Risky Business: Interview with Kenneth McKellar

What’s your appraisal of the region, given the events since the start of the year?

Leaving aside the Arab Spring, we are at a turning point in the region now as far as energy resources are concerned.

The region has always been very well known for its very large reserves of oil, and more recently, gas. It’s also increasingly a centre for petrochemicals, partially as a result of the very cheap cost of feedstock.

So the oil and gas side of things is well-known and well understood. I think what is less understood are the opportunities, and the necessity, of restructuring electricity and water sectors and renewable sources of energy.

Energy demand in the region is expected to increase massively over the next few years – by around 150% by 2030 – a huge amount, as the region’s countries become more sophisticated, as more businesses are attracted here.

And of course the key differential between electricity here and electricity in Europe for example is that much of it is used for desalination. So typically you have water and electrical companies joined to together.

We are looking at a very large restructuring of the entire electricity and water industries in virtually every country in the Middle East. It reminds me of the kind of restructuring seen in Europe 20-25 years ago. There is a huge need to make more efficient the electricity and water supply.

Do you mean a drive towards greater private ownership and enterprise and away from the era of state-owned companies?

There is going to be privatisation but not as we understand it in Europe and America. What privatisation means in terms of electricity and water companies is a large increase in foreign involvement in the running of those companies rather than private entities taking stakes in the companies.

For example, typically it could mean bringing in a strategic shareholder in a minority investing role that can bring people, technology, access to markets. If we look at nuclear, for example, which is going to be one of the big stories for me going forward, each country is contemplating or staring it’s own nuclear program. It’s more an expertise importing process.

And how does this restructuring fit in Arabization and similar national programs? There is a clear need to go beyond treating this on a project-to-project basis, with quotients of nationals imposed.

It’s a key part of every government’s strategic plan to build capacity in the skills needed to do nuclear energy, to do renewables in the future. A good example is in the nuclear industry in Saudi Arabia.

What they are doing is trying to build the knowledge base in terms of education and training of young Saudis in nuclear and renewable energy so that, post-oil, they’ll have a sustainable energy base.

These kinds of programs fit in perfectly with the Saudization or the Emiratization drives. As in the UK, these programs only work if you go back to teenagers and try to get them to take science, engineering and technology degrees.

Which is a real problem at the moment in the UK.

Yes, it’s totally faded in the UK. And a problem is you’ve actually got not only a lack of skills in the Middle East but a lack of skills in the countries whose skills the Middle East is trying to attract.

There are also shortages now. There was a recent article in the UK press saying that the UK nuclear authorities are not going to have enough nuclear inspectors because in the next three years the current crop are all retiring without replacements. And yet we are still trying to get these fewer people out and into positions of influence in the Middle East.

In terms of getting MENA nationals involved, it’s surely going to take more than individual programs? Nationals need to be involved in the whole chain from construction, to law and so on, and at all levels.

This is the way things have to go. One of the things I was heavily involved with was the LNG industry take-off in Qatar. There are basically two phases to all of these industries.

The first is highly capital and knowledge intensive – building liquefaction trains, building the big pieces of kit, project management and so on. Then, once the kit is up and running and you’re exporting LNG to external markets, the organisation almost has to transform itself into an outward-looking sales and marketing business.

This is actually quite a challenge, because when a large company invests heavily in a project, they on completion want to pull back on their resources and say “we are going to harvest the fruits of our investment”.

The issue then is, who do you put in their place? Quite rightly in Qatar they have a program which means that they are trying to replace expensive – and generally old – people like me with newer, local hires.

You mentioned nuclear energy in Saudi. Do you think the country will be taking the lead in the region, and the region in the world? Europe now seems to be stalling and the US has invested in shale gas in a big way.

First of all I think the region has no option but to pursue nuclear, because if you look at the fuels that currently generate electricity, there is heavy fuel oil, but it’s environmentally unfriendly. There’s the argument that hydrocarbons should be exported for market value rather than being used internally at a subsidised price.

There is not enough gas in the long term to sustain combined-cycle gas turbines for electricity production. Clearly, it will take some time before renewables become a significant part of the energy supply balance. So you are left with nuclear.

Essentially the people who will drive nuclear are those who have lots of money to spend on it: the UAE, Saudi, and Qatar.

Regarding North Africa, that region has obviously seen far greater turmoil than the Gulf. How can companies manage strategic risk there?

Oil companies are no strangers to managing political risk. I would characterise the mood of IOCs by saying they are monitoring the situation closely, rather than being panicked or concerned.

There have been all sorts of nationalisations and asset seizures before in places like South America. There have also been fairly major changes to fiscal regimes in Algeria and Libya which make them less attractive to oil & gas companies, simply because they need more money.

The main change in the risk profile then and now is that companies do an awful lot more in terms of appealing directly to the communities they serve.

So my argument to an oil company is regardless of which regime is in power, make friends with people.

There is a lot of focus on corporate and social responsibility now by IOCS and it is increasingly a requirement by governments that IOCs spend money on socio-economic projects.

So that’s one risk mitigator, if you like. The other is the contracts. Production Sharing Agreements, or PSAs, have become a lot more transparent, and companies now have recourse to litigation or arbitration of more claims than they had in the past.

Abu Dhabi’s upstream concessions are slated to be renegotiated in 2014, and it wouldn’t surprise me if a number of the royalties arrangements to incoming companies are changed. A lot of the big reserve rich countries in the region are very aware of what other countries are doing and want to be competitive.

We’ve done a lot of benchmarking of countries around the world on the attractiveness of various fiscal regimes around the world, and this includes transparency and consistency. The United Kingdom, believe it or not, is one of the most volatile fiscal regimes in the world.

What are you focussing on now? Who are you advising?

Deloitte is doing a lot of risk consulting, for both oil and electricity companies. After the financial crisis there has been a huge focus on operational risk.

This is typically risk within the business, be it credit risk, delivery risk and really trying to re-shape organisation so that if the senior executives fall under a bus, the organisation has enough resources to survive and thrive.

The other thing we are involved in heavily is human capital management. This problem is exacerbated in the Middle East because there is simply no modern, integrated HR function in a lot of the companies that we see here that we would expect to see in the West. This is true of companies generally, other than subsidiaries of Western companies.

We are addressing how to create a modern HR function in the region; how to manage talent right through people’s career paths. You’re not going to see Arabization programs being successful unless you have proper HR functions in place that map people’s careers and split people off according to their talents. This is possibly the biggest are of work that we see and are involved in, especially in the fields of energy and resources.

To what extent are you and Deloitte working in Iraq and what do you make of the current situation there?

What we’re seeing is almost a two-level strategy. In the North, in Kurdistan, things are booming. They are bringing in mainly independent oil companies and a large number of exploration and production licences gradually ramping up production.

However, the real prizes are of course in the south. The main problem there is infrastructure. There are also concerns that the government’s production targets are on the optimistic side.

Despite this everyone is really willing Iraq to succeed and retake its rightful place at the table. Once Iraq gets up and running – as everyone would like it to – has the potential to rival Saudi Arabia as an oil producer.

We are working with some of the entrants to the market in the north. We’re advising on cost recovery, on farm-ins – whereby a company, not at present a licensee on a particular licensed area, can acquire an interest from one of the existing licensees.

A particular focus for us is helping companies and government bodies to manage a joint venture (JV) from contemplation to dissolution. In the wake of the financial crisis there has been more pressure on governments to maximise their treasury take to fund domestic programs that will prevent the Arab Spring becoming a hot summer.

That in turn puts pressure on National Oil Companies to toughen up the terms on which they offer to International Oil Companies. So there are quite a lot of potential flashpoints in JVs. What we do is apply the knowledge we have of different fiscal regimes, of tax, of a lot of the risk issues surrounding running JVs, we can advise at most stages of a JV.

What do you make of the fallout and implications of the last OPEC meeting?

We’re seeing the effects of the Arab Spring percolating into the Gulf OPEC members. Saudi Arabia is desperate to increase production, especially given the price of oil, and is able to do so. A lot of the non-gulf members don’t feel demand is overwhelming enough to justify an increase.

And even if it were, a lot of countries are now finding it very difficult to produce up to their existing quotas.

We cannot rely too heavily on Saudi Arabia to be the swing producer of oil due to the actual marginal product when Saudi says it will increase production.

We’ve lost a lot of barrels out of Libya, largely sweet light crude that is exported to Italy and to the South of France. It is difficult for Saudi Arabia to, in the short term at least, replicate that sort of supply.

Hence the recent proposed swap deal with the US.

Indeed. There are other changes too. If you’d have told me five years ago that the US could be self-sufficient in gas I’d have laughed at you. But the EIA (the US government’s energy body), are saying there is a real possibility that shale gas can make that happen.

I’m not such a fervent supporter of shale gas, but we are seeing the US developing shale because they rightly want to increase security of supply to lessen their dependence on unstable far away providers.

On the other hand, Russia has come into the Middle East and has a new project in Bahrain, in a bid to diversify its sources of demand as much as possible. This has included protracted negotiations with China, which have been very difficult. We are seeing this with the Nord stream pipeline to Germany and the south stream. There is also the potential for swap deals between Russia and Qatar. So the Russians are going for security of demand.

Nascent developments in the Gulf include Carbon Capture and Storage (CCS) and carbon trading. What’s your assessment?

Governments have to take a really strong lead on this. One of the reasons BP pulled out of a carbon capture and storage (CCS) project to pump carbon dioxide into the depleting Miller field in the North Sea is because then BP head Lord Browne said there wasn’t the sort government support he needed.

There is a long way to go before carbon markets becomes important in the Middle East. There are no meaningful commodity trading markets yet. The day of CCS and carbon markets will definitely come, but there needs to be a commercial imperative to do it here, which there isn’t at the moment. Higher prices, ironically, could be the key.