to clean water, or in some cases flowing water at all. Instead of oil, he said, these countries would be better off focusing on developing infrastructure. "People ask why I am focused on infrastructure, the most boring of industries," Klumb said. "I bring in a few facts, and they see where the opportunities lie."

End To Oil Exports?

If the Middle East, which is one of the largest dry areas in the world, were to find ways to improve its renewable water resources and to develop innovative water management systems, then the oil industry would pale in comparison, especially in countries like Bahrain, which basically have no oil.

That is where an increased role from the private sector — particularly after the Arab Spring movements — will come into play. "The private sector is far better than government investment for allocation of risk," Klumb said. "The developer is good at being a developer. The contractor is better at construction, and so forth. It is not the government trying to do everything."

Thus, whether it is better water supplies or whatever the populace now needs, it will be, hopefully in Klumb’s eyes, more private capital going toward the whole infrastructure of the region, not just that of the oil producing industry.

Though it may sound strange to many Western observers, some parts of the Middle East may well stop exporting any oil at all. According to Hesham Tashkandi, the senior operations leader at GE Energy, based in Saudi Arabia, the United Arab Emirates will be using all of its own oil by 2017.

"The UAE does not have as much oil as other countries, so it may find that it would be better to burn the gas and oil itself, rather than continue to trade on the global market," Tashkandi said, adding that keeping oil at a high price does not always mean prosperity for many of the people in the Middle East.

"Only a few countries care about oil in the region — those that make more selling it than burning it themselves," he said. As countries see a broader base of their population being more affluent, even those that produce the most oil, they themselves are using more oil. Countries and provinces like the glitzy sheikhdom of Dubai, which has scant oil, yet is growing and seeking green energy alternatives.

"Nuclear power has been considered in the Middle East for quite a while and Dubai will be the first in using it," Tashkandi said. "Unfortunately, that has to balance the risk and the reward. The reward is to be efficient and the risk is to the environment. But in the long term, things will be more nuclear."

He also sees the region moving toward solar power and other alternatives — and he said it would be surprising to Westerners to know who the leaders were.

"Saudi Arabia and the United Arab Emirates are building the most solar plants," he said, noting that those countries have a goal of having seven percent of their power coming from solar energy by 2020. "Especially in the Middle East, where you have the sun all the time, this is the way to go." The goal in Kuwait, he said, is to save 7000 tons of carbon dioxide emissions a day, which, with solar energy, will save a gigawatt of electricity each of those days.

There is also a big move in waste-to-energy solutions in the Middle East, Tashkandi added. "They have plenty of sewage water, and will have more as the population grows," he said. "It is not as efficient and it will take a lot of infrastructure." But it is coming, Tashkandi said.

The biggest problem is not the technology to produce energy, he said, but to distribute it. The power grid is growing along the Arabian Peninsula, particularly connecting Saudi Arabia, Kuwait, Qatar and Bahrain, but it is only in a nascent stage. The ultimate goal is to connect that grid to Europe, particularly the southern countries like Italy and Spain, which will increase energy exports to Western nations.

The country most concerned about its energy production and export capacity is, to be sure, Iran. Sara Vakhshouri is an independent energy consultant who formerly was an advisor to the director of the National Iranian Oil Company International. Her perspective is that while Iran is one of the world’s great exporters of oil, it is also, ironically, the second largest consumer of oil in the Middle East, so is a major importer of refined gasoline.

The population of Iran is between 60 and 70 million, she said, and in the past, Iranians consumed an average of a liter of oil products a day, though that has declined in recent years. Its total refinery capacity is only 1.5 million barrels a day, so that is only about 36% of the production needed to sustain its own population. "The oil business is more complex than it seems on the surface," she said.

This is especially so in light of the potential boycotts of Iranian oil because of nuclear weapons concerns. On Iran’s side, Vakhshouri said, it is unlikely it would close the Strait of Hormuz for any length of time, despite its threats to do so. The Strait of Hormuz is only 22 miles wide at its narrowest point, but it is the place where much of the oil from the region has to go through.

Iran’s biggest customer may be China, but it only accounts for 11% of China’s oil imports. Countries more vulnerable are Sri Lanka, which imports 93% of its oil from Iran and the more tottering European economies of Greece, Italy and Spain, which respectively import 34%, 13% and 10% of their oil from Iran.

Vakhshouri said that those countries could not readily join a boycott, even if they wanted to politically."Their refineries are set to the Iranian product," she said. "If they have to import from other places, they would have to change what their refineries do." Even if they wanted to, said Vakhshouri, it would take months at least to convert them. "They say Libya will open up and replace the Iranian oil, but that oil is of a different type. It is why the Europeans, in a boycott, would have to give it six months to take effect."

Japan, too, is in a difficult position when it comes to boycotting Iranian oil. Before the recent nuclear disaster, it had already imported 10% of its oil from Iran, but now with the nuclear reactors down, it faces the prospects of having to increase that. Despite pleas from Secretary of State Hillary Clinton, Japan is not willing to follow the sanctions on Iran, said Vakhshouri.

"So even if the coalition doesn’t break, Iran is likely to find customers for its oil," she said. Vakhshouri said that the effects of the sanctions, however, are being felt in Iran, as the national currency has dropped precipitously. "The big question is whether the oil sanctions will be a tool to change the country’s behavior," she said. "It is not clear yet whether that will happen."

More Sharia Finance

Islamic finance will continue to grow in the region, said panelist Michael J.T. McMillen, managing director at River Stone Capital, and a lecturer in law at University of Pennsylvania Law School. Financial transactions, even those in international business, will be conducted at least in part in Sharia-compliant finance, said McMillen, who has an expertise in Middle Eastern banking.

Those transactions must follow Sharia law, he said, which prohibits fixed or even floating fees on loans, which is counter to Islamic prohibitions against usury. Thus, in order to do business, there are complex buying and selling practices.

"Sometimes you will see a transaction based around some metal, where there is a mark-up and then it is sold back to the original owner," said McMillen. "No one has any interest in that metal, but it is a way to do a different transaction under Sharia law."

Though Islamic banking began in earnest in the 1970s, it was not until a decade ago that Islamic financial transactions became prominent, and since 2007, it has increased dramatically, McMillen said.

"There is lots of pressure to do more Islamic financing, for infrastructure and for everything else," he said. "There are issues arising from this, but what is important is that everyone will have to know how it is used in order to do business in that area of the world."

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"Despite Wealthy Appearances, the Middle East’s Oil and Gas Exporters Worry about the Future of Energy." Knowledge@Wharton. The Wharton School, University of Pennsylvania, [02 April, 2012]. Web. [01 August, 2014] <http://knowledge.wharton.upenn.edu/article/despite-wealthy-appearances-the-middle-easts-oil-and-gas-exporters-worry-about-the-future-of-energy/>

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