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5/31/2021 Oil producers face costly transition as world looks to net-zero future | Financial Times

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Anjli Raval in London, Chloe Cornish in Beirut and Neil Munshi in Lagos MAY 26 2021

Ali Allawi, Iraq’s finance minister, found himself in a quandary last year as the spread
of coronavirus cut demand for oil and prices tumbled. Allawi’s treasury, which
receives more than 90 per cent of its revenues from crude sales and spends 45 per
cent of its total budget on salaries and pensions, suddenly didn’t have enough money
to pay millions of public employees and retirees.

Opec’s second-largest producer borrowed billions of dollars, mostly from local banks,
to bridge the shortfall. But public anger boiled over. The fallout of the virus then
battered businesses as their most important customers — public employees — cut
their spending.

Iraq’s economic fragility was laid bare: the hit to both public and private sectors
caused the country’s gross domestic product to shrink 11 per cent in 2020 according to
the IMF, and poverty rose amid worsening unemployment.

Yet this scenario — a huge fall in revenues as demand for Iraq’s oil drops — is not just
a pandemic phenomenon, it is the future for oil producing countries.

The Big Read Oil & Gas industry

Oil producers face costly transition as world looks to net-zero future

Many fossil fuel-dependent economies will struggle to diversify despite intense pressure to hit 2050

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5/31/2021 Oil producers face costly transition as world looks to net-zero future | Financial Times

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Ali Allawi, Iraq’s finance minister, says that if the country — which has 145bn barrels of proven crude reserves — stays dependent on
oil, ‘it could be catastrophic’ © Ahmad Al-Rubaye/AFP/Getty

Last year’s oil crash coincided with an unprecedented focus by global governments,
corporations and the public on committing to net-zero emissions targets by 2050. For
producers, a global shift towards cleaner fuels will amplify the challenges of the past
year, prompting questions about which resource rich countries can come out of the
energy transition in the best shape.

The International Energy Agency has warned of the drastic impact that pursuing a
net-zero emissions target by 2050 could have. Opec’s share of world production would
rise to more than half of the total, as oil and gas supplies become concentrated among
a smaller number of countries, but annual per capita income from these commodities
could fall by as much as 75 per cent by the 2030s.

“We’re facing a potential declining market in terms of size,” says Allawi, “a potential
decline in price [and] demands by our trading partners and allies, mainly in the
industrial world, that we should abide by the Paris climate agreement terms.”

If Iraq — which has 145bn barrels of proven crude reserves — stays dependent on oil,
Allawi says, “it could be catastrophic”. Sweeping state and economic reforms could
avert this scenario, but the minister has struggled to push through change.

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For decades oil price booms and busts have provided shocks to producer states,
underscoring economic frailties and the urgent need to develop new business sectors
to reduce fossil fuel dependence. The worst-off countries tend to be the most exposed:
states where hydrocarbon exports make up a large part of GDP. They are also the least
resilient: where the revenues from the sale of oil, gas and coal have not been
adequately managed. This could mean failing to use the cash to diversify and foster
other industries domestically or create a sovereign wealth fund that makes
investments abroad to secure long-term revenues.

How fossil fuel-dependent economies make the adjustments heralded by the energy
transition will be critical. They represent almost one-third of the world’s population
and a fifth of global greenhouse gas emissions. Their success or failure in a lower-
carbon global economy could have widespread implications for geopolitics, global
inequality, energy security and migration patterns.

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Among those least prepared include Iraq, Libya, Venezuela, Equatorial Guinea,
Nigeria, Iran, Guyana, Algeria, Azerbaijan and Kazakhstan, according to the World
Bank. These nations have not diversified exports or shifted their economies towards
non-polluting industries. Most have been mired in war, plagued by widespread
poverty or unable to secure international investment to drive a shift away from fossil
fuels. Many of them are also among the most vulnerable to the real-life effects of
climate change.

A protester sits in front of a Baghdad mural that reads ‘I want my oil’ during a protest in December 2019 © Nasser Nasser/AP

Iraq is not only struggling to pull itself together after decades of conflict and
instability, it is already on the frontline of global warming — desertification, water
stress and extreme temperatures have an impact on daily life already hampered by
rolling electricity blackouts.

The pandemic, the World Bank says, offers these countries “a once in a generation
moment” to diversify from hydrocarbons.

Allawi, too, had hoped last year’s shock would pave the way for sweeping reforms. But
the alarm did not last as prices began to rise again — from $38 a barrel in October to
near $70 today. Instead of cutting government salaries and pursuing the investment
and economic overhaul he says are necessary, the state dealt with unemployment by
adding even more college and university graduates to the state payroll.

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5/31/2021 Oil producers face costly transition as world looks to net-zero future | Financial Times

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“It was a wake-up call last year,” says Allawi. “But as the oil price crept up [again] the
demands of various constituencies forced themselves back on to the agenda and the
pressure returned to use the public [spending] trough.”

A fight to be ‘last man standing’
The transition towards cleaner fuels is likely to play havoc with supply chains and
businesses that serve the natural resources sectors. The disruption to revenue streams
and labour markets means there is little incentive, for now, for these national
producers to join global initiatives to combat climate change, say economists and
energy analysts.

Ashim Paun, a climate change strategist at HSBC, says it is a tough pill to swallow:
“When you have so much cheap oil and gas you stay hooked on it.”

Fossil fuels have provided unimaginable wealth, leading to economic modernisation
and prosperity in some countries, including the Gulf states. But in many cases these
riches have been squandered or concentrated in the hands of a few. Still, the lure of
this cash windfall is so great that countries such as Guyana — which produced its first
commercial-grade oil in 2019 — are, even now, trying to become petrostates.

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Many oil economies have recognised the downside of being beholden to fossil fuel
exports and volatile commodity prices. Corruption, mismanagement of state funds
and subsidies have also led to bureaucratic, government-dependent nations rather
than dynamic entrepreneurial states.

Yet it is not entirely clear which economies will lose out in the energy transition. Saudi
Arabia and Russia — the second and third-largest oil producers in the world — are
vulnerable but their more complex economies and bigger financial buffers have
boosted their resilience despite their high exposure to hydrocarbons exports.

A worker at an oil refinery in Atyrau, Kazakhstan. The World Bank lists the country as one of the least prepared for the looming
energy transition © Andrey Rudakov/Bloomberg

“This is not a homogenous group and their resilience and core sources of comparative
advantage vary tremendously,” says Bassam Fattouh, director of the Oxford Institute
for Energy Studies, who adds that some countries are “in a position to benefit from
transformations associated with the energy transition”.

Canada, Norway, Australia and the UAE are among those reliant on fossil fuel sales
that have successfully developed other areas of their economies. Some are trying to
add clean energy capabilities.

Success or failure will depend on the pace of change. A slow and smooth transition
towards cleaner fuels is possible, but so is a brutal upheaval.

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Dictating the speed of change will be technological advances, political momentum,
regulation and how big energy consumers choose to meet their needs. New supply
chains linked to the energy systems of the future will also pose challenges — from the
supply of metals such as lithium to the production of batteries, wind turbines and
solar panels.

Most energy ministries in producer countries are banking on fossil fuels remaining a
big part of the energy mix for decades to come. State-owned energy companies are set
to spend $1.9tn on new oil and gas projects by 2030, according to the New York-based
Natural Resource Governance Institute. Despite net zero ambitions, the reality of
today’s consumption is quite different. Developing economies in the Asia-Pacific
region alone are expected to account for nearly two-thirds of global energy demand
growth between now and 2040.

For producers, the calculation is that even if demand for oil and gas falls, they will still
be able to sell their precious commodities for years to come and be the “last man
standing”.

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https://www.iea.org/reports/energy-security-in-asean6

5/31/2021 Oil producers face costly transition as world looks to net-zero future | Financial Times

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“There is a massive need to bring energy to the billions of people that continue to go
without,” says Mohammed Barkindo, Opec secretary-general. “Opec supports the
need to reduce emissions and use energy more efficiently, but we do need to be
cognisant of the implications of under-investment . . . It is not just crude oil, it is the
plethora of products that are derived from it.

“A shortfall in investments could affect stability in markets, prices could rise, and we
could see product shortages, all of which would have an impact on the global
economy,” he adds.

Big fossil fuel consumers — such as Japan — are also wary of the growing momentum
to shut down new investment into oil, gas and coal developments. They are fearful of
their energy security should renewables fail to replace robust demand for
hydrocarbons.

Mohammed Barkindo, Opec secretary-general, says that during the energy transition, ‘a shortfall in investments could affect stability
in markets, prices could rise, and we could see product shortages, all of which would have an impact on the global economy’ ©
Kamran Jebreili/AP

For investors, governments and the public, a country’s future depends on its ability to
attract foreign investment, eliminate inequality, manage inflation and other factors.

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But among producers even Saudi Arabia, the world’s largest oil exporter with the
lowest-cost barrels, is nervous. Despite a stronger economy than other producers and
grand plans to create new industries — from technology to tourism — the kingdom is
concerned about a cash shortfall before it is able to sufficiently develop new revenue
sources. Mohammed bin Salman, the crown prince, said in a recent interview: “We are
an oil country, not a rich country.”

“We were very rich in the 1970s and 1980s when we had a smaller population and a
lot of oil. But now . . . we are growing quickly,” he said. “If we do not maintain our
savings and distribute our tools every day, we will be transformed into a poorer
country.”

Workers at a refinery near Lagos. Oil provides roughly half of Nigeria’s government revenues, but the lack of refining capacity and
the big import bill for petroleum products all but nullify the benefits of higher global oil prices © Akintunde Akinleye/Reuters

Ill prepared for change
At a petrol pump on Akin Adesola Street in Lagos, managed by the state oil company
Nigerian National Petroleum Corporation, a couple of dozen cars are queueing up in a
knotty, noxious snarl, waiting for the cheapest fuel available in sub-Saharan Africa.

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The subsidy that discounts petrol prices for the country’s 200m people mainly
benefits the wealthy and costs the government $300m a month. It is emblematic of
the mismanagement at the heart of Nigeria’s energy sector — from oil and gas to
electricity — undermining the entire economy.

Clarkson Pwabili, a 38-year-old driver filling up his boss’s car, says even the N162
($0.38)-a-litre price is too high. “The economy keeps going down, so even this price is
a hardship on people [because] it increases the cost of transportation,” he says. The
minibuses he rides to and from work have doubled in price over the past year, to
N1400 a day. “This is very high for me,” he adds.

The Niger Delta: smugglers ferret away an estimated 30% of Nigeria’s petrol supplies into neighbouring Benin and Cameroon, where
fuel prices are higher © Ron Bousso/Reuters

Nigeria is Africa’s biggest oil producer, churning out about 1.7m barrels a day from
pumps far offshore in the Gulf of Guinea or deep in the swamps of the Niger Delta. Yet
the government-subsidised fuel is imported. Oil provides roughly half of government
revenues and nearly all of its foreign exchange, but the lack of refining capacity in
Nigeria and the chunky import bill for petroleum products all but nullify the benefits
the state gains from higher global oil prices. Smugglers ferret an estimated 30 per cent
of the country’s petrol supplies into neighbouring Benin and Cameroon, where fuel
prices are higher.

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When the oil price crashes, as it did last year, the consequences are horrific.

The failure to manage its resources properly means most ordinary Nigerians are yet to
see any real benefits from the billions of dollars in revenue extraction. Forty per cent
of Nigerians live in poverty and state funds are yet to stimulate alternative industries.
Yet with the population expected to double by 2050, the need to act is urgent.

The sector’s dysfunction is typified by the bloated NNPC, notorious for
mismanagement and corruption. It s, sells and trades oil and refined products
while also acting as its own regulator. “If the government had managed it well, I don’t
think we’d be in this situation,” says Pwabili.

Workers at a solar plant factory near Riyadh. Saudi Arabia’s Crown Prince Mohammed bin Salman has warned that during the energy
transition, ‘if we do not maintain our savings and distribute our tools every day, we will be transformed into a poorer country’ ©
Faisal Al Nasser/Reuters

Other sectors are hamstrung by Nigeria’s inability to generate and distribute
electricity across the country. Africa’s most populous country is among the least
electrified in the world on a per capita basis, with many businesses largely forced to
generate their own power using costly, polluting diesel generators. This is preventing
a shift from a hydrocarbon-led, capital-intensive growth model to one that is labour or
knowledge-driven — from technology to agriculture and industry.

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President Muhammadu Buhari’s administration has made efforts to exploit Nigeria’s
natural gas reserves, which at about 5.3tn cubic metres are among the biggest in the
world. The hope is a resolution of the power crisis will help other sectors thrive.

When trying to understand what a successful transition looks like, energy analysts say
properly managing existing fossil fuel infrastructure and investments should be the
priority. Only then can a country try to navigate a move in to new industries.

Mark Finley and Paul Kolbe of Rice University’s Baker Institute in Texas say poorer
economies are unlikely to join the net-zero bandwagon with fervour given their
limited economic and political choices.

“The uneven pace of the energy transition could threaten to derail its success if not
properly managed. Given the global nature of the challenge, winners have a stake in
the overall success of the transition, not just in their part of it,” they said in a recent
paper. “It is not helpful (or appropriate) for richer countries to force the cost of this
transition on to poorer countries.”

For those in Nigeria, this double standard is abundantly clear. “A transition [away
from] the fossil fuel economy [would] represent doom for Nigeria and her people,”
says Idayat Hassan at the Abuja-based Centre for Democracy and Development. “The
country will get poorer and the naira worthless . . . and lawlessness [may] reign . . .

“Neither the country,” she adds, “nor her people are really ready for it.”

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