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The case for energy transitions in major oil- and gas-producing countries

The world needs to adapt the way it produces and consumes energy if it is to avoid a disastrous increase in global temperatures. For the “Producer Economy” countries that rely heavily on oil and gas exports, implied shifts in the energy sector introduce significant uncertainty. Energy transition pathways that imply an imminent peak and then a steep drop-off in oil demand, as outlined in the International Energy Agency’s Sustainable Development Scenario, would result in sharply reduced revenues for such countries. The Covid-19‑induced curtailment of oil demand this year, and the commensurate impact on prices, has provided a cautionary vision of the future if ongoing efforts to diversify producer economies do not succeed. In the Middle East and North Africa (MENA), the economies of net oil and gas exporters are expected to shrink by 6.6% this year, compared to 1% for the net importers. Given these fiscal and economic constraints, countries may be tempted to halt their own energy transitions plans. Yet this would merely delay necessary change while putting at risk their future prospects, as energy transformation could have significant impacts on a broader economic change.

The narrative regarding the impact of energy transitions in the prominent producing countries in the MENA region has focused on the potentially adverse effect on economies posed by lower revenues. However, this conversation needs to be much broader. The region’s vulnerability to the impacts of climate change means that it has a significant stake in mitigating the rise in greenhouse gas emissions. Some countries, such as Qatar, have already seen average temperature increases above 2° Celsius. Moreover, climate models predict that the Middle East and North Africa will be particularly impacted by further rising temperatures, which, among a range of other potential stressors, would exacerbate water shortages in a region that is already designated as the most water-stressed in the world (all of the region’s producers have been categorised as “high stress” or “extremely high stress” by the World Resources Institute). According to the World Bank, the economic impact of climate-related water stress alone could reach between 6% and 14% of their gross domestic product by 2050.

The hotter climate will also have significant impacts on the energy required by producer economies in the region to sustain normal life. As of today, space cooling represents 70% of peak residential electricity demand on the hottest days in some countries. By 2050, electricity demand for cooling is expected to triple. At the same time, the lower expected precipitation, coupled with demographic growth, means that the production of desalinated seawater for water usage in the Middle East is projected to increase almost fourteed-fold to 2040.

How this increasing energy demand across the region is met is important. There are compelling arguments for renewables, particularly solar PV, to play a larger role in the energy mix across the MENA region’s producer economies. In the IEA’s estimation, solar PV is already competitive, on a levelised cost of electricity basis, with the existing oil-fired generating fleet (when oil is priced at USD 40/b and above). Furthermore, the progressive cost reductions anticipated from solar PV mean that by 2030 it will also be competitive with natural gas-fired generation. These, coupled with the fact that the region enjoys some of the best solar resources in the world (the least advantaged areas of Iraq, for example, still enjoy an average solar irradiance for solar generation that is one-third higher than Germany’s best), provide clear justification to redouble efforts—and ambitions—in this area. Indeed, some producers, including the United Arab Emirates, have launched ambitious projects that are already yielding results and have contributed to pushing down the cost of solar PV at successive auctions in recent years.

The argument for increasing energy efficiency measures is likewise strong. Future cooling demand in the region could be 8% lower if more stringent minimum energy performance standards ensured a higher efficiency in air conditioning stock. In such a scenario, the Middle East would require 100 GW less power generation capacity to meet its cooling needs. Studies in Iraq have found that introducing thermal insulation in buildings could reduce that building’s energy consumption by as much as 90% – a clear net gain in a country whose housing stock needs to grow by 2.5 million just to meet current demand and where entire cities need to be rebuilt following war.

Significant local benefits could be realised carrying out retrofits of existing building stock. The Middle East and North Africa region has one of the world’s fastest growing populations, and many countries see the possible rise in unemployment as a significant and potentially destabilising risk. The IEA’s detailed assessment on prospects for sustainable recovery shows that buildings retrofits create up to 30 jobs per million dollars of capital invested. This could be particularly compelling in countries with larger populations, such as Algeria and Iraq, which lack the financial wherewithal to pursue extensive industrial transformations.

The roll out of renewables and efficiency measures may lead to a more efficient allocation of capital and could also assist with diversification strategies for producer economies. Many of the most prominent oil and gas producers have a competitive advantage in producing energy not only because their resource base is large and comparatively low-cost to produce, but also because they have developed significant domestic expertise in this sector over the past 40 years. Diversification strategies that seek to deploy these strengths, which range from managerial experience to established supply chains, towards clean energy industries could yield significant benefits.

The energy transformation is not just about providing carbon-free energy, but about prospering while on the journey to doing so. A number of producer economies have recognised the need to diversify their energy production at the same time as they seek to diversify their economies, putting energy transitions at the heart of their development strategies. Oman, for example, is pursuing the formation of a national hydrogen strategy, which it believes it is well placed to do given its accumulated transversal capabilities it developed over decades in oil and gas exploitation. Saudi Arabia, the world’s largest oil exporter, has formed a joint venture to build a “green hydrogen” plant, powered by 4 gigawatts of renewable electricity, with a planned capacity of 650 tonnes per day. In September, Saudi Arabia shipped its very first cargo of “blue ammonia” to Japan. The emissions generated from the formation of the ammonia were captured for use in methanol production and enhanced oil recovery. These provide a possibility for several of the region’s producers with cost efficient, carbon storage options, and point to a potential locational advantage for heavy industries seeking to move to low-carbon production processes.

Another route to large-scale decarbonisation in the industry sector is the move towards electrification. Countries that are able to provide low-cost, carbon-free generation could prosper as abundant solar, and, in some cases, wind, resources among major oil producing economies in the Middle East and North Africa could also prove to be an enduring source of long-term advantage.

The Middle East and North Africa’s oil and gas producers are aware of the potential adverse impacts that climate change will have on the region, and of the acute risk to their economies posed by continued dependence on oil and gas revenues. The argument in favour of addressing these dual challenges simultaneously is growing. So too is the evidence in favour of taking a proactive approach to leveraging their competitive strength in supply chains and expertise in the oil and gas sector to optimise new opportunities going forward. Linking the energy and industrial transformations enabled by the energy transitions to a broader economic diversification strategy could help ensure that the region continues to make the most out of its abundant resources, while also achieving the immediate and longer-term objectives of more resilient and productive economies.