Energy Policy in the Gulf Arab States: Shortage and Reform in the World s Storehouse of Energy

Energy Policy in the Gulf Arab States: Shortage and Reform in the World s Storehouse of Energy By JIM KRANE, PhD candidate Judge Business School, Cambridge University Trumpington Street, Cambridge CB2 1AG, UK +44 7552 464 058; jkrane@gmail.com 1

Introduction The hydrocarbon bounty held by the six Gulf Cooperation Council countries, Saudi Arabia, the United Arab Emirates, Kuwait, Qatar, Oman and Bahrain, represents one of the world s vital supplies of energy for the coming decades. Global dependence on these resources stems not just from the size of the reserves or the level of production, but from the small populations in these Persian Gulf countries and their own historically low levels of consumption. It is the GCC s large resource per capita that has allowed it to export most of its production and to become a dominant force in international oil markets. This story is beginning to change. Rising populations and consumption in these producer countries threatens assumptions about the sustainability of GCC energy exports. 1 At current rates of consumption growth, Saudi Arabia could see oil exports reduced by the end of the decade, much sooner than expected. 2 Kuwait is only slightly better off. Oman and Bahrain, the GCC states with the smallest endowments, are already in depletion-led decline. This scenario presents a policy puzzle. Petroleum exports form the bedrock of the GCC political economies. Distribution of oil and gas revenues has cemented near-absolute monarchs in power long after the demise of this form of government elsewhere. 3 Given the vital importance of these revenues, why have GCC rulers been unable to curb the domestic resource consumption that jeopardizes exports and ultimately endangers the survival of their regimes? This paper examines the drivers of domestic hydrocarbon demand in these six countries. It pays special attention to seemingly paradoxical government policies that encourage local consumption of chief exports. These include subsidies on electricity, desalinated water, industrial feedstock and transportation fuel, which exacerbate demand for exportable resources. Two aspects of the Gulf energy quandary are examined in detail. First is the electricity market, where unconstrained consumption and low tariffs is most effectively addressed by breaking a political taboo. Second is the underdeveloped market for natural gas, the main feedstock for generating that electricity, where low pricing is driving a shortage. 1 (Gately, Al-Yousef and Al-Sheikh 2012) 2 (Mitchell and Stevens, Ending Dependence: Hard Choices for Oil-Exporting States 2008); (Lahn and Stevens 2011) Also Jadwa, HSBC and others. 3 A large body of political economy literature has made this case, under the rubric of rentier state theory and the resource curse. These include: (Beblawi 1987), (Luciani 1987), (Anderson 1987), (Herb 2005), (Schlumberger 2006), (Gause III, The Persistence of Monarchy in the Arabian Peninsula: A Comparative Analysis 2000), (Smith 2004), (Chaudhry 1997), (Crystal 1990), (Gause III, Oil Monarchies: Domestic and Security Challenges in the Arab Gulf States 1994), (Ross 2001), (Schwarz 2008) 2

The paper finds that the GCC Qatar excepted is in the midst of a shift to a higher-cost model of energy provision. The era when primary energy was considered nearly free is being eclipsed by one where new sources of demand are met by more expensive resources, either unconventional domestic energy or market-priced imports. For now, governments have absorbed these cost increases and insulated energy consumers from price signals that might otherwise moderate consumption. This practice intensifies the call on domestic resources that might otherwise be exported. The main school of literature that examines Gulf political economies, that of the Rentier State Theory, has not yet produced a close examination of issues which could undermine its continued relevance in its empirical heartland. Since diversion of energy into the domestic market threatens regime patronage systems, it also threatens the theory s chief tenets. More importantly, by illustrating these trends, it may be possible to reveal the advancing endgame of the oil-based rentier state in the Gulf. The consumption dilemma, coming at a time when opportunity for reform has been constrained by pan-arab uprisings, presents difficult questions for these tribal-autocratic regimes. Hydrocarbons provide ruling families with political legitimacy, through in-kind domestic distribution; and they provide regimes with economic viability, through export revenues, some of which are also distributed. For the system to continue functioning, resource revenues from the international side of the equation must not be displaced by resource demand from the domestic side. The choice for regimes is one of short-term political stability versus longer term economic sustainability. As populations rise and energy production reaches a plateau, domestic consumption will gradually displace exports, as has happened in other oil exporting states. Politically difficult reforms that moderate domestic consumption can therefore extend the longevity of exports, and perhaps, the regimes themselves. Looking ahead, Section 1 describes the state of primary energy consumption in the Gulf producer countries, and the economic short-sightedness of subsidized redistribution of domestic resources. Section 2 directs attention at regional electricity and natural gas markets, the most worrying and politically sensitive aspect of the energy puzzle. Section 3 looks at the likely transformation of the Gulf into a gas importing region, and the conclusion examines the political implications of shrinking exports and rising fiscal burdens that are symptomatic of resource depletion. 3

2000 2002 2004 2006 2008 2010 2012 2014 2016 2018 2020 mtoe Section 1: GCC Energy Consumption Dynamics In the past four decades, energy demand in the Gulf Arab countries has undergone a dramatic transformation. At the start of the 1970s, these territories were poor and underdeveloped, with tiny populations emerging from centuries of isolation. Energy consumption in Arabia was a rounding error on global demand. Forty years later, the Gulf, with just 0.5% of the world s population, consumes 5% of global oil output. 1.1 Primary energy consumption GCC primary energy consumption rose by an average of 5% per year between 2001 and 2010 4, nearly doubling from slightly more than 200 million tonnes of oil equivalent (mtoe) to almost 380 mtoe, evenly divided between oil and gas. By 2020, that figure will nearly double again, to 660 mtoe. 5 (See fig. 2) Over the last decade, Gulf energy consumption grew twice as fast as the world average of 2.5%/year, but slower than that of China and India. (Fig. 1) 10% 9% 8% 7% 6% 5% 4% 3% 2% 1% 0% Average yearly growth primary energy consumption (BP) GCC Iran US China India OECD World 1992-2001 2002-2011 GCC Primary Energy consumption; projections to 2020 (EIU) 700 600 500 400 300 200 100 0 Saudi Arabia UAE Kuwait Qatar Oman Bahrain Figure 1: GCC energy consumption vs others (Source: BP, 2012) Figure 2: Projected GCC PE consumption to 2020 (Source: Economist Intelligence Unit, 2010) 1.2 Natural gas The GCC countries represent a major repository of natural gas, but most production is consumed domestically. Only Qatar is an exporter of note. In 2010 the GCC produced 310 bn 4 (BP 2012) Primary Energy Consumption, Mtoe. Note that the BP figure does not include Oman and Bahrain. 5 EIU projections from chart. Note that primary energy in the GCC is nearly 100% oil and gas and derivatives. 4

1970 1972 1974 1976 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 bcm/yr cubic meters (bcm) of gas and consumed 209 bcm, with the balance exported. Removing Qatar the remaining five countries produced 189 bcm and consumed nearly all of it, 185 bcm. Overall the GCC represented 6.3% of global gas demand but held 20.3% of its reserves, which foreshadows difficulties in production, regional trade and pricing. Natural gas consumption has exceeded production in the UAE and Kuwait since 2008. (Fig. 3) In Bahrain and Saudi Arabia consumption and production are nearly matched. Neither exports raw gas. Oman remained a small net exporter in 2011, since its LNG exports were larger than its pipeline imports. 70 60 Gas consumption and production: UAE and Kuwait (BP) 50 40 30 20 10 0 UAE production Kuwait production UAE consumption Kuwait consumption Figure 3: Gas consumption surpasses production in UAE and Kuwait (Source: BP, 2012) 1.3 GCC oil consumption in global context In contrast with gas, most GCC oil production is exported. But domestic use is on the rise. Between 2000 and 2009, yearly oil consumption grew by an average of 6.5%. The percentage of oil production consumed domestically in 2009 ranged from a low of 13% in Qatar to a high of 26.5% in Saudi Arabia. Among major oil exporters, only Angola, Algeria and Kazakhstan maintained similar consumption growth. (Fig. 4) 5

12% 10% 8% 6% 4% 2% 0% Oil cannibalization: Domestic consumption of potential exports (IEA) 45% 40% 35% 30% 25% 20% 15% 10% 5% 0% avg y-o-y oil consumption gwth 2000-2009 (LH scale) % oil production consumed domestically 2009 (RH scale) Figure 4: Avg. yearly growth in oil consumption, with production consumed domestically in 2009 (Source: IEA, 2012) Rising consumption in Saudi Arabia has pushed the kingdom into the upper echelons of world oil consumers, despite its comparatively small population, economy, and industrial base. In 2009, it surpassed Brazil and Germany to become the world s No. 6 oil consumer, behind Russia. 6 In 2011, the kingdom s domestic oil consumption represents lost revenues of more than $80bn, or 13% of GDP, given the average price of Saudi Arabian light crude that year of $107.80/bbl. 7 Country Oil consumed 2011 (m b/d) GDP 2011 $bn Population (2011) Oil consumption per capita Saudi Arabia 2.86 $578 bn 28 million 37.2 bbl/yr Brazil 2.65 $2,493 bn 195 million 5 bbl/yr Germany 2.36 $3,577 bn 82 million 10.5 bbl/yr Sources: IMF, BP Table 1: Saudi oil consumption in perspective 6 (BP 2012) 7 This simple calculation does not take into account the varying prices for grades of Saudi crude, nor the effects on the oil markets of an extra 2.86m b/d of available oil. 6

million bbl/day 20 18 16 14 12 10 8 6 4 2 0 Oil consumption by country, 2011 (BP) 2.86 Figure 5: World's top oil consumers (Source: BP, 2012) At the time of writing, simultaneous increases in domestic and global demand appeared to be eroding the Saudi reserve margin, the spare production capacity it deploys to calm oil market volatility. 8 In April 2012, Saudi Arabia was reported to be producing oil at its highest levels in 30 years, only to be moving some of that production to storage. An investment bank report surmised that the kingdom was storing oil for domestic use during peak summer months, when air conditioning demand requires burning of increasing amounts of crude oil in power generation. The report declared that the kingdom s spare production capacity had shrunk to the point where domestic summer consumption may have otherwise displaced exports. 9 In recent years, summer electricity demand has led the kingdom to import heavy fuel oil feedstock. 10 In Kuwait, domestic burning of crude oil, diesel, and heavy fuel oil is already reducing exports and state income. Fuel consumption in power generation was equivalent to 12% of the country s oil production in 2010. This figure is expected to rise to 21% by 2030. 11 8 Krane, Jim. (2012, April 4) The End of the Saudi Oil Reserve Margin. Wall Street Journal. A13. 9 Kaminska, Isabella. (2012, April 25) Saudi oil puzzle, continued. Financial Times. http://ftalphaville.ft.com/blog/2012/04/25/973651/saudi-oil-puzzle-continued/ 10 Pamuk, Humeyra and Jasmin Choo. (2012, May 3) Analysis: Mideast Fuel Oil Poised for Tight Summer. Reuters. http://www.reuters.com/article/2012/05/03/us-fueloil-mideast-iran-idusbre8420pu20120503 11 Wood, Michael, (27 June 2012), Kuwait Ministry of Electricity and Water, email interview with author. 7

Energy consumption per capita (kg oil equiv) 1.4 Energy intensity Energy is a key input for industrial development. Most countries increase consumption and improve efficiency as they develop. Consumption in the GCC differs from this typical pattern. Energy demand is rising alongside energy intensity. Thus, as the world squeezes more economic growth from each barrel, the GCC countries are moving in the opposite direction. (Fig. 6) Energy exporting countries tend to exhibit higher energy intensities than importing countries. On a per capita basis, most GCC countries, as well as oil and gas exporters Trinidad and Tobago, Canada and Norway consumed more energy than did the United States. Residents of Qatar and the UAE burned more than four times as much as did residents of Japan. (Fig. 7) Differences in levels of development, geography and climate explain some of these differences, as do low prices. 25,000 Energy intensity, GCC in global context, 2007 (World Bank) 20,000 QATAR 15,000 Iceland Trinidad & Tobago 10,000 5,000 0 KSA Kazakhstan Russia Turkmenistan Ukraine China KUWAIT BAHRAIN UAE Brunei Canada USA Finland OMAN Australia Sweden Norway Korea Netherlands Singapore Japan Ireland Switz. Hong Kong Luxembourg $0 $10,000 $20,000 $30,000 $40,000 $50,000 $60,000 $70,000 $80,000 GDP per capita ($2005, PPP) Figure 6:Global energy intensity (Source: World Bank, 2011) 8

QATAR Trinidad & Tobago UAE Singapore Canada KUWAIT Norway SAUDI ARABIA US Belgium Netherlands Australia South Korea Sweden Finland Turkmenistan Russia France Germany Japan UK Israel Kazakhstan Iran Venezuela South Africa Malaysia Argentina China World Chile Turkey Mexico Brazil Azerbaijan Algeria Egypt Ecuador Indonesia India toe per capita 18 16 14 12 10 8 6 4 2 0 Primary energy consumption per capita 2011 (BP) Figure 7: Energy consumption per capita, selected countries (BP, 2012) 1.5 The dichotomy between energy value and price There is a disconnect between energy prices in the GCC and the value of energy to the six national economies. Wanton consumption implies that domestic energy has a low value. Pricing in these countries for instance a liter of gasoline often being cheaper than a liter of bottled water signals to the consumer that energy is a resource that can be wasted. Low pricing encourages consumption at rates above those warranted by the opportunity cost of these fuels on global energy markets. Low prices also distort energy allocation preferences while undercutting upstream investment and efficiency incentives. Each of these factors has contributed to ongoing shortages of natural gas. 12 But the lack of constraints on energy consumption in the GCC is at odds with the near-total dependence of Gulf governments on hydrocarbon export revenues. In 2008, the economic contributions of oil and gas exports provided 39% of collective GDP, 79% of goods exports, and 83% of government revenues. 13 In economic terms, such one-sided dependence should confer a high value on energy resources. 1.6 Domestic consumption and the depletion trajectory Intensity of domestic consumption is a key determinant of the longevity of a country s status as an oil exporter, as Lahn and Stevens (2011) have shown. As domestic consumption outstripped production in China and the United States, for example, these former oil exporters became net importers. Their diversified economies were able to absorb the loss. Oil and gas exporters 12 (Darbouche and Fattouh 2011) 13 National Bank of Kuwait (3 Feb. 2011) GCC Research Note: The GCC hydrocarbon sector: Big and getting bigger. Report. [See: http://tinyurl.com/ccwgajk] 9

Malaysia and Indonesia are reaching this stage. As Chatham House research has shown, both have diversified their economies in preparation for the transition. 14 Oil exporting countries face depletion at varying time horizons, based on the level of production relative to the size of their resources, and the cost of production relative to the commodity s price. As production reaches a plateau, exports tend to drop as domestic consumption rises. This is the typical depletion trajectory of oil exporting countries. Unless an increase in the commodity price makes up for the drop in exports, the producer experiences a decline in export revenues as resources sent abroad are gradually displaced by domestic consumption. As depletion sets in, production and exports are forced downward. When exports drop below domestic consumption, the country becomes a net importer. This trajectory suggests that deriving maximum benefit from natural resources requires careful consideration of domestic use. Encouraging demand through subsidies and underpricing, especially when, as in the Gulf, most consumption does not contribute to productive activity, runs counter to economic logic. Energy economists such as Heal, Mitchell and Stauffer write that converting depletable resource stocks into cash revenues represents a transfer of one type of asset to another; these revenues should not be considered income. Sustainable depletion requires conversion of below-ground assets into new forms of above-ground wealth. Heal and Stauffer argue that oil revenues should not even be reflected in GDP figures, since revenues stem from asset disposal rather than earnings. Heal is especially pessimistic about current spending of resource revenues. He writes that a country becomes poorer by spending resource income for any purpose other than capital investment. 15 By this reckoning, the GCC countries are not maximizing the value of their depleting resource. Much of the Gulf s resource consumption does not even cover cost, let alone create aboveground wealth. Domestic consumption of the GCC s potential hydrocarbon exports is usually done near the cost of production, rather than at global market prices. Instead of providing income, local consumption thus serves to reduce the state s revenue flows, either real or potential. Gulf regimes invest only a portion of their resource revenues in diversification, as the literature advises. Large shares of the rents are deployed by regimes as welfare benefits, delivered to citizens in exchange for political support. The well-documented exchange of oil revenues for 14 (Mitchell and Stevens, Ending Dependence: Hard Choices for Oil-Exporting States 2008) and (Lahn and Stevens 2011) and (Stevens and Mitchell 2008) 15 (Mitchell and Stevens, Ending Dependence: Hard Choices for Oil-Exporting States 2008) and (Mitchell, Economic Background: The Challenges Faced by Petroleum-Dependent Economies 2006) and (Stauffer 1987) and (Heal 2007). Also see World Bank (2006) Where is the wealth of nations? for procedures on accounting for depleted natural resources. 10

political quiescence has been practiced by Gulf ruling families since the onset of oil exports in the 1930s, and particularly after the windfalls from the 1970s oil boom. Distribution of oil rents allowed ruling families to undercut power of competing groups and maintain power long after neighboring monarchies were swept aside: Egypt in 1952, Iraq in 1958, Yemen in 1962, Libya in 1969, and Iran in 1979. Bueno de Mesquita and Smith (2010) argue that the structure of government finances impacts policy choices and the survival of small coalition regimes, such as monarchies. In particular, oil rents increase leaders ability to survive by allowing them to distribute private goods to supporters even as they engage in otherwise economically counterproductive policy, such as restricting political freedoms and institutions such as the press and judiciary. 16 Domestic cannibalization of Gulf energy resources, therefore, not only poses a threat to national economies, but also to the longevity of these monarchies. 17 Outside the literature, aggregated results of an expert elicitation exercise conducted for this paper found that experts broadly consider current levels of domestic consumption a threat to GCC economies other than Qatar. 18 1.7 Section 1 Summary In summary, growing energy consumption in the Gulf producer countries is: - Contributing to waste and economic inefficiency; - Restricting or threatening to restrict exports; - Not contributing to economic diversification or industrialization to the extent possible; and - Potentially undermining the longevity of Gulf monarchies. This paper now turns to focus on the GCC electricity sector and its role in the regional energy balance, particularly in natural gas consumption. Section 2: Electricity Policy: Power Generation, Fuel Mix and Prices 2.1 Growth of electricity generation and consumption in the GCC The arrival of electricity in the Arabian Peninsula is a relatively recent development, coming within the lifetimes of many residents. Much of the region was un-electrified as late as 1960; in some areas even later. Abu Dhabi only received municipal power in 1968. Electrification in Oman did not begin in earnest until the 1970s. Since then, growth in power generation has been dramatic, especially in the richer states of Kuwait, Qatar and the UAE, which now 16 (Bueno de Mesquita and Smith 2010) 17 Many of these issues are explored in depth in Chatham House s Project on the Good Governance of the National Petroleum Sector. See: http://www.chathamhouse.org/research/eedp/current-projects/good-governancenational-petroleum-sector 18 Initial results of survey of 82 experts conducted by author. 11

consume more electricity on a per-capita basis than the United States. Aggregate (unweighted) power generation growth averaged 7% per year between 2000 and 2010, slightly faster than average (unweighted) GDP growth in the region at 6.5% per year. Avg. yearly GDP growth (1999-2008) Bahrain 6.1% 7% Kuwait 5.8% 5.1% Oman 4.8% 6.3% Qatar 13.5% 9.3% KSA 3.3% 5.6% UAE 6.3% 9% Source: IEA, IMF Table 2: GCC GDP vs power generation growth Avg. yearly power gen growth (1999-2008) Overall electricity production in the GCC nearly doubled from 238 terawatt-hours (TWh) in 2001 to reach 462 TWh in 2011, nearing that of Brazil (501 TWh) and surpassing the United Kingdom (365 TWh). 19 In all but Qatar, growth in electricity demand has outstripped domestic supply of natural gas, the most common generating feedstock in the GCC. This shortage heralds an important shift in the Gulf power generation paradigm. In the past, governments had to cope with the cost of building power plants, while feedstock came from cheap and plentiful domestic sources. Now, regimes must cope with the higher cost of importing feedstock at global market prices. Or, if they choose to maintain domestic self-sufficiency, they face the opportunity cost of burning liquid fuel, or the high production costs of developing unconventional gas. The rising costs of electricity generation are not, for the most part, offset by rising end-user prices. Most electricity and water prices in the GCC, as well as that of retail fuels, are subsidized and fixed at some of the lowest levels on earth. As feedstock shortages emerged in 2008, power demand began to be described as an economic threat. 20 However, other industrializing economies experienced more intense demand growth. (Table 3) During their boom phases, Korea, Japan and China outpaced the GCC s recent growth. In industrializing East Asia, rising power generation appears to have been understood as a necessary input to economic growth. The difference in perception in the Gulf stems from the residential sector s domination of electricity demand. Thus power consumption is seen as undermining rather than bolstering growth. 19 Power production figures for the GCC are from International Energy Agency (2011): Electricity information (Edition: 2011). ESDS International, University of Manchester. Figures for Brazil and UK from BP, 2012. 20 (Moody's Investors Service 2008) and (International Energy Agency 2008) 12

1971 1974 1977 1980 1983 1986 1989 1992 1995 1998 2001 2004 2007 GWh Avg. yearly Avg. yearly power GDP growth generation growth GCC 2000-2010 6.5% 7% Korea 1972-2000 7.4% 12% Japan 1960-1970 9.4% 11.5% China 1998-2008 10% 11% Source: IMF, IEA Table 3: GDP vs power generation growth, selected boom periods 2.2 The GCC power generation fuel mix In 2009, power generation consumed about a third of all gas produced in the GCC, (3,000 bcf of the total 9,500 bcf), which accounted for 61% of aggregate power generation in the Gulf, versus 39% for liquid fuels. Removing Qatar, power generation consumes 44% of gas production. 21 Saudi Arabia, Kuwait and Oman also consume significant amounts of liquid fuels. In 2009 55% of Saudi power was derived from liquid fuel-based generation, as was 71% in Kuwait and 18% in Oman, where (as in Saudi Arabia) diesel generation is still used to provide electricity in rural areas away from the main transmission grids. 60% 50% 40% 30% 20% 10% 0% Proportion of natural gas production used in power generation 2009 (IEA) 400,000 350,000 300,000 250,000 200,000 150,000 100,000 50,000 0 GCC power output by fuel (IEA) Total Gas Liquids Figure 8: Proportion of gas used in power sector Figure 9: GCC electricity generation and fuel used 2.3 Electricity Prices 2.3.1 Historical basis for low electricity prices GCC residents enjoy some of the world s lowest electricity prices. While pricing is behind some of today s distortions in demand, the situation was far different when prices were set. Associated gas was considered a nuisance and flared off until the 1970s and 80s, when 21 IEA (2011). Natural Gas information (Edition: 2011). ESDS International, University of Manchester. 13

investments were made into diverting it for power generation. 22 Logic dictated that, if stranded gas could produce power, the price for that electricity ought to reflect the near-zero domestic value of the gas. Electricity tariffs need only cover capital costs of generation, transmission and distribution infrastructure, and the associated operation and maintenance costs. Since there were few export prospects, gas was used to develop these lightly populated states, providing improvements in lifestyle while shoring up the political legitimacy of ruling families. Once fixed, electricity tariffs that might have covered costs in the 1970s or 80s have stagnated. Kuwait s price of 2 fils (0.7 US cents) per kilowatt-hour has been fixed since 1962, a year after independence. Nowhere in the GCC were tariffs indexed to inflation. Electricity has thus grown cheaper in real terms, year by year. Low pricing contributed to path dependency on high consumption, encouraging big homes, preferences for cool ambient temperatures, and luxuries like artificially chilled swimming pools and gardens irrigated by desalinated water. Even so, governments left tariffs untouched, since as recently as the mid-2000s these (by then) subsidized prices were seen as a convenient way to distribute oil rents and maintain legitimacy of ruling families. Cheap tariffs have contributed to social expectations for welfare benefits, even becoming regarded as rights of citizenship, according to public survey responses gathered for this paper. Many respondents said subsidized power represented their share of national resource wealth and said they would be unable to afford the full cost of their consumption. 23 2.3.2 Political rationale for pricing priority to citizen residential sector By the mid-2000s, as population and consumption growth exerted pressure on gas supplies, governments began raising tariffs on customers deemed less politically central to ruling family legitimacy. These include industrial and commercial customers in Saudi Arabia, the UAE and Qatar. In Qatar and the UAE, where expatriate residents far outnumber citizens, policymakers also reduced or eliminated subsidies given to foreigners. Low tariffs for citizens were deemed a crucial endowment within the paternalistic relationship between ruling sheikhs and their subjects. Expatriate residents were more likely to see low pricing as a windfall, rather than a gift from the ruler. Thus tariffs were separated into citizen and non-citizen rates. In each of the four tariff regions of the UAE, non-citizen prices were raised to triple the level of citizens. In Qatar, citizens continued to receive free power, while foreign residents were charged 2.5 US cents per kilowatt-hour. (Fig. 10) 22 Aramco World Magazine. Foundations: The Keystone. Vol. 33 No. 6. Nov/Dec 1982. Accessed Aug. 24 2012 at: http://www.saudiaramcoworld.com/issue/198206/foundations-the.keystone.htm 23 Public survey of 800+ GCC nationals conducted for the author by YouGov. Details forthcoming. 14

US cents per kwh $0.14 $0.12 Retail electricity prices in GCC vs USA 2011 (Utility sources, EIA) $0.10 $0.08 $0.06 $0.04 $0.02 $0.00 KSA Kuwait Oman Bahrain Qatar Abu Dhabi Dubai Sharjah Northern UAE USA Nationals-Residential Foreigners-Residential Industrial Commercial Figure 10: Electricity prices in comparison across sectors and countries (Source: Utilities, EIA) Split tariffs offer an opportunity to examine consumption levels at differing prices in the same environment. While data that separates citizen versus expatriate electricity consumption is not usually available, Abu Dhabi released this data in 2008. The chart below shows that citizen households consumed nearly three times more power than expatriate households, and six times more than U.S. households. Despite huge differences in consumption, average yearly bills were nearly equal. Customer Avg. consumption (kwh) Tariff per kwh Avg. yearly bill Abu Dhabi nationals 71,000 (2006) 1.4 US cents $ 967 Abu Dhabi expatriates 26,500 (2006) 4 US cents $ 1,082 U.S residents 11,500 (2010) 11.8 US cents $ 1,357 Source: RSB, World Bank, EIA (consumption is per household) Table 4: Electricity consumption and pricing, Abu Dhabi vs USA Caution must be taken when making inferences from these figures. Citizens in Abu Dhabi generally enjoy high incomes, live in large houses (as opposed to the apartments favored by expatriates) and support large households. In Kuwait, where citizens and foreigners pay the same rate (0.7 US cents per kwh), Kuwaiti households tend to consume roughly four times the electricity and water of expatriate residents, for similar reasons. 24 24 Wood interview (2012) 15

Residential share (%) 2.4 Electricity consumption by sector One of the consequences of policies that reserve the cheapest electricity for residential customers has been that sector s rise to dominance. In all but Qatar the residential sector is the largest consumer of electric power. In Kuwait, Saudi Arabia, Oman and Bahrain, more than 50% of national power consumption accrued in the residential sector in 2009. In the UAE, homes were responsible for 43%, the largest sector overall, higher than industrial or commercial sectors. 25 Fig. 11 details the relative dominance of the GCC residential electricity sectors compared with oil exporters and importing countries. 70 60 Residential share of total electricity consumption 2008 (IEA) 50 40 30 20 10 0 Figure 11: Residential electricity consumption as a share of total, selected countries (Source: IEA, 2011) 2.4.1 Issues created by residential consumption Residential overconsumption poses two policy problems for governments. First, electricity provision is a drag on the economy rather than an input for productive activity. In peak months, most power is consumed as ambient air conditioning. Subsidies mean that each additional kwh delivered increases governments fiscal burdens. Second, this consumption represents a political challenge. The residential sector is the most difficult to reform, because it represents a key component of the social contract. Cheap electricity is a welfare benefit that is exchanged for social peace. Taking it away according to theory represents a risky reneging on the ruling bargain. The difficulty in reforming residential demand is apparent in Oman s recent announcement of cost-reflective tariffs. Electricity tariffs for commercial and industrial customers, already at the upper end of those in the Gulf, are set to rise from current levels of between 3 and 6 U.S. cents (12-24 Omani baiza) per kwh to cost-reflective levels, which increase during peak months and 25 IEA, 2011. 16

peak times of day. The intent is to reduce Oman s recent 10% yearly increases in electricity demand, which claim an ever-larger share of the sultanate s depleting natural gas resources and the government s subsidy load. However, the cost-reflective tariff scheme bypasses the residential sector, which is unaffected by the new rates. 26 An Oman electricity official interviewed for this paper said that it was likely that some residential tariffs would be raised in the future, especially for consumption deemed excessive, but that the government had a duty to protect low-income customers. He said the Arab Spring uprisings, which included virulent demonstrations in Oman in early 2011, increased government sensitivity to potentially unpopular measures. 27 Among the nine tariff-setting entities in the GCC, only Dubai has raised prices on citizens residential consumption in the last decade. In 2011, the emirate raised all electricity prices by 15% and imposed a surcharge that passes along LNG import costs. 2.5 GCC Fossil Fuel subsidies in global comparison In per capita terms, the GCC countries lead the world in fossil fuel subsidies. (Fig. 12) 28 Discounted electricity accounted for a large portion. In 2009, underpriced electricity made up more than a third of the fossil fuel subsidy in Saudi Arabia and Qatar, 40% of that in the UAE, and 54% of that in Kuwait. In total cost terms, Saudi Arabia s $35bn subsidy made it the No. 2 fossil fuel subsidizer in the world, behind Iran. (Fig. 13) However, Iran eliminated many energy subsidies in 2010 and recast them as cash payments to families. In future rankings, Saudi Arabia may assume the world No. 1 position. 26 (Authority for Electricity Regulation of Oman 2009) 27 John Cunneen, Executive Director of the Authority for Electricity Regulation, Oman, author interview, Nov. 15, 2011, Muscat. 28 Note that Oman and Bahrain are omitted from the IEA s analysis 17

Kuwait UAE Qatar Saudi Arabia Iran Turkmenistan Venezuela Libya Uzbekistan Iraq Algeria Russia Kazakhstan Ecuador Egypt Malaysia Ukraine Argentina Thailand Azerbaijan Iran Saudi Arabia Russia India China Egypt Venezuela Indonesia UAE Uzbekistan Iraq Kuwait Pakistan Argentina Ukraine Algeria Malaysia Thailand Bangladesh Mexico Turkmenistan South Africa Qatar $3,000 $2,500 $2,000 $1,500 $1,000 $500 $0 Per capita fossil fuel subsidies, US$ 2009 (IEA) $70 $60 $50 $40 $30 $20 $10 $0 Fossil Fuel Subsidies by country and type, US$bn, 2009 (IEA) Oil Gas Coal Electricity Figure 12: Fossil fuel subsidy rankings on per capita basis (Source: IEA, 2011) Figure 13: Fossil fuel subsidy rankings by country, total cost basis (IEA, 2011) 2.6 Section 2 Summary In summary, 40 years of rising electricity consumption has been exacerbated by an historic undervaluation of domestic natural gas, as well as patrimonial politics that procure monarchical legitimacy through redistribution. The combination of these attributes manifests itself today in the world s largest per-capita fossil fuel subsidies, which continue to distort the outsized demand for energy in the Gulf. To date, GCC regimes have managed to keep pace with demand for electricity, water and fuel (with a few exceptions, such as the UAE s northern emirates) despite the expense involved in increasing generating capacity, and extensive evidence of wasteful consumption. The Gulf Arab states have launched few efforts to reduce demand in the politically sensitive residential sector, the largest overall electricity consumer. Section 3: Natural Gas: Production, Price and Projected Shortfalls The political structures driving electricity demand are paradoxically contributing to underinvestment in domestic natural gas production, despite predictions that gas will grow ever more prominent in the GCC power generation mix. The marginal costs of producing or importing that feedstock are expected to rise. 18

3.1 Disincentives for domestic gas production The Persian Gulf region is one of the most gas-rich places on earth, holding more than a third of the world s proven conventional gas reserves. 29 (Table 5) But several factors conspire to stop production meeting demand. Most current gas production stems from associated gas yielded in tandem with oil, production of which is governed by OPEC quota. Unassociated gas reserves in the five gas-short states tend toward the geologically difficult: very deep formations, rockbound tight gas, highly sulfuric sour gas, or a combination. Given the technological challenges, production costs run between $3 and $9 per MMBtu. 30 Such costs render investment commercially unviable in countries with bulk gas pricing capped under $2. In the UAE, inexpensive imports from Qatar, priced below production costs of unassociated gas in the UAE, have further dampened appetite for investment. And, since any gas produced tends to be restricted to domestic customers, the typical incentive for IOC investment a profitable netback is eliminated. Natural gas reserves of the Gulf and Arabian Peninsula Size (Tcm) Share of world total Bahrain 0.3 0.2% Iran 33.1 15.9% Iraq 3.6 1.7% Kuwait 1.8 0.9% Oman 0.9 0.5% Qatar 25.0 12.0% Saudi Arabia 8.2 3.9% UAE 6.1 2.9% Yemen 0.5 0.2% GCC total 46.0 20.3% Region total 79.5 38.2% World total 208.4 100% Source: BP 2012 Table 5: Gas reserves in the region 3.2 Gas trading in the Gulf region Unmet demand in the five gas-short countries suggests that pipeline imports from gas-rich neighbors, especially Qatar and Iran, would be attractive. But the Persian Gulf region is underserved by cross-border gas pipelines. The only operating international pipeline serving the GCC at the time of writing was the Dolphin Pipeline, with a capacity of 33 bcm/year. In 2011, it operated at about two-thirds capacity, carrying 17.25 bcm from Qatar s North Field to the UAE emirates of Abu Dhabi and Dubai, and a further 1.95 bcm to Oman. Across the Gulf, Iran has also become a net gas importer in recent years. In 2011, Iran s imports from Turkmenistan and Azerbaijan outweighed its 8.35 bcm of exports to Turkey. (Tables 7 and 8) The failure of several pipeline proposals has curtailed supply, particularly in Kuwait and the UAE. (Table 6) In the UAE s case, privately owned Crescent Petroleum built an undersea pipeline from its Sharjah base to an offshore receiving platform on the Iranian side of the Gulf. Crescent s pipeline was to have delivered up to 5.2 bcm/year of Iranian gas, but it has been 29 (BP 2012) 30 Gulf-based IOC executive, interview with author on condition of anonymity, Nov. 15, 2011. 19

sitting empty since 2006. 31 Iranian political opposition to an agreed export price below $1/MMBtu is said to be behind the cancellation. 32 Saudi Arabia blocked a proposed pipeline from Qatar to Kuwait in 2005 which was to have crossed its maritime boundary. Unable to source sufficient gas via pipeline, Kuwait and the UAE have resorted to importing LNG including from nearby Qatar an inefficient alternative given the reserves within pipeline distance. Failed gas pipeline projects in the Gulf region Year launched Gas source Importing countries Reason for failure Source GCC gas grid 1988 Qatar KSA, Kuwait, Bahrain, UAE Crescent Petroleum 2001 Iran UAE (Sharjah) Pricing disagreement. Contract pipeline nullified by Iran after pipeline built Peace Pipeline 1995 Qatar Israel Approval depended on peace settlement between Israel and Palestinians GCC pipeline to 1995 and Qatar Pakistan, India, via Pricing disagreement, competing Pakistan and India 2000 Oman pipeline proposals Dolphin Pipeline 2005 Qatar Kuwait Saudi refusal to grant access to extension to Kuwait territorial waters Table 6: GCC gas pipeline proposals that failed Political and territorial disputes Dargin, 2008 Jafar, 2012; Carlisle, 2010; Adibi and Fesheraki, 2011 Dargin, 2008 Jafar, 2012; and Dargin, 2008 Dargin, 2008 Regional gas trade by pipeline 2011, bcm (BP) To From From From Total imports Azerbaijan: Turkmenistan: Qatar: Iran 0.39 10.20-10.59 Oman - - 1.95 1.95 UAE - - 17.25 17.25 totals 0.39 10.20 19.20 29.79 Table 7: Gas trade by pipeline in the region (BP, 2012) GCC LNG imports and sources 2011, in bcm (BP) To Trinidad & Spain Qatar UAE Egypt Nigeria Australia Malaysia Total Tobago (re-export) (Abu Dhabi) imports Kuwait - 0.08 1.52 0.05 0.07 0.80 0.26 0.39 3.18 UAE (Dubai) 0.25-0.92 - - 0.09 0.08 0.08 1.43 totals 0.25 0.08 2.45 0.05 0.07 0.89 0.34 0.48 4.60 Table 8: GCC LNG imports and source countries (BP, 2012) 31 Jafar, B. (2012) interview with author. See also: (Carlisle 2010) 32 (Adibi and Fesheraki 2011) 20