COVID-19 in the Middle East and Gulf States: Coping With Historic Demand Drop

COVID-19 in the Middle East and Gulf States: Coping With Historic Demand Drop

Author: Dr Ibrahim Al-Muhanna, World Energy Council Vice Chair for the Gulf States/Middle East and Adviser to the Minister of Energy, Industry and Mineral Resources, Kingdom of Saudi Arabia.

The world has witnessed major economic and energy crises in the last 50 years. While there is generally a linkage between the two, that is not always the case. The causes behind each of the previous crises were different but all led to structural changes in the years that followed. The 2008/09 financial crisis is an example. At the time the global economy shrank by around 1.7%. Oil demand fell by 1.6% and oil prices fell from a historic high of $147 per barrel in 2008 to $32 per barrel within just four months. What began as a financial crisis in the United States spread to other countries and led to a global economic downturn.

The Covid-19 crisis is completely different to any previous crisis we have seen in modern history because it has delivered a dual shock – a catastrophic health crisis and an economic crisis at the same time. It started with a virus that caught the world unprepared. It spread so fast and so quickly to every country, infecting millions and leading to 450,686 deaths as of June 19.  The world had gone through a far worse health crisis in 1918, when the Spanish Flu pandemic is estimated to have caused the deaths of between 20-30 million people around the world. But the economic fallout was not of the magnitude that we are seeing today with Covid-19.

In 1918, China was not the giant economy it is today and the European Union had yet to emerge as a significant trading bloc. Oil had not yet been discovered in the Middle East and Russia was part of the Soviet Union and transitioning to a closed, centralized system under communism.

The present situation is different because humanity is more mobile and our economies are more interconnected. China accounts for roughly a quarter of global energy consumption so when the first case of the novel coronavirus appeared in Wuhan and the Chinese economy slowed down sharply, the global economy and oil markets took an initial hit before the virus spread to all continents, forcing partial or total lockdowns.

The world economy is expected to contract by 10% in the first half of 2020 as businesses and industry scaled back operations and work stations moved from office to home. Movement by land and air declined sharply and energy demand plummeted as economic activity shrank.

Oil consumption is estimated to have fallen by 25 million barrels per day in the first quarter of 2020, an unprecedented decline in the history of the industry. Oil prices collapsed and at one point in April fell below zero in the United States. The scale of the demand destruction took the Middle Eastern oil producers and the Organization of the Oil Exporting Countries (OPEC) by surprise.

At first, Saudi Arabia and other producers in the Gulf region believed that extending production restraint already in place would be enough to staunch the fall but it soon became apparent that collective action beyond just the 13 OPEC states and a dozen other producers led by Russia known as the OPEC+ was needed to restore stability to the oil market. That is when geopolitics came into play and the United States, which, until last year was the world’s largest producer of oil, stepped in along with other G20 nations to help stabilize the market. This type of coordination was unprecedented and led to an agreement to remove roughly 10 million barrels per day from a global market that had become saturated with oil. Contributions from other producers who have agreed to slash output or have been forced by economics to shut down wells will take the total to around 15 million barrels per day in reductions. An unprecedented event required unprecedented measures.

Three world leaders played a key role in the diplomatic process that followed. U.S. President Donald Trump, concerned about the impact of collapsing oil prices on U.S. oil producers, contacted both King Salman of Saudi Arabia and President Vladimir Putin of Russia to urge the top two producers after the United States to work together to rebalance the market. As U.S. oil production has risen sharply during the last decade, it has become an exporter of oil and therefore more affected by developments in the global oil market.

Oil prices have recovered since the supply reduction agreement came into effect at the beginning of May yet the negative impact on the global economy, the economies of the Middle Eastern oil producers, and the energy industry is not over. A full recovery might take another one or two years. The economies of the Middle Eastern oil producers, particularly the Gulf Arab producers, will suffer as a result of weaker oil prices, forcing governments in the region to cut fiscal spending and allocate funds for rescue packages. The crisis has exposed the weaknesses of our current economic and energy models, where an adjustment is needed to manage the post-crisis period if we are to emerge from the pandemic as a more resilient society. We in the region are working hard to ensure that oil and gas remain relevant during this period of energy transition and a drive to decarbonise the global economy. The size of the oil market’s share in the energy mix is too large to ignore and we are aware that the industry on which many of the Middle Eastern economies rely for their foreign revenue earnings have to adapt.

Across the Gulf Cooperation Council region the national oil companies and their international partners among the oil majors are developing new technologies to reduce the carbon footprint of oil and gas production. Saudi Aramco is investing heavily in sub-surface management of its oil production, which has yielded significant reductions in carbon emissions. Along with other GCC states, it is tapping into its huge natural resources to develop a circular carbon economy through development of carbon capture and storage technologies, where carbon emissions from oil and gas production are trapped, stored underground and then re-used to produce clean products. The United Arab Emirates is leading the region in deployment of renewable energy with its large solar plants and will soon be operating the first nuclear power plant in the Gulf region. We are investing in hydrogen technology and implementing tight energy efficiency standards to reduce our own consumption of energy, which is amongst the highest in the world in per capita terms.

The Kingdom of Saudi Arabia, as current president of the G20 group of industrialised nations recognises that it has an important role to play in helping with the global recovery effort. The energy alliance with Moscow and the strong diplomatic ties with Washington are important factors in this process. China, the world’s second largest economy after the United States, is a big trading partner and a major importer of oil from the Middle East. The health of its economy is vital for the Middle Eastern countries that rely on its huge market. It will need to be involved in the effort to restore stability and confidence once the threat of Covid-19 recedes.

Lower oil prices have a geopolitical impact on the region. They have reduced capital flows and risk delaying economic reform programmes that are necessary as part of a gradual move away from overreliance on oil and gas exports. Petrochemicals exports, an important economic sector across the region, have also been affected. The Gulf states represent a huge labour market for the less wealthy Middle Eastern nations and southeast Asia so any disruption to normal economic activity has a spillover effect on the economies of these countries.

The countries in the region are managing the crisis differently but all have slashed their spending and some have raised taxes to make up for the revenue shortfall. I believe that the worst of the crisis will be behind us by the middle of 2021 though no one can say for sure what shape the recovery will take. We know that we will need better management of our energy systems if we are to ensure an orderly exit that is inclusive and sustainable.

The World Energy Council’s Trilemma Index provides a yardstick for countries to assess their performance on the key energy challenges of energy equity, energy security and environmental sustainability. The Middle East and Gulf States region performs well on energy equity and security though the oil producing countries tend to perform better than the oil importers, who are more exposed to potential supply disruptions due to geopolitical or market shifts. However, the countries of the region and in particular producers of hydrocarbons are aware of the need to improve their credentials with regard to environmental sustainability, more so now than previously as we emerge from crisis. Efforts are under way across the region to advance the circular carbon economy and reduce the carbon footprint of our main industries, including production of oil and gas.

We also see huge potential for developing a hydrogen economy, which, if combined with carbon capture and storage, will provide solutions that can be applied to a number of sectors, including the all-important transportation sector, which accounts for a large percentage of harmful emissions. Saudi Arabia and the UAE are leading the drive to test applications for hydrogen. Studies show that hydrocarbon rich countries A number of the region’s National Oil Companies , as well as in greenhouse gas emissions, are investing heavily in research and development in the effort to find solutions to the challenges resulting from the energy transition that has gained traction around the world. Renewables are one solution and the region has an abundance of solar capacity that is being deployed in a number of countries, including Saudi Arabia, the UAE, Oman and Qatar, among others. The challenge we face now is to ensure that shrinking revenues from oil and gas exports do not derail the effort to diversify the region’s economies and prepare their energy systems to accommodate a wider variety of energy sources, including wind, solar and nuclear power. We are also aware of the social cost of transition and are working to reduce energy subsidies while ensuring that energy access and affordability to the more vulnerable sections of society are not compromised. Covid-19 might lead to some delay in implementing some projects due to logistical and supply chain disruptions but these are hopefully short-term rather than long-term challenges.

The World Energy Council and its global network of energy stakeholders around the world has a key role to play. It has reached out to its members to detect signals of change to design a set of scenarios of plausible exit pathways to lead us out of crisis. There is a human cost to any economic and energy transition and it is important to remember that a recovery has to be equitable, sustainable and resilient to future shocks.