The hydrocarbon-exporting economies of the GCC will remain reliant on oil and gas as it will continue to be the primary source of economic activity well into the next decade. As investors across the world 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 decarbonization initiatives. Climate change is also driving political backing for more public investment in alternative energy across Europe, Asia, and the Americas. Hence, the economic and political incentives for large hydrocarbon importers to find a sustainable substitute for oil has never been greater.
Since 2012, GCC economies have made some progress in diversifying away from oil. Despite the challenges of measuring oil versus non-oil GDP, we estimate that the nonoil private sector’s share in Gulf economies’ real GDP will reach an average of 36.8% by 2022, up from 29.2% in 2012. This represents an increase of 7.6 percentage points (ppt), or 0.8ppt per year on average. Partly, the percentage increase in nonhydrocarbon private sector economic activity reflects lower oil prices.
In terms of ESG risks and opportunities, oil and gas companies are among the most exposed to energy transition. Oil and gas prices and refining margins are extremely sensitive to medium- and long-term demand expectations. Current long-term industry projections still show fossil-based fuels account for the lion’s share of global primary energy demand, supported by its vital role in the global economy and mobility. That said, the speed of the transition away from carbon-based fuels is uncertain but is beginning to accelerate.
For the exploration and production (E&P) industry, S&P Global Ratings sees the environmental risks as above average, stemming from two types of risks. The first stems from inherent material exposure to greenhouse gas emissions. The second type concerns lower probability but potentially high-impact risks for individual companies from pollution because of well head and transport spills and leaks, and increasingly water use and contamination risks. The most significant risk is the pace of the energy transition away from carbon-based fuels; this could result in stronger deviations from the industry demand forecasts outlined below. It will likely be strongly influenced by long-term government policies for renewable energy, as well as the pace of electric vehicle penetration growth.
Whereas, in the refining and marketing sector the environmental risks are well above average because of the refining process itself is an important source of carbon dioxide emissions and produces carbon-based fuels and products, demand for which will be influenced by the energy transition. The sector has material exposure to regulations on greenhouse gas emissions and carbon taxes, as well as to pollution, transport spills, and contamination risks. The risk of pollution and accidents is significant for companies refining and distributing hydrocarbons and may result in material financial and reputational damage.
The risk of land contamination during operations and the cost of clean-up before property can be turned over for alternative use are also significant, especially at refineries. Therefore, asset retirement obligations that we include in adjusted debt can be material. Hydrocarbon fuels are flammable and frequently produced near and distributed through populated areas. Therefore, most countries have stringent operating and safety requirements for refiners and marketers of oil products. The costs of remaining compliant with these requirements can be material and may be one differentiator between companies’ competitive positions and profitability in different countries and regions.
In terms of social risks, the oil and gas sector equally is above average based on its exposure to safety management, social cohesion, and ultimately consumer behaviour risks, which may lead to substitution of products. These factors that can influence producers’ profitability, as well as substitution risks ultimately driven by consumer choices. Safety management is a key risk given drilling activities and sometimes harsh environmental conditions, especially offshore.
Companies in the sector typically track and manage incidents and have specific programs to educate workforces. The costs to ensure adequate safety and compliance with local regulations can be material, for example, in instances where crew time offshore is limited.
Social risks in the refining and marketing sector are also above average and weighted toward exposure to safety, social, and, ultimately, consumer behaviour. Safety management is critical and generally routine given that oil products are combustible and pollutants. With the large scale of some refinery complexes, accidents can be major events involving fatalities. Companies in the sector typically track and manage incidents and have specific programs to educate workforces
While governance is best measured at the company level, we believe the E&P sector has above-average exposure. This results from the strong compliance and oversight needed because of the sensitivities around bidding for and corruption relating to natural resources, particularly in emerging markets. Government ownership can exacerbate the sector’s lack of transparency. Furthermore, the high severity of safety incidents also means board oversight and understanding of risk management and company culture have high importance.
Although GCC governments’ diversification efforts have picked up pace, a move towards green transition takes time. Creating new industries and educating a suitable workforce requires decades to implement. Further moves into industries that build on the GCC’s comparative advantage will likely yield benefits faster and with more certainty than the creation of new ones, and we do not expect this equation to structurally change.
