By Dr. Raed Kombargi and David Branson
For decades, GCC countries have benefited from abundant reserves of cheap, easily accessible gas that exceeded their needs. Today, that no longer holds. Demand for gas is growing at a compounded annual rate of about 5 percent, even as new production becomes more expensive. With the exception of Qatar, GCC governments must start making hard decisions about how best to use a finite resource amid increasingly competing demands.
A smarter approach could unlock significant value. Our research shows that reallocating just 10 percent of current production levels to different industries could increase GDP and foreign earnings by up to $10bn annually, or support the creation of 100,000 jobs.
Moreover, sustainably increasing the gas price for end users by $0.5 per million British Thermal Units could add over $6bn to GCC government coffers annually. To capture these benefits, governments must start managing gas as a strategic asset rather than a by-product of oil production. GCC countries must take action in three areas:
First, they must allocate gas to create socioeconomic value. Gas markets in most GCC countries did not spring from a thought-out strategy to unlock value, rather they emerged from a series of independent decisions.
The days of abundant cheap gas in the GCC are over. Governments must start making better decisions about how to manage this finite resource
The conventional wisdom among governments is that the greatest economic benefit comes from providing gas to industry. Usually, this means for petrochemicals, aluminum, methanol, and fertilizers. However, using gas to ensure a cheap and reliable source of power could lead to a larger payoff in terms of GDP growth and potentially jobs. That is because cheap power supports all sectors of the economy resulting in economic diversification and the development of the services sector. Similarly, allocating gas for export through liquefied natural gas can have the biggest positive impact on a country’s trade surplus.
Second, they must price gas to reflect its true value. Overall, gas pricing in the GCC is opaque. Prices remain artificially low by international standards. Growing gas demand and increased fiscal pressure on GCC governments are, however, making the price issue more urgent. At present, governments consider gas operations as cost centers linked to oil production. Instead, GCC governments must treat them as separate, profit-generating entities. That requires setting wholesale gas prices that reflect its true value.
One approach is “cost-plus pricing.” This includes all costs needed to deliver gas to an end user, such as supply and transportation costs, plus a government margin. Generally, cost-plus pricing is applied to gas destined for domestic consumption. A second approach is “net-back pricing.” This indexes gas prices to the price of goods that use gas as a raw material. The net-back pricing approach ensures that governments accurately capture the value of gas, rather than allowing a manufacturer to benefit from artificially low prices. Generally, net-back pricing is commonly used for gas that is destined for export.
Third, they must implement structural market reforms. GCC governments need to ensure that the right market structure and institutional elements are in place. For example, as the process of managing gas supply and demand becomes more complex, GCC governments could create a gas aggregation company to coordinate all gas sales and purchase agreements. Governments in the Netherlands and Nigeria have used this approach, leading to greater transparency, higher government revenue and margins, and lower risk. Similarly, GCC governments could create a standalone gas transportation company—with its own profit-and-loss responsibility—to run gas transmission. Mexico has used this approach, which allows for more transparent accounting of transport costs.
Governments consider gas operations as cost centers... [They] must treat them as profit-generating entities.
An independent regulator can make sure that the aggregation and transportation companies operate fairly and provide equal access and treatment to all sector participants, in both the public and private sector. Regulators can also advise policymakers about proposed regulations, conduct due diligence on market participants, enforce policies, and resolve disputes, among other functions.
The days of abundant cheap gas in the GCC are over. Governments must start making better decisions about how to manage this finite resource amid competing demands. Together, these measures represent a significant advance in the management of national gas assets on commercial principles. A more coordinated and strategic approach will allow countries to meet their varying demands for gas and will maximise socioeconomic value. This new approach is also an opportunity. The country that moves first to introduce commercial principles will have the greatest chance of securing the prize of hosting the GCC gas hub of the future.
Contributor: Fabio Gungui, Director, Strategy & Italy