Spotlight: A closer look at the Middle East’s decarbonization drivers and implications—a shrinking window for hydrocarbon export revenues

While Middle Eastern countries and or national oil company (NOC) participation in decarbonization strategies appear to lag other regions, Rajeev Lala, Director, Upstream Strategies and Transition at S&P Global Commodity Insights, said it is essential to dig a bit deeper to understand the regional approach to decarbonization.

"The region produces 30% of the world’s oil, and its economies are primarily hydrocarbon-based, so many leaders understand that the opportunity to optimize their hydrocarbon resources is most significant in the short term, and over the long term, that value becomes less certain," Lala said. "While oil will be needed for decades, their window of opportunity to gain export revenue from those resources is shrinking. The national economic priorities and the shrinking window to gain export revenue make the NOCs and their host governments even more dependent on hydrocarbon developments in the near term."

Lala said he was intrigued by how COP 28 got many NOCs to join the decarbonization initiative and thinks that, in the near term, the group wanted to push back on investor sentiment that has largely soured on oil and gas. He said there is a palpable sense that ‘the window is shrinking’ for the Gulf countries.

"So, they ask themselves: How can we profit? How can we invest in tomorrow’s technologies today? And the largest NOCs –Saudi Aramco, ADNOC, and KPC– are asking themselves if they are willing to explore new business areas and go big if the opportunity presents itself (ADNOC was reportedly looking at buying BP)," Lala said.

Lala said there is also a growing understanding in the aftermath of the European GIOC sentiment swing (first with gusto towards low carbon and then a reality check in 2022-2023) that low-carbon businesses have significant hurdles in achieving returns.

"The challenges for the regional NOCs are even starker when you consider that their internal rates of return are probably the highest in the global oil landscape, so prioritizing low-carbon businesses with relatively lower returns is difficult for management," Lala said. "Nevertheless, if decarbonization leads to higher exports (such as Aramco developing gas to substitute for oil being burned by power plants during summer), then decarbonization becomes a priority. Suppose lower carbon activity supports protecting the core (hydrocarbon business) and extending the value generated from the oil and gas sector. In that case, you can expect regional players are certainly working toward that goal."

Oman is a good example, Lala said, of working with oil and gas companies to build green hydrogen capacities.

Regarding decarbonization strategies, Lala segments Middle Eastern countries and companies into two primary groups—the drivers and the participants. The drivers are active and vocal in driving (and reacting to) global narratives on oil demand and the carbon-emission story. Saudi Aramco and ADNOC fall under this category. They are keen to be the ‘last producer standing’ and are banking on the premise that the world will need oil, and they intend to be the provider of the lowest-cost and lowest-emission barrels.

The participants are a group that views the world’s appetite for oil as shrinking, so they see the need to participate and make the most of their market opportunities in the short term. These countries/NOCs believe that there are limits to their ability to influence the global energy landscape, either because they lack the scale or have significant domestic issues.

Both groups primarily target maximizing revenues in the short term, speeding the development of existing discoveries, and taking opportunistic exposure to low carbon as a business opportunity if they can afford it. Historically, this topic of ‘low carbon as a business’ has sat outside the purview of the core NOC. However, Lala said the region’s NOCs remain tethered to the oil value chain, with decarbonization of core operations as the primary driver of low-carbon activity.

Lifting the veil on low-carbon projects
From the outside, Lala said some might perceive the NOCs as not doing enough relative to low-carbon investments. Still, a closer look reveals that some of the region’s NOCs are participating in renewables and low-carbon projects but are doing so indirectly.

For example, ACWA Power in Saudi Arabia is a private power company with significant existing renewable capacities and more under development. Saudi Aramco has primarily focused on upstream and downstream developments. The renewables story is driven by other government and private players, with companies like ACWA doing the heavy lifting. Interestingly, the Saudi Public Investment Fund (the country’s sovereign wealth fund) expanded its stake in ACWA to 50% in 2020.

The story in Abu Dhabi is similar, with Mubadala taking the lead on ‘low carbon as a business’ activity, even though both Mubadala and ADNOC have the same leader – Sultan al Jaber. So, most of the host country’s low-carbon activity was not directly run by the NOC, which historically would usually take the lead on fulfilling national economic priorities.

The Gulf governments and national oil companies — notably those of Qatar, Saudi Arabia, and the UAE — are implementing carbon capture, utilization, and storage (CCUS) and other emissions mitigation strategies seeking to keep the emissions intensity of their production low as they maintain or expand capacity, Lala said. At the other end of the spectrum, he said, international oil companies have a significant opportunity to help some of the region’s highest methane emitters — Algeria, Iraq, and Libya — via gas capture and other projects that offer more immediate economic upside alongside emissions reduction. The ‘last producer standing’ group led by Saudi Arabia and the UAE is growing in global influence, with an increasingly unified voice (e.g., at COP28).

"The move may give OPEC a new raison d’être and reinvigorate the push to decarbonize hydrocarbons and extend oil and gas life spans," Lala said. "In this vein, Saudi Arabia and the UAE are championing a new Oil and Gas Decarbonization Charter (launched at COP28), under which companies have pledged to bring methane emissions close to zero by 2030.

"I believe that the clean-barrel premium is coming, although it is difficult to pinpoint the timing or what it will look like," Lala said. "I suspect Aramco and ADNOC aim to drive the global narrative towards this direction."