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Venezuela – Economic Crisis Strikes Consumers and Companies

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Venezuela, a country considered as a role model economy for other Latin American countries a few decades ago, has now fallen into deep economic, social, and political crisis that seems to never end. Venezuela’s economy, highly dependent on oil exports, witnessed a steep decline when global oil prices dropped dramatically during 2014-2017, followed by the government ill-treating national funds, and a massive reduction in import of goods. Under this scenario, several multinational companies, such as PepsiCo, Palmolive, and Coca Cola, chose to reduce or temporarily cease production in the country, which has led to increased unemployment. As a result, many Venezuelans started to flee the country in search for a better life quality, while those who chose to stay face low salaries, hyperinflation, empty supermarket shelves, and increasing violence as political turmoil is deepening amid opposition and criticism of the current government of Nicolas Maduro.

The root of the problem

Venezuela’s deep social and economic crisis is driven mainly by mismanagement of national funds and lack of investment in industries of national importance. For several years, the Venezuela’s government-established projects involved providing social aid for households with low income, and these programs were supported by revenue generated through oil exports. Therefore, as gas and oil sector revenue accounts for 25% of the country’s GPD, a steep plunge in global oil prices from US$85 in 2014 to US$36 in 2016 deeply affected Venezuela’s social projects turning them unsustainable.

Venezuela’s deep social and economic crisis is driven mainly by mismanagement of national funds and lack of investment in industries of national importance.

In addition, Venezuela did not invest in its oil industry, one of the main pillars of the country’s economy. Petróleos de Venezuela S.A. (PVDSA) the Venezuelan state-owned oil and natural gas company has witnessed limited investment, causing Venezuela’s crude oil production to decline from 2.7 million barrels per day in 2014 to two million in 2017, expected to further crumble to 1.4 million barrels per day in 2018. This also translated into a decrease in oil exports revenue by 64% during 2010-2015, deepening scarcity of funds and progressing economic instability in the country.

Venezuela - Economic Crisis Strikes Consumers and Companies

Plummeting imports in import-dependent economy

Venezuela has been highly dependent on imported goods and raw materials such as food staples and medicines, among other goods. After the fall in oil prices and decrease of crude oil production, Venezuela redirected a large percentage of the remaining revenue from oil export to repay foreign debt, drastically reducing import volume of goods. As a result, imports severely dropped from US$58.7 billion in 2012 to US$18 billion in 2016, leaving the country with shortage of wide range of goods, including pharmaceuticals, sugar, corn, wheat, etc.

Soaring inflation and unemployment

In addition, Venezuela established strict price control regulations as a way to counterbalance hyperinflation, which directly hindered production of goods by multinational companies. Consequently, several key market players reduced or partially stopped operations in the country as a way to avoid losing profits. In February 2018, Colgate Palmolive, a US-based consumer goods company, stopped production for a week after the government demanded that the company reduces the price of its products, which resulted in a large loss in profit for the company. Subsequently, the reduction of multinationals’ operations in Venezuela greatly increased the unemployment rate to 30% as of 2018, causing Venezuelans to opt for unreported employment or to flee the country looking for job opportunities. It is estimated that between one to two million Venezuelans will have migrated by the end of 2018.

EOS Perspective

Throughout 2017, the ministry of urban farming encouraged people to grow food, e.g. tomatoes and lettuce, at their homes and to start eating rabbits as a way to prevent starvation as a result of massive shortage of basic goods. Meanwhile, as a way to ease the situation, Venezuelan authorities sell a monthly bag containing corn flour, beans, rice, pasta, dried milk, and some canned foods at VE$25,000 – this is less than a dollar. These bags with food are distributed only among people registered in the communal councils and those who possess a Carnet de la Patria, a home registry system in order to receive the food. Additionally, president Maduro decided to open 3,000 popular meal centers as part of a nutritional recovery scheme seeking to feed hungry Venezuelans. However, none of these measures have clearly had enough impact to aid in the difficult situation amid the deepening crisis in Venezuela.

Migration to neighboring countries in Latin America has been the way many Venezuelans have found to escape the crisis. Argentina, Chile, and Colombia, among other Latin America countries, have received over 629,000 Venezuelans in 2017 alone, which is 544,000 more Venezuelans than in 2015. The mere number of fleeing people indicates the scale of the issue, yet the socialist administration of Nicolas Maduro refused to accept any help, aggravating the already strained political relationships with his Latin American counterparts. Further, Venezuela also refused to accept any aid from international institutions such as the WHO, which would help as a short-term solution or at least a relief for starving Venezuelans.

Moreover, Venezuela seems to be continuing to drown, as South American trade bloc Mercosur – one of the most important commercial blocs in the region, suspended Venezuela’s membership indefinitely in 2017. Such a measure translates into further reduction of imports into Venezuela from the bloc and, potentially, Venezuelans banned from legally migrating to any of the countries from the Mercosur bloc. So far, South American countries have welcomed waves of Venezuelans, but the dormant prohibition could negatively affect a considerable volume of the population seeking to flee from the crisis.

Venezuela seems to be continuing to drown, as Mercosur suspended Venezuela’s membership indefinitely in 2017. Such a measure translates into further reduction of imports by Venezuela from the bloc.

In addition, the USA issued an executive order banning any American financial institution from investing in Venezuela, that same year, which restricted the inflow of capital and increased the financial isolation of Venezuela from the North American markets.

This dramatic situation, both in Venezuela’s domestic as well as international arena, calls for president Maduro to reevaluate and encourage reforms that should empower small domestic producers, e.g. coffee makers, agricultural producers, among others, in order to reactivate internal consumption and counterbalance shortage of food and other supplies. Further, it is high time that the country’s leadership opens their borders to external help, however this seems unlikely to happen, considering that this would mean an acknowledgment that the socialist political management of the country has failed, and this in turn would play into Maduro’s opposition’s hands to easily overturn his government.

by EOS Intelligence EOS Intelligence No Comments

OBOR – What’s in Store for Multinational Companies?

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One Belt One Road (OBOR) Initiative, also known as Belt and Road Initiative (BRI), is part of China’s development strategy to improve its trade relations with countries in Asia, Europe, the Middle East, and Africa. OBOR envisions to not just bring economic benefits to China but to also help other participating countries by integrating their development strategies along the way. It has the potential to be one of the most successful economic development initiatives globally. Opportunities are countless for investment along this route. Multinational companies are looking to make the most out of this project, however, capitalizing on this opportunity will not be easy. To benefit from this initiative, companies need to understand that assiduous research and effective long-term planning is crucial, as the nations involved, though offer economic growth, will also present a series of geopolitical risks and challenges.

Chinese President Xi Jinping unveiled OBOR in 2013, aiming to improve relations and create new links and business opportunities between China and 64 other countries included in the OBOR. The initiative has two main segments: The Silk Road Economic Belt (SREB), a land route designed to connect China with Central Asia, Eastern and Western Europe, and the 21st-Century Maritime Silk Road (MSR), a sea route that runs west from China’s east coast to Europe through the South China Sea and the Indian Ocean, and east to the South Pacific. These two routes will form six economic corridors as the framework of the initiative outside China – New Eurasian Land Bridge, China-Mongolia-Russia Corridor, China-Central Asia-West Asia Corridor, China-Indochina Peninsula Corridor, China-Pakistan Corridor, and Bangladesh-China-India-Myanmar Corridor.

OBOR brings opportunities and challenges

Multinational companies will have a plethora of opportunities to explore along these economic corridors – for instance, trading companies can take advantage of these routes for logistics, while energy companies can use these corridors as gateways for exploring new sites of natural resources such as oil and natural gas. Along with dedicated routes, OBOR will require huge investment which is proposed to come from three infrastructure financing institutions set up as a part of this initiative – Asian Infrastructure Investment Bank (AIIB), The Silk Road Fund (SRF), and The New Development Bank (NDB).

The development of OBOR opens up a range of opportunities for overseas businesses. However, with the initiative being launched by the Chinese government and all the six corridors running across the country, it is clear that China will play a major role in most of the business collaborations. Thus, multinational companies investing in OBOR can prefer to partner with Chinese companies and leverage the partnership to access projects and assignments in other countries. Companies are also likely to be able to access new routes to sell products cheaply and efficiently, but looking for opportunities across OBOR would definitely involve initial partnerships between multinationals and Chinese state-owned enterprises.

OBOR – What’s in Store for Multinational Companies

Oil, gas, coal, and electricity

OBOR has the potential to open up opportunities for collaboration in the areas of oil, gas, coal, and electricity. Several energy opportunities may emerge with the OBOR initiative, and these energy-related investment projects are likely to be an important part of OBOR. For instance, the Gwadar-Nawabshal LNG Terminal and Pipeline in Pakistan includes building an LNG terminal in the Balochistan province and a gas pipeline between Iran and central Pakistan. Estimated at a total value of US$46 billion, the project was announced in October 2015 along the China-Pakistan Economic Corridor.

Energy projects along OBOR include initiatives largely by Chinese companies due to funds coming in from China-led financial institutions. In another investment, General Electric, an American corporation, signed a pact with China National Machinery Industry Corporation (Sinomach), in 2015, to offer project contracting (for supply of machinery and hardware tools) for developing a 102-MW Kipeto wind project in Kenya. The project aims to set up 2,036 MW of installed capacity from wind power by 2030. Kipeto wind project was originally a part of US president Barack Obama’s ‘Power Africa’ initiative, but with Sinomach joining in hands, it is clear that more initiatives like this can be expected to come up in the near future as a part of OBOR.

Logistics

Players in the logistics industry can also benefit from the improved infrastructure along the OBOR. In 2015, DHL Global Forwarding, providing air and ocean freight forwarding services, started its first service on the southern rail corridor between China and Turkey, a critical segment of China’s OBOR initiative. This rail corridor is expected to strengthen Turkey’s trading businesses along with benefiting transport and freight industries of Kazakhstan, Azerbaijan, and Georgia. Logistics companies can also initially partner with local postal or freight agencies to set up new business in these regions. OBOR can provide fast, cost-effective, and high-frequency connections between countries along the route. Improved infrastructure, reduced logistics costs, and better transport infrastructure will also contribute to driving e-commerce businesses in the regions.

Tourism

Tourism is expected to also see a major boost as a result of OBOR initiative. As connectivity between countries improve and new locations become easily accessible, the tourism industry is expected to see positive growth in the coming years. To support tourism, Evergreen Offshore Inc., a Hong Kong-based private equity firm, in 2016, launched a US$1.28 billion tourism-focused private equity fund called Asia Pacific One Belt One Road Tourism Industry Fund to boost relations between China and Malaysia by investing in tourism sector. The company invested in Malaysia as the country is considered an ideal investment destination for a long-term gain. This is in sync with the long term vision of OBOR to promote tourism sector in countries and regions along the MSR.

As OBOR develops, new markets along the routes are likely to open to business. The already existing routes will experience business diversification as infrastructure and connectivity improves. Trade barriers will most likely reduce as developing countries become more open to international investment which brings new jobs, better infrastructure, economic growth, and improved quality of life. There is bound to be growth in consulting business, professional services, and industrial sectors apart from trade and logistics.

EOS Perspective

While OBOR initiative assures opportunities for multinational companies, the path may not be smooth for all. Investing in these new geographies, companies will come across various economies with different legal and regulatory frameworks. Political stability is also a matter of concern – some regions may have sound political structures while others may be dealing with ineffective government policies. In fact, political instability and violence are some of the key challenges in the development of OBOR. Weak government policies and lack of communal benefit lead to political instability including terrorism and riots. These factors influence the availability of resources, negatively impact the setting up of businesses locally, thus resulting in financial losses for multinationals. Local investments need policies and investment protection backed by the governments to facilitate growth which is far more difficult to achieve in case of political and economic instability. Taking advantage of the opportunities associated with OBOR may be of strategic importance, but the companies need to be cautious about the obstacles associated with it.

While OBOR initiative assures opportunities for multinational companies, the path may not be smooth for all. Political instability and violence are some of the key challenges in the development of OBOR.

Local competitors will also present obstacles to multinational firms. The competition is stiff for international players as local companies can operate better in riskier environment at low operating costs. Not only will regional companies pose a threat for survival of multinationals, in many scenarios, partnering with Chinese companies will also be a massive challenge. Many Chinese companies do not implement a clear structure while partnering with other international companies. Decision making and profit sharing is often not properly documented. Lack of clarity in business dealings give these state-owned enterprises an upper hand.

Complexity and lack of transparency in local regulatory framework for setting up a new business is also a hindrance for investments in many geographies along the OBOR. Absence of clear policies and delays in decision-making processes can prove too challenging for companies to adapt to which may even lead to financial losses or failed attempts to establish local operations. Issues such as corruption, challenges associated with supply chain security, and financial risks are some of the other obstacles that companies are likely to face while setting up businesses in new countries along the OBOR route.

Complexity and lack of transparency in local regulatory framework are a hindrance for investments in many geographies along the OBOR.

OBOR is still in the initial years of implementation. The initiative offers great potential for developing regions in need for improved infrastructure and economic growth but what this really means for multinational companies is still somewhat unclear. It encourages participation from international companies to turn the initiative a success, but there are no clear guidelines on how these investments would be integrated into the OBOR. With a major part of investment coming from China-based institutions, dominance of Chinese companies in major projects cannot be avoided. While the underlying aim of the initiative is to reduce China’s industrial overcapacity and to strengthen its economy, there are concerns about the part being played by multinational companies. To what extent would they participate, who would be the main investor (Chinese company or multinational companies), and how much share and what say would the multinational company have in a project, etc., are some of the questions that still remain unanswered.

With major part of investment coming from China-based institutions, dominance of Chinese companies in major projects cannot be avoided.

In view of these risks and challenges, we believe it is too early to estimate the scale of potential monetary benefits for companies wanting to invest along the OBOR route to expand their businesses. It will surely not be easy for multinational companies to compete for benefits from OBOR in an environment heavily dominated by Chinese companies. Developing business policies and financing schemes through related institutions can help the multinational firms to benefit from this initiative in the long run. There is no doubt that OBOR has the potential to open new markets for doing business by redrawing the global trade map, however, with no clarity and transparency on the role MNC’s as part of OBOR initiative, companies need to correctly identify the best opportunity by accessing the right market and find effective ways to mitigate a wide range of associated risks. For now, the future role of MNC’s in this environment is uncertain. They will have to wait and watch to work out a stable business arrangement. But in current times of global geopolitical turbulence, such a harmony is never guaranteed.

by EOS Intelligence EOS Intelligence No Comments

A Close Look at Iran’s Post-Sanctions Growth Story

Iran’s emergence from economic isolation in 2016 was considered by many industry experts as the largest market opportunity since the fall of the Union of Soviet Socialist Republics (USSR), paving way for plethora of new business opportunities. They expected massive influx of foreign direct investments (FDI) and a rapid economic growth in the country. As a result, many business delegations traveled from all over the world to Iran, hoping to tap its lucrative industry opportunities. Over a year later, we take a close look at Iran’s progress so far and whether it has truly leveraged its growth potential.

At first glance, multinationals saw the lifting of sanctions as the opening up of paths for foreign investments and international trade in crucial sectors such as oil and gas, automotive, aviation, mining, tourism, and financial services. In addition, Iranian president Rouhani’s long-term political vision with its focus on various domestic structural reforms and the stance on improving relations with the West were viewed by the international business communities as promising signs. Iran achieved 6.6% GDP growth during 2016-2017 as well as a drastic decline in annual inflation to 8.9% from nearly 40% during 2013.

Despite the economic growth achieved, a closer look at the ground realities in the country depicts a different picture, especially when comparing the expectations and the country’s actual achievements so far. The growth achieved in 2016 was largely due to the oil sector’s rebound in both production and exports. Growth in non-oil sectors was mere 0.9% during the first half of 2016. In the same year, unemployment rate also increased to 12.8% from 11% in 2015. There are still serious questions about the country’s ability to sustain its economic stability in the long run. To add fuel to the fire, Iran’s ballistic missile testing and accusations of sponsoring terrorism in the region have brought the nuclear deal again in jeopardy, eroding newly-regained investor confidence.

Although the FDI saw a massive 600% increase in 2016, it is still nowhere near the government’s projections. While several MoUs were signed, not many have converted into actual deals till date. It was realized soon by many that Iran still remains a challenging place for multinationals to conduct business due to high levels of state interruption, bureaucratic bottlenecks, lack of transparency, and outdated business and financial systems. Iran still continues to be isolated from the global financial systems. Majority of international banks are reluctant to re-engage in Iranian transactions mainly due to potential links with terrorism they might be implicated in and massive financial repercussions such transactions could entail. Therefore, investors are holding their horses amid current ambiguity over local and global political developments (Trump’s final stance on nuclear deal as well as President Rouhani’s reforms post elections).

Automotive

The automotive sector is Iran’s second largest industry after oil and gas, contributing around 10% of the GDP. Iran Khodro Company (IKCO) and SAIPA, the two major companies (state funded), have long benefitted from monopoly and protectionist policies, and therefore are reluctant to innovate. Currently, Iranian cars are considered to be of inferior quality mainly due to lack of technological innovation and outdated production platforms. The industry also suffers from price controls, unfavorable import tariffs, and other state interventions.

Since the lifting of sanctions, many expected car prices to decline and FDI to increase, both of which have not materialized quite yet due to the overall financial and political hurdles the country currently faces. Despite 19 MoUs already signed by global automakers, only few have progressed so far. With the new reforms pertaining to local content and export requirements, and the government’s ambitious plan to boost domestic production from 1.6 million cars at present to 3 million cars by 2025, the automotive industry presents a lucrative opportunity for foreign investors. Vehicle sales are projected to grow at a CAGR of 13% by 2020. Joint ventures with foreign automakers and deregulation are the top priorities for the government to unleash the industry potential.

Aviation

Due to the years of economic isolation, Iran’s aviation industry has failed to stay abreast with the latest industry developments, which we discussed in detail in our article New Wings to Fly – Post-Sanction Scenario of Iran’s Aviation Industry in April 2016. The sanctions restricted Iran to procure new planes as well as any maintenance or repair services for its existing fleet. As a result, the nation remains inherited with an outdated fleet that requires immediate modernization. Iran requires nearly US$220 billion in investment to uplift its aviation industry. Besides investments, Iran will have to make significant changes to the existing business and financial policies that have become outdated and unprofitable. The current pricing and finance management strategies have resulted in many local airline companies running with severe losses.

In the post sanctions era, Iran has signed four major procurement deals for over 240 new passenger aircrafts. However, industry experts believe that it will be challenging for Iran to finance these deals. The delivery of third Airbus A330 was postponed recently (March 2017) and banking restrictions were cited as the main reason. Considering the heavy investments required in this sector as well as the current ambiguity of political developments and financing bottlenecks, Iran’s aviation industry will still take a few good years to start its journey towards growth trajectory.

Oil & Gas

Iran’s underdeveloped oil and gas industry has attracted the eyes of many. This was evident from the visit of Chinese president Xi Jinping to the country just weeks after the sanctions were lifted. Oil production has increased rapidly from 3.2 million barrels per day (BPD) in 2015 to 3.7 million BPD in 2016. The total output is expected to reach 4.2 million BPD in 2017. Similarly, exports in the post-sanctions period have also witnessed a rapid surge as many countries resumed purchasing Iranian oil. Experts suggest that Iran also has the potential to supply Europe with around 35 billion cubic meters of gas each year by 2030.

While many multinationals have recognized the country’s potential, various legal, political, and financial hurdles are holding them back from acting on their interest. As a result, despite the high number of initial MoUs signed throughout 2016, only the joint deal between Total, Petropars, and China National Petroleum Corporation (CNPC) has materialized so far. With the current government’s strong focus to develop and boost the petrochemicals industry as well as to improve contract politics and terms to attract more investments, there are signs of growth in the medium to long term. The need of the hour for Iran’s oil industry is to attract FDI and technology to improve the current infrastructure in order to meet its long-term goals.

Implications for an Average Iranian

The nuclear deal and its expected socio-economic rewards are yet to yield significant benefits for an average Iranian. Before the recent elections, sentiments were mixed as many Iranians felt that their living standards have not improved as expected. In a recent 2016 survey by University of Maryland, only 46% of Iranians believed the country’s economic situation was good, compared to 54% expressing the same opinion in 2015. It is important to note that structural reforms at a national level and FDI deals require longer timeframes to be implemented and show their true impact on the economy as well as society. For example, it will take years for Airbus and Boeing to complete their deliveries and for Total to start pumping oil, and even longer for the financial benefits of these and other deals to trickle down to general population. Attaining economic prosperity as a result of investment deals is a time-consuming process and not something that happens overnight, hence, it is too early to judge the success or failure of the nuclear deal as of yet. Keeping in mind Iran’s current volatile environment, it will take at least few more years for Iranians to slowly start reaping the rewards.

EOS Perspective

The lifting of sanctions has helped Iran to boost its GDP, oil production, and trade, while at the same time, the country’s continuation of testing nuclear weapons and supporting terrorism has dampened investor confidence and business opportunities. The political and financial risk of doing business with Iran has forced many multinationals to refrain from pursuing new opportunities. In the current context, Rouhani’s recent victory echoes public acceptance towards his overall political propaganda including economic liberalization. The election results are expected to have a positive impact on Iran’s prospects in the next four years, as the government will continue to work towards reviving the economy by improving foreign relations and business policies.

In order to sustain the current economic recovery and to rekindle investor confidence, the government will have to implement major reforms with regards to its state-owned enterprises, financial systems, and business policies. In its second term, the government will have to push for investment promotion, upgrade its outdated policies, promote competitiveness, and business-friendly environment to encourage FDI. Further, with the current level of unemployment and present economic framework, it is clear that the pace of job creation is inadequate. There is a pressing need to diversify the economy and develop private sector free of current bureaucratic challenges. In the long run, the key question is whether Iran can leverage its natural resources to diversify its economic structure and ramp up its economic modernization.

Looking at the promising developments that Iran’s automotive, aviation, and oil and gas sectors have shown so far, there is no doubt about their growth potential in the long term. Over the next year or so, Iran should attempt to re-integrate itself into the global trade and finance systems. This would boost trade and open up more business opportunities, fueling growth in key industry verticals. In the short-term however one can only expect moderate growth.

by EOS Intelligence EOS Intelligence No Comments

GCC Warms Up to Renewable Energy

The development of fossil fuels in the GCC has led to a rapid economic growth of the region. A couple of the GCC countries boast some of the highest GDP per capita globally, with the good economic performance attributed primarily to the hydrocarbon sector growth. Saudi Arabia, the UAE, and Kuwait are the second, sixth, and ninth largest producers of oil in the world, respectively in 2015, reflecting their position as hydrocarbon exporters and producers. However, with rising domestic demand for energy and the need for a sustainable future energy supply, GCC has been making efforts to introduce renewable energy sources with a view to balance economic needs with environmental factors.

The Gulf Cooperation Council (GCC) comprises countries that are among the largest hydrocarbon producers in the world, with GCC collectively holding around one third of crude oil reserves and almost one fifth of global gas reserves. While oil and gas exports have underpinned an extraordinary economic growth of the GCC over the past several decades, the increasing domestic demand for energy has made it difficult for these countries to maintain their export levels. For instance, in 2014, Saudi Arabia, one of the largest oil producers globally, was the seventh largest consumer of oil in the world. In the same year, its domestic energy consumption stood at 28% of production against 17% in 2000, reflecting a rising domestic demand.

Domestic demand for energy is increasing in GCC 

Various reasons including industrialization, water desalination, and increase in population size, have led to this increase in domestic demand for energy in GCC. Industrial sector (comprising mostly oil refining, petrochemical, water, and fertilizer industries) accounts for nearly half of the total demand in the region.

The growth of the residential and commercial sector has also contributed to the rising energy demand, and currently almost half of the total electricity produced in the region is used by the residential sector. Moreover, electricity consumption by recent housing and commercial projects has grown at an average rate of 6% to 7% per year between 2003 and 2013, faster than anywhere else in the world in this time period.

Furthermore, rapid economic development in the region has led to rising water demand, leading countries to generate fresh water through seawater desalination. Desalination fulfills a large share of GCC’s water demand (e.g. around 27% of the total water demand in Oman and 87% in Qatar in 2015). Since desalination is an energy-intensive process, it has also put pressure on the consumption of fossil fuels.

These factors have forced GCC to focus on diversifying its energy mix to meet the domestic demand while still sustaining the countries’ economic growth. A diverse energy resources portfolio is needed to allow GCC to make the domestic energy production available for export. In addition, it would also reduce carbon-dioxide emissions to create a more environmentally sustainable future. Countries in the GCC region are thus focusing on developing the renewable energy sector, particularly solar energy.

The region is turning to alternative sources of energy

Several GCC countries have embarked on a path of setting more aggressing targets for sustainable energy production from sources other than traditional fossil fuels.

For instance, UAE plans to invest US$ 163 billion in the next 30 years in renewable energy sector. Moreover, it aims to increase the contribution of clean energy in total energy mix from 25% at present to 50% by 2050. It also plans to generate 44% of its power supply from renewable sources (e.g. solar), 12% from clean fossil, and 6% from nuclear energy.

Further, as Saudi Arabia’s renewable energy represents merely 1% of the total energy produced, the kingdom targets to increase the renewable energy share to 4%, an equivalent to around 3.45GW.

Other countries are also developing plans, and these include the renewable energy program in Kuwait that aims to generate 2GW energy from renewable sources, thus contributing 15% of the total energy produced by 2030. The country also commissioned its first solar power project of 10MW with an investment of US$ 99 million in 2016 and plans to generate around 20% electricity from alternative sources by 2020.

Qatar aims to generate 200MW solar energy by 2020, an equivalent of electricity for 66,000 homes per year. In addition, it also plans to install 1.8GW of solar power capacity by 2020.

GCC Warms Up to Renewable Energy

EOS Perspective

While GCC is putting in efforts to become an energy efficient region and reduce its revenue dependency on exports, the pace of alternative energy sources development has been rather low. Lack of clarity in roles and responsibilities of policy makers as well as uncertain policies and regulations around energy planning are contributing to the slow growth of renewable energy generation.

Lack of clarity in roles and responsibilities of policy makers as well as uncertain policies and regulations around energy planning are contributing to the slow growth of renewable energy generation.

In most countries, no authority has been assigned at the governmental level to handle the affairs of the renewable energy sector. There is no doubt that more dedicated efforts towards the implementation of energy development projects would surely help speed up the process of the sector’s development.

The governments of the Gulf countries should focus on establishing renewable energy corporate framework and assign a body to handle the development and implementation of policies and projects in this sector. Only few countries have assigned units within governmental structures to take the responsibility of overseeing the renewable energy production capacity growth.

The governments of the Gulf countries should focus on establishing renewable energy corporate framework and assign a body to handle the development and implementation of policies and projects in this sector.

For example, in 2010, UAE, set up a dedicated department called Directorate of Energy and Climate Change (DECC) within the Ministry of Foreign Affairs (MOFA), to lead the development of renewable energy in the country, supporting the national climate change strategy. DECC was also established to coordinate with stakeholders for the promotion of green energy in the UAE. It engaged with International Renewable Energy Agency (IRENA), an intergovernmental organization assisting its member countries to include green energy in their energy portfolio. IRENA acts as a center of excellence offering expertise and financial support to its members.

All GCC countries are members of IRENA which aids them in scaling up green energy in their respective countries. For instance, in 2014, it conducted Renewables Readiness Assessment (RRA) with the Government of Oman with a view to create a renewable energy roadmap comprising policies, regulations, and the infrastructure required for the country to meet its energy goals. The organization, thus, helps in the decision making as well as the implementation of strategies regarding renewable energy in GCC countries.

GCC should also focus on nurturing the development of R&D institutes which could offer expertise to policy makers in energy portfolio diversification. Such institutions could also offer workforce training to enable faster project deployment along the value chain.

GCC should also focus on nurturing the development of R&D institutes which could offer expertise to policy makers in energy portfolio diversification.

International collaboration with private and public companies in the GCC to set up renewable energy facilities could also support the development of the renewable energy sector in the region. Furthermore, incentives should be offered to these companies to encourage the establishment of green projects and facilities.

Endowed with hydrocarbon resources fueling economic development, GCC now has the potential to fuel its economic growth in a more sustainable manner, taking advantage of other resources at hand (e.g. by utilizing abundant sun available in the region throughout large part of the year). However, a greater and more structured regulatory support and more focused implementation is required to pave the way for the renewable energy sector development in the GCC.

by EOS Intelligence EOS Intelligence No Comments

Russia’s Energy Economy Sanctioned

A host of countries are of the view that Russia is intentionally trying to destabilize Ukraine by allowing infiltration of arms and ammunitions to support Ukraine’s separatist groups. These countries also believe that Russia desires Ukraine to be a part of the newly formed Eurasian Union and be in its circle of influence. This is pinching more to the western group of countries because they, on the other hand, want to integrate Ukraine with the West and make it a member of NATO. Conflicting interests have resulted in the infliction of sanctions from both sides, Russia being the bigger victim.

In order to dilute Russia’s efforts towards annexing Ukraine, western countries imposed sanctions on Russia which initially followed a route of barring entry of people close to the Russian leadership and blocking their assets in those countries, but this strategy proved futile. The result was a series of new sanctions aimed at Russia’s various sectors in an attempt to further pressurize the country by slowing down its economic growth and deteriorating its investment atmosphere.

Russia's Exports

The latest series of sanctions (those released in July and September 2014) were articulated to weaken Russia’s economy by mainly influencing oil production and its exports (in 2013, exports constituted 28.4% of Russia’s nominal GDP, of which oil and natural gas exports had a share of 68%).

Major Russian energy giants such as Rosneft (integrated oil company majorly owned by the Government of Russia), Transneft (world’s largest oil pipeline company), Lukoil (Russia’s second largest oil company), and Gazprom Neft (fourth largest oil producer in Russia) were directly brought under the purview of sanctions.

The ‘energy sanctions’ prohibit western companies to share energy technologies and invest capital in any Russian offshore oil-drilling projects based out of the Arctic regions, Russian Black Sea, and western Siberia’s onshore. In addition to technology constraint, western companies are debarred from financing Russia’s key state-owned banks for more than 90 days in order to build up financial pressure on Russian energy companies indirectly.


Rosneft and ExxonMobil’s Discovery of Oil at the Universitetskaya-1 Well

One of the major projects under the Rosneft and ExxonMobil partnership was to discover oil and gas reserves in Kara and Black Seas through a joint venture established in 2012. The two companies had also agreed on other projects such as an attempt to conquer the Arctic region’s oil and gas reserves through establishment of the Arctic Research and Design Center for Continental Shelf Development (2013), understand feasibility of developing a LNG facility in Russia (2013), and a pilot project for tight oil reserves development in the shale basin of Western Siberia (end of 2013). Talking about some hard cash involved in research and development activities, Rosneft invested US$250 million while ExxonMobil gambled US$200 million.

In September 2014, the two companies announced their success at discovering oil at the Universitetskaya-1 well in the Kara Sea which became Russia’s second offshore Arctic project. This discovery was a big finding and they initiated drilling activities quickly through the West Alpha rig (originally owned by Seadrill subsidiary of North Atlantic Drilling but under a contract with ExxonMobil till July 2016). Till this time, the partners were under the assumption that they won’t be affected by western sanctions imposed on Russia but to their disappointment, the new sanctions restrained ExxonMobil to cooperate (restricted energy technology transfer) with Rosneft on this project any further. To their dismay, drilling came to a halt in October 2014 as Rosneft could not utilize ExxonMobil’s West Alpha rig.

Rosneft is presently on a lookout for a new rig managed by companies located in the East, China, or South Korea. An attempt to find a new rig and then adjust it at the Kara Sea’s well site is going to be a enormous task and expected to delay things at least till mid-2016. Meanwhile, China (through Honghua Group, for instance) is strengthening its chances of getting positioned as a substitute provider of energy sector technology to Russia, but it is doubtful if it will be able to match the capabilities of western companies. It will be a humongous challenge for Rosneft to find a rig provider which has the expertise to ensure safety operations in such a tough part of the world.

The objective of recent western sanctions appears to not only limit present oil production but harm the future of Russia’s energy sector. 90% of current oil production in Russia comes from conventional oil fields such as West Siberian brownfields which do not require highly advanced western energy technologies, but the problem is that these fields are depleting rapidly. Russia, therefore, faces an urgent need of finding new oil sources to retain its position of being one of the main players in the world’s energy sector (3rd largest crude oil producer – 10.44 million bbl/day, 2013; 2nd largest crude oil exporter – 4.72 million bbl/day, 2013; 2nd largest natural gas producer – 669.7 billion cu m, 2013; largest natural gas exporter – 196 billion cu m, 2013).

Delay of the Rosneft project is slowly fading Russia’s aspirations of increasing oil output as tapping of Universitetskaya well’s oil reserves (estimated to be up to 9 billion barrels) could have added approximately US$900 billion to the government coffer over the next 10-12 years. Similar projects might have led to discovery of new oil reservoirs in the Kara Sea where oil reserves are estimated to be around 13 billion tons (way more than Gulf of Mexico’s and Saudi Arabia’s independent reserves). As per Merrill Lynch, Russia might lose US$500 billion of direct investment and US$26-65 billion of budget revenue during the next 10 years, as energy investors from other parts of the world also become uncertain of Russia’s economic stability.

If western sanctions remain at this level, it would make it difficult for Russia to discover and exploit oil resources in areas like Arctic, as it is primarily western companies (BP, ExxonMobil, Shell, etc.) which have the required expertise and technology to do so. Since the Russian energy sector almost single-handedly drives the country’s economy through exports, impact of the western sanctions, which is already impacting various facets of Russian economy, will be felt heavily in the long-term.

by EOS Intelligence EOS Intelligence No Comments

Is Non-Oil Sector the New Champion of the Nigerian Economy?

The 1970s’ oil discovery transformed Nigeria from a largely agro-economy to a more oil-dominated one. Over the last several decades, oil played a significant role in Nigeria’s positive growth story, and its emergence as one of the key economic hubs in Africa. Interestingly, however, the last few years have seen a revival of non-oil sectors, such as agriculture, once the key economic driver of the country. What does this ‘change’ mean for Nigeria and how does oil fit into the bigger picture?

Post Nigeria’s independence in 1960, the country’s economy was primarily agrarian, with mainstay products such as cocoa, rubber, palm oil and kernels, groundnut, and cotton; the agriculture sector accounted for 60% and 75% of the country’s GDP and total employment, respectively. During the 1970s, the Nigerian government undertook various measures to exploit the naturally available oil reserves, such as extending oil exploration rights to foreign companies in Niger Delta’s offshore and onshore areas, to tune the economy to one which is oil-centered (petroleum revenue share of the total federal revenue increased from 26% in 1970 to 70% in 1977). The oil-centered Nigerian economy reached its peak in 2008 when oil accounted for about 83% of the country’s total revenue. In recent years, the oil sector has been experiencing a decline with its share in total revenue falling to 75% in 2012, largely due to a stagnant crude-oil production at 2 million barrels per day (mbpd) (2.3 mbpd in 2012 and 2.2 mbpd in 2013). A steep fall has also been observed in crude-oil exports to the USA (Nigeria’s main oil export market), which contracted by 11 percentage points in a single year, falling from 16% of Nigeria’s total oil exports in 2012 to 5% in 2013.

Upon closer introspection of the reasons for the declining dominance of oil in Nigeria, various factors come to surface. One of the main reasons is the delay in the approval of the Petroleum Industry Bill (PIB), which aims to ensure the management of petroleum resources according to the principles of good governance, transparency, and sustainable development; this delay has been stalling further investments in the oil sector. Perpetual oil thefts, pipeline vandalism, weak investment in upstream activities, and insignificant discoveries of new oil reservoirs have also hampered the growth of this sector. As a result, oil giants have been selling off their stakes in various onshore as well as offshore blocks. For instance, Shell sold 45% of their interest in OML 40 onshore block to Elcrest Nigeria Limited (an independent oil and gas company) and Petrobras (a Brazilian multinational energy corporation) is planning to auction its 8% and 20% stakes in Agbami oil block and offshore Akpo project, respectively.

So, where does this leave the Nigerian economy?

Apart from the unsatisfactory performance of the oil sector, Nigeria’s economic environment faces risks from security challenges prevailing in the northeastern part of the country, conflicts related to resource control in the Niger Delta region, and high levels of corruption (case in point being the suspension of Nigeria’s central bank’s governor over misconduct and irregularities).

Nigeria Government Policies

In the midst of all these challenges, the non-oil sector (described as a sector which is not directly or indirectly linked to oil and gas, and include sectors such as agriculture, telecommunication, tourism, healthcare, and financial services) is emerging as the new champion of the Nigerian economy.

This is mainly due to various policies adopted by the government in the light of the looming oil sector, along with the complementary effect of factors such as increase in private consumption and FDI.

 

FDI in NigeriaIn addition to government policies, FDI has played a key role in nurturing the non-oil sector. Nigeria has experienced a compounded annual growth of 20% in the number of Greenfield FDI projects from 2007 to 2013; 50% (total number of projects being 306) of these projects were service-oriented. The telecom sector particularly witnessed strong growth by attracting 24% of all FDI projects, while coal, oil, and natural gas received only 8% of foreign direct investment during 2007-2013.

Private consumption (forecast to reach US$231.2 billion in 2014) has also fuelled the growth of the Nigerian non-oil sector. The largest consumer market in Africa, Nigeria’s consumer spending (an indicator of private consumption) has increased from US$94.3 billion in 2007 to US$309.9 billion in 2013.

The cumulative effect of all these factors has proven exceptionally positive for the non-oil sector. This is evident from the increase in percentage share of the sector in the Nigerian GDP. Agriculture remains the largest contributor, among both oil and non-oil sectors, with a share of 22% in GDP, in 2013. Other non-oil sectors such as manufacturing (GDP share increased from 4% in 2010 to 6.8% in 2013), construction (GDP share increased from 1% in 2010 to 3.1% in 2013), wholesale and retail trade (GDP share increased from 13% in 2010 to 17% in 2013), transport and communication (GDP share increased from 3% in 2010 to 12.2% in 2013) have also strengthened their position in Nigeria’s growth story.

Moreover, non-oil sector’s contribution to government revenue has improved from US$154.3 million in 2000 to US$3,018.2 million in 2011, which is a significant increase. A growth has also been observed in non-oil exports, which have increased from 1.28% in 2000 to 3.59% in 2010, in terms of percentage contribution towards total exports.

The Nigerian non-oil sector has also been attracting a number of investments in recent years, for instance:

  • July 2014: Procter & Gamble, a multinational consumer goods company, announced the construction of a new manufacturing plant worth US$250 million, in Nigeria’s Ogun state. The manufacturing plant is expected to employ 750 Nigerians and offer opportunities to 300 SMEs

  • February 2013: Indorama, a global chemical producer, launched a Greenfield urea fertilizer project worth US$1.2 billion, in Nigeria’s Port Harcourt. The project claims to support Nigerian and West African requirements for affordable fertilizers

 

Apart from giving credit to an increase in private consumption, investments in the non-oil sector must also be attributed to the measures undertaken by the Nigerian government. To showcase the attractiveness of the Nigerian economy, the government undertook a GDP rebasing exercise (GDP calculations are now performed on 2010 year’s figures instead of 1990’s). The exercise led to a better coverage of the informal sector, addition of new industries, and increase in the contribution factor of sectors such as service, manufacturing, and construction.

According to the National Bureau of Statistics, Nigeria’s GDP is valued at US$498.9 billion as compared with US$263.7 billion, prior to rebasing, in 2013. In spite of several criticisms around the authenticity of figures, rebasing of the GDP gave a strong competitive edge to Nigeria, among other emerging and developing economies, by showcasing a high GDP to allure investments. Additionally, implementation of the government’s Industrial Revolution Plan is expected to continue driving the country’s manufacturing sector. Since regular and ample power supply is a critical issue in Nigeria, the plan has implemented reforms in the power sector which aims to facilitate a continuous power supply, thereby, supporting the manufacturing sector by reducing power generation related costs and encouraging further investments.

 

Final Words

While the oil sector did well to provide Nigeria with a strong foundation and help build basic infrastructure to support a long-term growth potential, the rekindling of the non-oil sector is likely to strengthen Nigeria’s growth story and help it attract much needed foreign investments to create a balanced economy.

The approval of the PIB, post 2015 elections, might improve the oil sector performance, which should go hand-in-hand with non-oil sector development, making Nigeria an attractive market for global investors. It will be important that the Nigerian government undertake continuous reforms in both sectors to ensure the emergence of a strong economy, able to compete with the more established emerging markets of the world.

by EOS Intelligence EOS Intelligence No Comments

Mexico Energy Reforms – Pleases Energy Companies, Displeases Nationals

In H2 2013, we published an article on Mexican President Enrique Peña Nieto’s proposed energy reforms. Eight months after constitutional amendments were introduced to actualize these reforms, the President has taken a historic step and signed the energy reform bills passed by the Congress into law. While analysts seem happy with the new package of laws, the key question pertaining is that, has the government done enough to satisfy the key stakeholders, the oil companies, PEMEX, and the Mexican public.

Mexican President Nieto has set a blistering pace for reform of the nation’s oil, gas and electricity sectors, with final Congressional approvals being in place in less than a year of the initial proposal. The secondary legislation signed into law by the President on 11th August 2014 has opened up the oil and gas sector to private investment for the first time in 75 years. The Mexican government estimates that the new framework will result in an investment of US$50 billion by 2018 in oil exploration, production and refining activities.

The determination with which the President has pursued energy reform is highlighted by the move to pre-pone the ‘Round Zero’ process by a month, which entailed the granting of exploration and production rights to PEMEX. PEMEX has been awarded rights to 83% of the country’s proven and probable oil reserves and 21% of the nation’s prospective resources. The next round of bidding, Round One, will involve private companies, foreign companies, and PEMEX bidding on equal terms for the remaining 79% of prospective reserves. This tender process will be overseen by the National Hydrocarbon Commission (CNH), and is expected to take place between May and September of 2015.

The reforms are considered ‘fairly pro-market’ as private players will be allowed to pursue joint ventures on their own accord or with PEMEX. More importantly, addressing earlier concerns regarding share in resources, foreign and private companies will be allowed to book reserves, even though oil and gas resources will remain under state ownership until they are produced. This has resulted in keen interest from leading global energy companies, few of whom have given official statements stating their intent to bid. The new law also opens up the electricity generation market, while the state retains monopoly in transmission and distribution. The government looks to set up an electricity wholesale market under the reforms.

In addition to introducing private investment into every segment of Mexico’s hydrocarbon sector, the regulation encompasses the strengthening and autonomy of regulatory bodies, CNH and Energy Regulatory Commission (CRE) as well as setting up of new independent bodies for supervising environmental protection as well as controlling and operating the natural gas and electricity network. This it to ensure smooth and transparent implementation of the reforms.

From the point of view of the energy companies, the reforms could have not come at a better time, with several of their current operation zones (of the likes of Iraq, Libya, Nigeria, and Russia), facing violence and above-the-ground problems. In comparison, the situation in the Mexican territory seems much less risky. However, there exists a slight amount of political risk for international companies.

President Nieto has bagged several wins in his first two years, including banking, education, telecommunication, and energy reforms. Unlike the case of the three former reforms, the public has not supported their President in his latest endeavor. According to a poll published in Mexican newspaper, Reforma, 40% of Mexicans believed that the changes under the energy reforms would be bad for the country. Should President Pena Nieto’s PRI party lose elections in 2018, an incoming government may be likely to roll back such reforms that displeased the Mexicans. Nonetheless this risk, most energy companies are likely to welcome the reforms with open arms.

Overall, Mexico’s energy reforms are expected to be transformational for both the country as well as the global energy industry. While they are running well within the timelines in terms of policy formation, time will determine the success, or lack thereof, of the reforms, especially with regards to implementation.

by EOS Intelligence EOS Intelligence No Comments

Mexico’s Energy Reforms – The Balancing Act

Mexico’s president Enrique Peña Nieto seems to be a man on a mission. Since his term started in July 2012, he has worked towards weeding out the inefficiencies and monopolies plaguing several sectors in Mexico and has received much appreciation for that. But this time, has he gone too far? With Pemex being Mexico’s much-guarded jewel, the attempt to bring in private investment seems much more ambitious than the previously introduced overhaul in the labor laws and telecom sectors.

President Enrique Peña Nieto took a bold step in June 2013 by reforming the country’s quasi-monopolistic telecom sector, voicing his seriousness about bringing real changes to Mexico’s economy by tackling inefficiencies and welcoming foreign investment. While the results of the telecom reforms remain yet to be seen, he has moved to an even more ambitious project – to allow foreign investors to enter Mexico’s energy sector, which has been closed to private participation since 1938.

Pemex, which is the world’s 10th largest oil producer, has been a government monopoly for over 75 years. The country’s oil output has been falling since 2004, as a result of its inability to explore unconventional (deeper) sources driven by lack of investment and outdated technology. It is expected that if further exploration is not undertaken, Mexico will become a net energy importer.

To combat this, the president sent a bill to congress that aims to end the state’s 75-year old monopoly over the energy sector. According to the proposed bill, private oil exploration companies would gain access to the Mexican oil reserves under profit-sharing contracts for upstream oil and gas development (exploration and production).The bill also cover reforms regarding the restructuring of Pemex to make it more transparent and accountable.

The bill also encompasses reforms in the electricity market, wherein it looks to allow private participation in electricity generation, while maintaining transmission and distribution under state control. While few amendments to partially allow private participation in the electricity sector have been introduced in the past, they have left much to be desired. The current amendments only allow private companies to generate or import electricity for self-supply or to undertake cogeneration. In addition, Independent Power Producers that produce less than 30 MW of electricity and exclusively sell to the state-owned Comision Federal de Electricidad (CFE) or export to other countries are allowed to generate electricity under the existing amendments. As against the state-owned CFE choosing the players from which it would like to purchase electricity, these reforms would boost competitiveness in the sector by establishing an independent system wherein power generator participation would be decided based on lowest generation costs.

These reforms are expected to boost investments in the oil sector by about US$10 billion per annum. Further, an influx of investments is expected to help Pemex offset its current US$60 billion debt. In addition, they are also expected to bring down electricity prices in the country (which are 25% higher than that in the USA), boost employment, and strengthen the participation of renewable energy in the energy mix primarily underpinned by private participation in electricity generation.

While these reforms spell out immense benefits for Mexico’s economy, their implementation and outcome are a different story altogether. The Mexican population that applauded and supported the government through the education and telecom reforms, is now much less convinced regarding this arm of reforms. Mexicans have for long considered Pemex to be symbol of their national independence and the oil found beneath Mexico’s soil and water, a part of their national heritage. Moreover, March 18th – the day when president Lazaro Cardenas nationalized the country’s oil industry in 1938 is celebrated proudly as a national holiday. Unlike the case of the previous successful reforms, the government faces much opposition from the leftist groups. However, with full support for the reforms from Peña Nieto’s Partido Revolucionario Institucional (PRI) and the Partido Acción Nacional (PAN) parties, which control more than two-third seats in congress, there are strong chances of this proposed law becoming a reality.

The bill also falls short from the point of view of leading global oil exploration companies. While the reforms give foreign companies access to extract and exploit oil, share risks and profits, they would not be able to have a share in the resources. This makes the Mexican agreements far less lucrative for large oil players when compared with proposals offered by neighboring oil-producing countries, such as Brazil and Columbia, which allow the producers to own a certain amount of oil in their books. Thus, although leading oil companies, including Shell, Chevron, BP, and Exxon Mobil have welcomed the wave of reforms in Mexico, their participation will largely depend on the nature and attractiveness of the final profit-sharing agreements.

Therefore, while these reforms look at altering history, it remains extremely premature to predict their outcome. These reforms run the risk of offering ‘too much’ from the eyes of the Mexican public or ‘too little’ from the point of view of resource-hungry energy companies and can only be a success if they manage to find the perfect balance between both the stakeholders. Thus, the key question that remains is not regarding the approval of reforms, but if these reforms will actually manage to stir foreign investment into the Mexican oil sector.

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