Badr Jafar: time to liberate MENA’s energy markets

I believe that there are two central steps that MENA Region policy makers can take to optimise energy policy:

First, allowing a greater role and freedom for the private sector to compete in the energy sector of the economy.

This is not to deny in any way that there is a crucial function of the state.

Second, a shift in energy policy to allow natural gas to assume a primary role in the MENA region’s economy, addressing the subsidies which prevent natural gas from being utilised in the most economically efficient way, and in-turn encouraging the development of gas infrastructure to increase Regional integration.

To maximise the benefit from the second, one need’s the first policy shift: the private sector can be a key partner in ensuring that the full transformative effect of natural gas on the economy is realised.

In combination, greater roles for the private sector and natural gas can go a long way towards delivering the countries of the MENA Region more sustainable, more diverse and more robust economic growth.

Given the strong economic growth of the region over the last decade, one may wonder why such shifts are needed when the current arrangement appears to have served the region well. From 2004 to 2011 the MENA region’s nominal GDP has grown by about 160%, but one must bear in mind that much of that GDP rise was driven by average oil prices going from around $40 to $100 per barrel.

Such a secular shift in the price of oil is unlikely to be repeated.

Furthermore, such strong growth in one part of the economy, may have accidentally skewed economic development elsewhere.

Without broad-based economic growth it is difficult to ensure broad-based jobs growth and sustained high employment. There is a risk that the MENA Region’s economy is doubly fragile: over-dependent on oil revenues, and at the same time vulnerable to instability. The Region needs to diversify its energy sector to build on this economic boom, and ensure that further growth can be delivered on a more stable platform.

Furthermore, current policies and development plans within the E&P sector have still left the MENA region with the conundrum of huge reserves and relatively low production, particularly in natural gas. With 42% of proved global gas reserves, the region only produces less than 20% of global gas output. Consequently, the Region has the longest gas reserve life in the world, able to produce at current levels for at least 130 years, compared to the global average of 64 years.

With an increasing abundance of gas being found around the world, and falling gas prices first in North America and now Europe following the breaking of oil linked pricing, the window of opportunity for the MENA region to use its cheap gas endowment as a competitive advantage in industry at home or for export abroad, is closing.

Indeed the longer such development is delayed, the more likely that gas-dependent industries in the Region will be at a competitive disadvantage to industrial players with access to very low cost gas, such as in North America for instance.

The investment challenge to achieve this energy transformation will be great: the IEA estimates that the MENA countries will in aggregate need to spend over $2.2 trillion in the next 25 years to keep their oil, gas and power infrastructure up to speed. Ensuring energy policies most conducive to delivering this investment are in place, will better place the Region to build on its competitive advantage in energy resources in a timely manner.

Having set out the need for a transformation, I would now like to turn to consider the potential policy responses that may deliver such a change.

It is widely known that the State has a very strong role in the Middle East and North African energy sectors, with the Region’s national oil companies first and foremost in people’s minds, directly managing the vast majority of the Regions oil and gas reserves and resources.

Behind the NOCs are also a range of state-owned energy users and utilities. As a matter of central strategic importance to all of the MENA countries, it is essential that the state protects each nation’s interests in the energy sector. Therefore undoubtedly there should always be a central role for the state in regulating the energy sector. But this does not mean there is no scope for the private sector in the delivery of the goals I have outlined earlier.

The competitive environment in which the private sector operates, competing against each other to deliver the best results according to the objectives and policies the government sets, can greatly help sustain innovation and maximise efficiency within our economies.
The private sector can offer new forms of competition, which can complement the existing E&P sector structure.

In a situation where we need to move increasingly rapidly from doing what has always been done – that is, pumping oil to sustain the economy via exports – to something new: a more diverse energy mix for both diversified domestic, as well as export uses.

The fast adaptive pace of the private sector under competitive pressures can provide this essential support.

While the violent ‘boom-bust’ nature of US business may not suit the MENA Region entirely, it is undeniable that it drove the development of this new shale E&P sector. With several MENA region states, Algeria for example, potentially possessing their own substantial shale resources, there is a direct relevance of the shale revolution to the region, but I wish to draw from it the more general point about how much the private sector can achieve in an environment of naked competition.

Qatar Petroleum’s work with the Western Major oil companies and various LNG buyers around the world has allowed the Country to grow into the world’s largest LNG supplier in under a decade, providing over a quarter of global LNG volumes.

Qatar was able to maintain majority control, secure the lion’s share of the economic value of these projects for the Qatari people, while incentivising the Private sector to commit to deliver several mega projects quickly and efficiently. The State did not abandon its role as custodian of the nation’s resource and strategic interests, but it did allow the Private sector sufficient room to maximise the benefit to the State from their involvement.

Another example of private and state-sector companies working together would be my company, Crescent Petroleum’s own alliance with the Russian state giant Rosneft.

Our actions are part of a trend for greater NOC and private cooperation that we see as a growing phenomenon internationally, for instance between BG and Petrobras in Brazil, Tullow Oil with various state bodies in West Africa, and ENI with the Mozambique authorities in East Africa.

Just as my call for greater Private sector involvement, at its heart, is about promoting competition to ensure the best overall outcome for the MENA Region’s economies, so is my call for a greater role for natural gas in the energy sector about promoting inter-fuel competition to ensure the best energy mix is delivered for the Region’s economies.

This is to be achieved, not by selecting natural gas as the fuel of choice by government mandate, but by removing the energy market distortions which have the effect of suppressing natural gas use, both at the supply and demand ends of the energy chain.

Because natural gas offers the best combination of affordability, cleanliness and abundance, when compared to other fuels, (particularly to oil and nuclear power in the MENA context), it should easily rise to the top in an open market.

At the supply end, in many MENA countries the gas sales prices and tax regime is such that it does not fully recognise the full cycle cost of production, and is slow to adjust when pricing pressures shift. The consequence of this is chronic underproduction compared to the resource potential that these countries are endowed with – the 130 years of reserves to production I mentioned earlier.

In Saudi Arabia, for example, gas resources are believed to be substantial, but the incentives to explore for unassociated gas fields are very weak when gas must be sold for under $1 per thousand cubic feet to industrial and power producers.

I would argue that pricing gas to more fully reflect its economic benefit would actually result in greater, not less gas use downstream.

As I described earlier, because gas prices are currently low in many MENA countries, production is curtailed, meaning that in reality demand cannot be met and alternatives must be sought. In many of the Region’s countries this means that much of its power supplies are produced from oil – a huge waste of economic potential.

Meanwhile, when downstream users get access to natural gas at deeply discounted prices, they have less incentive to use it efficiently or develop more cost-effective energy usage patterns, leading to environmental consequences, and also potentially preventing other industrial players from using that gas for more valuable economic purposes.

Of course if one is to address the pricing of gas, then one must also address the pricing of the energy products associated with it, including power and water, to ensure that the distortions eliminated for gas don’t re-emerge elsewhere in the energy system. So, such a proposal would require a substantial and sector wide transformation that might take time, but is such that it will eventually shift to a market based system, leaving the energy system and wider economy permanently strengthened.

The current energy subsidies arrangements cost the MENA Region almost $200 billion/year in lost economic potential, so the scope for gains are huge.

So, what is the appropriate market pricing benchmark to be considered if one were to reform gas and other energy pricing arrangements?

While I believe that focusing on meeting domestic needs should be of paramount concern to energy players and policymakers, I would argue that it is opportunity cost of export for that natural gas, or in other words the netback value from exporting natural-gas-based products like aluminium or fertiliser.

Only by considering the cost of natural gas in this wider context would it be possible to develop a level playing field for natural gas, rival fuels and rival uses of energy.

While the economic realities of production costs and regulated sales prices apply to private and state producers alike, it will only be possible to get the full benefit of Private sector involvement if such pricing regimes are liberalised.

The two feed off of each other, and provide the greatest scope for increased output at minimum cost. If gas prices remain artificially low and regulated, then no amount of Private sector involvement will change the basic economic decision not to invest.

Conversely, liberalising pricing while at the same time limiting Private sector involvement would not take full advantage of the more competitive environment created as a result. The addition of more Private sector players creates greater scope for the process of creative destruction which can assist the development of an efficient gas producing market.

If gas is given a fair chance to establish itself in individual MENA economies, the effect will be further magnified if governments work more closely in coordination, and utilise the Private sector to improve gas integration between countries in the Region.

Currently, even in parts of the Region where gas use is established, the integration of gas infrastructure across national borders is still underdeveloped.

While governments have taken strong positive steps with certain projects, such as the Dolphin Pipeline from Qatar to the UAE, these initial successes need to be built on, to pursue the idea of a fully connected Regional gas grid. Such a grid will both increase security of supply and ensure resources are directed to where they are most needed, at a Regional as well as National level.

I believe that the MENA Region has the potential for an energy and economic transformation to deliver on the Region’s full E&P resource potential, securing the next phase of reliable economic growth, and locking in greater and wider prosperity with a stable system that provides the best outcome for its citizens.

I believe that the best way to deliver this transformation is via the encouragement of a substantial, vigorous Private sector to work alongside the State in its role as custodian of the nation’s energy interests, in combination with energy market reforms that ensure effective competition across all sectors of the economy.

I believe that the private sector, if suitably incentivised in a liberalised market, can deliver innovation, remain closely aligned with the State’s 18 interests, and deliver private projects that further public goals.

I believe that in a liberalised, regionally-interconnected market, natural gas is likely to become the fuel of choice due to its superior price, cleanliness and availability, when compared to rival fuels.

I believe natural gas can reduce the region’s reliance on oil for its economic well-being, and prove further avenues for industrial diversification. Lastly, I believe that it is the combination of private sector and energy price reforms that will most effectively energise the MENA Region’s economies.

The size of the challenge to achieve this, is a reflection of the scale of the rewards which await.