High Oil Prices, Iran Concerns Define the Middle East in 2011

As 2010 came to a close, Sheikh Ahmad Al Abdullah Al Sabah, Kuwait's oil minister, told journalists that, in his opinion, the world economy would be able to withstand oil prices reaching US$100 a barrel this year. His statement confirmed the forecasts of industry observers that Americans will likely be paying high prices at the pumps this summer, with gas potentially costing US$4 a gallon in some parts of the country.

Such a development will inexorably tie the West's economic performance to the Middle East's oil economy, said Wharton management professor Raphael "Raffi" Amit, during a visit to Abu Dhabi, the capital of the United Arab Emirates (UAE). A balance will have to be struck, he noted, between growing demand for oil from Asia's roaring economies and the prices needed to ensure a recovery in the West.

Intertwined with the oil price issue, he added, are the growing concerns about Iran's nuclear-weapon capabilities. Given Iran's role in determining global oil prices, the geopolitical balance will have to be managed deftly to avoid rapid price hikes reminiscent of the 1970's oil crisis, Amit said, adding that few diplomatic solutions have been provided so far, though.

Locally, the sentiment among Arab business leaders and government officials is one of cautious optimism. Having largely managed to avoid the effects of the global economic downturn, the Middle East anticipates renewed growth this year. Dubai has begun a slow recovery from its debt crash, while Qatar and Saudi Arabia are emerging as the region's economic leaders as they pursue ambitious development plans. Key to the growth, Amit noted, is the Gulf's bid to diversify economies from hydrocarbons along with investment in education and green energy initiatives.

But the wider implications of higher oil prices and concerns about Iran for the world economy, especially if current tensions turn into a full-blown conflict, bring much uncertainty for the region this year. "Overall, as we enter 2011, there are number of issues with question marks, the resolution of which will affect economic development," Amit said.

Seeking Other Solutions

A number of analysts began predicting last fall that oil prices would rise in 2011, keeping pace with consumer demand in the world's two largest economies, China and the U.S. Meanwhile, despite oil prices rising almost 30% since September, OPEC has so far decided not to increase output. Amit said if oil exporters do what Kuwait's oil minister predicted, the economic impact on the West would be tough.

"The issue there, to begin with, is that it will slow down the recovery in the U.S. and Europe," Amit noted. Higher oil prices would push governments to seek other solutions, either along the lines of energy innovation or tapping natural resources that have been so far politically controversial. "The search for alternative sources of energy will be intensified and redoubled and sources of energy such as in the North Pole, which were economically unrecoverable at prevailing prices of $80 a barrel … would become very economical at $100 a barrel."

The Middle East will also likely see "many more" joint ventures in petrochemicals and refining between the Gulf states and Asian Pacific economies, according to Christopher Davidson, a lecturer at the Institute for Middle Eastern Politics and Islamic Studies at Durham University in the U.K. "This will strengthen the interdependence of the world's greatest hydrocarbon producers and consumers," he added. He also foresees "a growing thirst for gas to supply domestic power stations. Gas will increasingly be imported to the region from further afield, such as Thailand and Indonesia."

Another factor possibly causing oil price advances is Iran. Concerns about the development of Iranian nuclear weapons present a challenge to the overall geopolitical balance, Amit observed, because the country plays an important role in the global supply and demand for hydrocarbons. "The Middle East is a volatile area in the world … and clearly the issue of Iran is front and center," Amit said. "The extent to which there will be a diplomatic resolution to the current concern regarding the development of its nuclear weapons remains uncertain. This would certainly affect the region, depending on how things develop. Any disruption of supply can jack up oil prices literally overnight. Just go back in history. There were times when oil prices quadrupled in a period of a couple of weeks in the early 1970s."

Gulf Leaders Emerge

While Iran has attracted world attention because of its nuclear ambitions, its neighbors Qatar and Saudi Arabia are focused on ramping up the region's economic pace in 2011. Steady energy demand and economic opportunities within their borders are an appealing mix for investors. The two countries received US$44 billion in foreign direct investment in 2009, half the region's entire investment flow, according to the World Investment Report 2010.

Along with Kuwait, Saudi Arabia and Qatar "will have a major role in the economic development of the region, particularly the slow but consistent transformation that we are observing in Saudi Arabia," Amit noted.

Saudi Arabia has concentrated on internal investment, spending an estimated US$70 billion on infrastructure in 2010 alone. Seeking to diversify its economy, the Kingdom has embarked on an ambitious plan to build four new cities at an initial cost of US$60 billion. It has also made progress liberalizing its economy — real estate investors eagerly await passage of a planned mortgage law this year, which analysts expect will set off a residential building boom in the country.

And while basking in the limelight with its recent successful bid to host the 2020 World Cup, Qatar has been adding to its record of high-profile investment plays in other ways, including last year's US$2.3 billion acquisition of U.K.-based luxury retailer Harrods. Qatar now has roughly US$75 billion in external investments, according to RGE Monitor. Bolstered by efforts to diversify its economy beyond liquefied natural gas and crude oil exports, Qatar's GDP is expected to grow over 20% in 2011, according to the International Monetary Fund.

Such activity is a needed shot in the arm for the Islamic loan industry, which reached a five-year low in 2010. Qatar's World Cup preparations — expected to cost US$65 billion — are expected to bring new Islamic finance deals. Additionally, the restructuring of Dubai World's debt restored some confidence in the market. Providing a further boost will be the advent of more Western-based Islamic finance issuances, as markets from France to Australia revamp regulations to accommodate the industry.

"Clearly, Saudi Arabia and Qatar are competing with the UAE in terms of desires to be finance, commerce and tourist centers; [and] Oman for example is investing and developing its tourism industry," said Amit. "This is part of the strategy in the UAE as well — Dubai has heavily invested in tourism, and now so is Abu Dhabi. That there is competition is part of a confirmation of the strength of these economies."

Vital Resources

The UAE, Egypt and Saudi Arabia have decided nuclear energy is the route to meet rising domestic energy demands, but few solutions are at hand to buttress water supply in the region, which is around 1,200 cubic meters per person per year, compared with the average of about 7,000 worldwide, according to the World Bank.

Concerns about water use prompted Abu Dhabi's utilities authority to remind customers in November about how much the government subsidizes their water and electricity bills. Elsewhere in the Gulf, residents will also face increased utility costs in the form of higher municipal fees and shrinking subsidies. Inflation is a perennial issue, but aside from Saudi Arabia, which will likely increase oil production this year, the region is expected to see modest rises in inflation.

Efforts to diversify these economies from oil exports by investing in education and alternative energy sources are vital to the region's future, Amit noted. "As a frequent visitor to the region, I am impressed by the focus, particularly in the UAE, in reforming the economy from its sole dependence on hydrocarbons, to a knowledge-based economy through education," Amit said. "The focus on education should continue relentlessly and that will contribute to the transformation of the economy. The human capital developed through education will allow companies in the UAE to compete in the more globalized economy that we all live in."

Amit also cited initiatives such as Masdar, the Abu Dhabi government's carbon-neutral city. The city aims to create sustainable alternative energy sources with the help of partnerships — for instance, it is negotiating with Japan to study the feasibility of air-cooling systems that use solar thermal technology. The Masdar Institute of Science and Technology, meanwhile, is expected to produce its first batch of graduates this year.

Amit applauded the "foresight of the leadership in terms of preparing the Emirates for the future, which we all know needs to be based on a much broader economic foundation than solely hydrocarbons. The UAE is very well positioned, but it needs to continue the relentless focus it has had on education and the transformation of the economy at full force since it is the human capital developed through education that will improve the quality of life and economy of Emiratis."

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