Middle East now feeling effects of global climate change

It seems there is as much of a surplus of news stories about global warming being human-caused as there is oil underground. While the debate over the links between human activity and climate changes rages with strong opposing views in meeting halls and chat rooms the world over, there can be no doubt that the oil industry itself is increasingly worried about climate change impact on its activities, from exploration and drilling to transport.

In the past, the Gulf’s oil producers were basking in the assumption that the region is not prone to severe storms and weather phenomena such as the hurricanes that each year pound the Western hemisphere’s crucial oil facilities in the Gulf of Mexico. But that self-assuredness has been thrown into question this summer when cyclone Gonu battered Oman with unprecedented fury. Although there may be no cause and effect between the patterns of global warming and storms like Katrina and Gonu, nevertheless, the impact of such storms has affected the oil industry worldwide and poses new threats that have yet to be assessed.

The Middle East will not be spared from the repercussions of global warming if climate change continues, Lebanon’s Greenpeace campaigner Basma Badran told Executive. “Climate change [in the region] is mostly tackled from the perspective of energy security rather than concern for the global climate. However, the latest cyclone, Gonu, that affected [Oman] and western Iran has shown that climate change will not spare the Arab region.”

Much of the oil and gas exploration in the Gulf is offshore, making the facilities vulnerable to tropical cyclones which build up over warm waters and gather strength as they move across open seas (the US term hurricane describes a tropical cyclone by another name; there is no quality difference in their destructiveness).

Impact in the age of economic interdependence

In Oman, Gonu disrupted oil industry operations, forcing the Sur liquid natural gas terminal southeast of Muscat and the Al-Fahl oil terminal to stop shipments for three days, costing $200 million in lost revenues.

A possible choke point for weather-related trouble in the Gulf is the Strait of Hormuz shipping lane. According to officials, all crude exports from the Arab states in the Gulf except Saudi Arabia — or about a quarter of world supplies — go through the strait, making it the world’s most important oil passage.

As people live in an economically interdependent age, catastrophes that happen across the globe naturally have a serious effect on global markets and business partnerships everywhere. The hurricanes Katrina and Rita, which hit the Gulf of Mexico in 2005, led to $45 billion in insured damages but the overall losses from the two storms were far larger.

The oil industry lost 115 offshore oil platforms, suffered damages to another 52 rigs, and had to write off months of production. US budget office estimates of the two hurricanes’ total damages to the area’s energy infrastructure said repair costs could be as high as $31 billion and insurance industry consultant Aon spoke of $10 billion in insured damages to the offshore oil sector.

From the perspective of the oil producing countries in the Middle East, the impact of weather problems on the international energy market was seen as proof that the consumer experiences from spiraling oil prices were industry more than resources related. Saudi Arabia’s oil minister, Ali Naimi, blamed “high oil prices on a lack of industry infrastructure, including rigs and refineries, rather than oil reserves.”

Ironically, the big five integrated oil companies reported record jumps in their profits for 2005; industry leader ExxonMobil had a whopping 46% increase in profit from 2004 to 2005 and other companies showed similar gains. Those extreme profit margins seem a possible reason why mum’s the word in the oil industry about the amount of money and time it took for production to come back to full swing and how much the industry is committing to improve its preparedness for future storms.

The American Petroleum Institute (API) said in a press release in July that member companies learned “critical lessons” from Katrina and Rita and from Hurricane Ivan in 2004. It mentioned equipment upgrades, revised emergency planning, and contingency plans with suppliers but did not give an estimate on the total cost that climate-related severe weather phenomena create for the industry or how much of their profits oil companies have been allocating to mitigate the impact of climate change on their own operations or the country at large. 

In examining the costs of mega oil companies one can take into consideration emission taxation, purchase of other nations’ emission credits, operational costs that include destruction of equipment, delays in shipping, all of which result in depreciation of share value. Oil and gas exploration costs include personnel day-rate fees for drilling contractors of between $45,000 and $80,000, which by multi-billion dollar standards are mere nuisance losses.

Development costs on the rise

Development costs include extracting and refining of petroleum products. New York-based analyst Adam Sieminski of Deutsche Bank “estimates find and development costs have climbed 15% a year in real terms from 2005 to 2007 and expects a minimum 7.5% year-on-year escalation from 2008-2010, a move which would then put worldwide find and development costs at $18-$20 a barrel.”

According to official sources oil rigs can cost between $90 million and $550 million, and take several years to deliver. Adding to the oil processing shortages in the United States is the fact that oil facilities are limited in number and are today much harder to build due to stringent regulations on emissions, which the structures must adhere to in order to ensure minimal emissions. These standards were not in place 30 and 40 years ago when the present rigs, which are falling short of supplying the ever-increasing demand for petroleum products, were constructed.

A World Resource Institute report on emerging environmental risks and shareholder value in the oil and gas industry looks at “the financial implications of prospective climate policies and limited access to reserves [that] were combined to obtain an overall assessment of the impact of these pending environmental pressures for [oil] companies.” The report concludes that “the average financial impact across all companies is a loss of about 4% in shareholder value.”

What all of these Western concerns mean to the outlook for the Arab oil industry looks positive only on the surface. New refinery projects — to a large share joint venture projects between local and multinational players — are mushrooming in the Gulf where there are fewer, if any environmental regulations like taxation on carbon emissions and seemingly no climate dangers.

But if the signs of cyclone Gonu and global climate change indicators — not to mention local pollution assessments in the oil processing centers — ring true, the Arab countries will have to deal with all these issues either now or, with huge additional backlogged cost, in the future. In the latter case, oil producers here could at some not overly distant point encounter conditions that will force them to stop operating.

On a broader scale, the international oil community is taking note of climate change, tacitly or openly, perhaps foreseeing a time in the near future when humanity will not be able to depend solely on petroleum for energy oil companies the world over are taking due precautions to stay ahead of the game.

The consequences of climate change on Arab oil companies starts very generally with its effects on the entire planet. The average surface temperature has warmed one degree Fahrenheit (0.6 degrees Celsius) during the last century, according to studies. In 1975, temperatures began spiking steadily and continue to do so.

This warming will, if not reduced, cause desertification in certain areas and flooding in others from melting ice caps — either way it means a sure end to crops and a natural progression into extreme poverty and disease. In a report on climate change, Greenpeace predicts, “If current trends in emissions of greenhouse gases continue, global temperatures are expected to rise faster over the next century than over any time during the last 10,000 years.” Whether human-caused or not, it’s clear from the global oil industry’s own behavior that it is indeed concerned for itself. The magnitude of the costs that oil producers will suffer as a result of climate change, from operational damage, loss of production, export/import delays, emission taxations and market repercussions, are forcing them to stop and take a look at what it can do to mitigate such risks. This applies to Arab oil companies as much as to all others, and the costs of cyclone Gonu may serve as reminder to the industry that it is in the same boat as

Region looks for its advantage

It’s all about energy, its sourcing, its usage, and the consequences thereof. On meadows next to London Heathrow, Europe’s busiest airport, protesters haggle with police. On a glacier in the Swiss Alps, news crews have a field day filming a glacier teeming with 600 in-the-buff Greenpeace activists.

In Singapore, worsted-wool clad energy ministers in the ASEAN trade block change the agenda of their main annual meeting and wrestle with carbon emission standards. In Vienna, an entire legion of state officials, industry personalities, and civil society representatives congregate for a week of debates, undoubtedly with a fair share of hot air.

The agendas of all these happenings in the space of less than a month (August 2007) center on one thing: climate change. Re-evaluate it.

The global energy dilemma is like most fundamental conflicts: amazingly straight forward and equally hard to crack. It results from two opposing needs. To widen the range of comfortable living conditions that have been made possible by the technical progress of the industrial age to include the majority of the world’s still growing population, the global output of energy and electricity has to double by 2050.

But to safeguard Planet Earth against the incalculable risks of climate change and global warming that would accelerate after 2050 and peak in the 22nd and 23rd centuries, the output of carbon emissions has to be reduced to achieve a net annual decline by 2030 and every year thereafter.

One global mechanism seeking to instigate reduction of carbon emissions is the Kyoto Protocol. By this 1997 treaty, a club of 35 developed countries are supposed to commit themselves to cutting their output of greenhouse gases — presumed by scientists to be big contributors to global warming — in increments between 2008 and the treaty’s expiry in 2012. The developed countries are obliged to progressively lower their emissions each year during this period to undercut a ceiling defined as their emission volumes in 1990 by 5% in average.

As they are not part of the countries with these reduction targets, most Arab countries have ratified or accepted the Kyoto Protocol between 2002 and mid-2006 along with the majority of the world’s nations. By the end of 2006, 169 countries and nation-level entities had ratified or accepted the Kyoto Protocol and its emission reduction mechanisms.

Kyoto’s benefits to developing nations

What makes the Kyoto Protocol interesting to developing nations are two benefits purposely built-in to their advantage: carbon emissions trading and the Clean Development Mechanism (CDM). These two tools are based on the same basic approach: because developed countries have to meet emission targets for their greenhouse gases and may face either very high costs for the required technology (especially if their emissions are already at the low end of what is technically possible) or even stiffer penalty payments, they are free to look for alternatives.

Countries or entities, such as power plants, factories, or large municipalities, which emit more than they are allowed to, can purchase “carbon credits” from others who emit less than they are allowed to. Or the emitters can invest into an emissions-reducing project in a developing country, which will also earn them credits at a cost advantage over reducing gas emissions at home because implementation of such projects in developing markets is cheaper.

Although countries of the MENA region have largely inked the Kyoto Protocol, steps to take advantage of emission trading and CDM investments are scarce. Up to August 2007, the CDM statistics show about 760 registered projects, of which 80% were concentrated in only four countries — China, India, Brazil, and South Korea.

CDM projects are dedicated mostly either to destruction of greenhouse gases (primarily hydro-flouro-carbons) or energy generation. Wind energy projects account for a notable share in the latter category but to date, there is no registered CDM project that would provide power for a water desalination plant, an omission noted by advocates of the mechanism in Arab countries.

Among a handful of companies that have ventured into Kyoto-related activities in the Middle East is the consulting firm Energy Management Services (EMS). The Jordanian-founded company, which last year became a subsidiary of Dubai Holding through acquisition by Dubai International Capital, has made its money by offering consulting services on energy efficiency for building projects (green buildings) but company managers told Executive on the sidelines of a conference earlier this year that the firm also has ventured into carbon credit trading.

According to a manger for the company, EMS has successfully marketed carbon allowances of a Jordanian power plant that switched from burning fuel oil to natural gas. Selling these carbon credits to European companies has created a revenue stream of 10 million euros annually for the Jordanian side.

Criticisms of the Kyoto process and the CDM include allegations, made in early 2007, that many of the CDM projects receive excessive payments, far beyond their cost of implementing improved energy efficiencies. Another point of critique is that the process of registering a CDM project is complicated, time consuming, and highly bureaucratic.  

Nonetheless, the mechanism offers substantial advantages to the limited number of renewable energy projects in the Middle East that are currently making use of it. In Egypt, this is the case in the Zafarana Wind Park, a renewable energy project on the Red Sea coast southeast of Cairo that has several expansions on its agenda for the coming three years, to reach a total projected capacity of 545 MW by 2010.

Egyptian officials are full of praise for wind energy, saying that although it is more expensive than power generation from fossil fuels it has become feasible through CDM revenues. According to a report from a recent conference, Egypt wants to expand its power generation from wind by 750 MW annually under its development plan until 2012 and has an overall target of generating 20% of its electricity from wind farms. The program is backed by research into wind conditions across the country. For Egyptian enterprises, it harbors strong manufacturing prospects with opportunities to set up new manufacturing plants and create thousands of jobs.

Securing alternatives

In their search for securing future electricity supplies, Arab countries aim for substantial usage of nuclear power with policies and projects either under discussion or in the planning stage by the GCC, Jordan, Egypt, and other countries. Additionally, the region sports renewable energy projects such as a plan for generating large-scale solar power for export in Algeria using a hybrid solar heating and gas burning method. The country’s aim is to be able to export thousands of megawatts to Europe by 2020.

Saudi Arabia, which hosted a first CDM conference a year ago this month, has an array of renewable energy plans and then there are some high profile projects in the UAE. Dubai planners this year have come up with a project to build a self-sufficient green skyscraper, the Burj al-Taqa and Abu Dhabi’s Masdar initiative recently entered an agreement with aluminum producer Dubai to implement a CDM project that will reduce greenhouse gas emissions at the smelter, without announcing further details on the costs and expected carbon trading benefits.

Despite those steps forward, the whole range of possibilities for profitable projects in this region as part of the global effort to fight global warming “has not yet been discovered completely,” said Salim El Meouchi, of Beirut law firm Badri & Salim El Meouchi. He told Executive that his firm started adding a specialization in Kyoto Protocol related finance and Islamic finance last year and found that no other major Lebanese law firm has yet ventured into this area.

According to El Meouchi, the evolution of CDM finance in the Middle East is still similar to last year when the lawyer presented a paper at the 2006 CDM conference in Saudi Arabia saying that despite their high potential returns, Kyoto-financed CDM projects remain a novelty “for the Islamic financial community and for the Middle East and GCC areas. This results in numerous foregone opportunities.”

However, he told Executive that he sees all countries of the region as generally interested in such projects because of their importance for the future, adding that he expects a new increase in projects once the rules have been laid out for the period after 2012 when the current Kyoto Protocol expires.

In conclusion of this year’s climate change agenda, a major international conference on the follow-up rules to the Kyoto Protocol is scheduled for December 2007 on the picturesque island of Bali.

New indices help investors choose alternatives

Alternative energy is not only a priority from the perspective of securing sustainable economic development in emerging markets without wrecking the planet. It is a sector that has great investor potential, with direct opportunities in innovative manufacturing ventures and renewable energy generation plants as well as for financial investors. 

It is a clear sign for the heightened attractiveness of renewable energy investing that Standard & Poor’s launched an alternative energy index last month. Probably with an eye to sensitivities of investors regarding the diverse aspects of alternative energy, the S&P new power focus arrives as a pair of indices — a clean energy index, created in February of 2007, and a new nuclear energy index.

According to the index fact sheet, 50 companies from 13 countries with a combined market capitalization of $512.5 billion are represented. It is currently (status review from July 31) weighted with a slight bias in favor of nuclear energy. Each of its two sub-indices groups energy production companies in equal ratio to relevant technology, equipment and services providers, creating four clusters of attention. 

S&P stated it does not promote or sell any index-based investment product; its declared mission of this thematic index is to “measure investable opportunities in the complete alternative energy space.” In an indication of the earning potentials for alternative energy investments, the agency gave return figures of 3.11% for three months and 25.73% for the year-to-date on its Global Alternative Energy product, comparing these figures with returns of 0.53% and 7.50% over the same periods for the S&P Global 1200 product. At a risk of 17.18% per annum on a three-year horizon, the agency put returns for the alternative energy index at 43.91% for three years.

Another big push for investment transparency and incentives in renewable energy comes from Credit Suisse. It launched at the beginning of August a global warming index with a selection of 40 companies involved in renewable energies or efficient energy usage and reduction of greenhouse gas emissions. This new index comes on the back of another CS introduction in January, when the bank presented its Global Alternative Energy Index with the comment that this sector is on its way to “becoming a full-fledged sector in most indices in the near future.”

Development forecasts for alternative energy companies have projected annual rates of global market growth it the coming three to five years at 15% for wind power and 30% for solar energy — even before the UN released a new climate change report in February which linked global warming stronger than ever to human activity and before a wave of natural catastrophes and weather phenomena rattled the nerves and very lives of planet dwellers throughout spring and summer.

Economics, not ideology

In the unending debate over the extent of and perceived or real damages stemming from human interference in the ecosphere, elements of ideology and conflicting convictions have played a major role in the past fifty years. For profit-oriented entrepreneurs and short-term cost focused corporations, the not scientifically compelling nature of the arguments at times did not provide sufficient impact to enact shifts to costlier methods of production or emissions control.

Additionally, the sharply contrasting views held by the opposing sides of the energy debate involved positions where one interest group would support civilian use of nuclear energy as alternative energy while the concept was anathema to renewable-energy fundamentalists. Such emotion-raising aspects of the renewable/alternative energies issue appear to be shimmering through some of the index categories and sector designations by the early implementers in the new energy sector index issuance that is bound to proliferate in the coming years.

For investors, however, these are only sidebars in a bigger picture. The confluence of the positive financial perspective behind the issuance of these new indices with the latest UN-sponsored research into global development needs marks a starting point for a great new range of money making opportunities.

The United Nations Framework Convention on Climate Change (UNFCCC), at the start of another climate and energy summit in Geneva from August 27, railroaded world attention with a report predicting that curbing of greenhouse gas emissions will require annual spending of $200-210 billion and that by 2030 up to 1.7% of total global investment and financial flows will be directed in response to climate change.

Whereas the predicted share of emission-reducing investments in total global investment is not overwhelming, a working paper for the conference pointed out that private sector investments will dominate in this field and that developing countries will draw in increasing shares of the investment flows. According to the UNFCCC document, “about $148 billion out of $432 billion of projected annual investment in [the global] power sector is predicted to be shifted to renewables, carbon dioxide (CO2) capture and storage (CCS), nuclear energy and hydropower. Investment in fossil fuel supply is expected to continue to grow, but at a reduced rate.”

This is a big pot of new opportunities for energy-savvy Middle Eastern investors who are alert to the future needs of the power industry and adapt their strategies accordingly. The number of regional investment experts with credentials in renewable energy is currently not large but there are some important recent initiatives and reference projects. The most financially potent of them is the Masdar Venture and the Masdar Renewable Energy Fund that the government of Abu Dhabi created a year ago this month, in collaboration with Credit Suisse and the Consensus Business Group.

Shining Examples

The Masdar clean energy fund has been armed with $250 million by the three partners and pursues a mixed investment strategy as fund-of-funds (with $60 million) and direct financing of qualifying ventures through the remaining $190 million at its disposal. Currently in its investing phase, the fund has a worldwide reach but so far focused in practical terms on investing in US (four) and German (one) companies, whose names by a quirky coincidence start either with the letter H or with the letter S.

The total number of individual investments by the fund is expected to reach 20 to 25 transactions. The fund’s two latest projects this summer were a $15 million investment into a company that manufactures a new type of water filtration systems targeting developing markets and an investment into a manufacturer of solar modules whose technology does not require silicon. Earlier investments were with Segway, the manufacturer of personal transportation devices, and with two other solar technology specialists, one in the US and one in Germany.

The combo of photovoltaic technology and Germany is actually an up-and-speeding example for the recent momentum of the renewable power sector. The country’s renewable energy firms claim that Germany today is the world leader in several specialized technologies and the implementation of solar power projects, specifically photovoltaic conversion of sunlight directly into electricity. Until about six years ago, experts assessed this technology as comparatively inefficient and too expensive to make a strong contribution to electricity generation. It was most successful in outer space, where it debuted nearly 50 years ago, in 1958, as power source for satellites.

However, with the right kind of push, photovoltaic plants have a chance to take off in a big and profitable way. The first six megawatts of the world’s largest photovoltaic plant — under construction near the eastern German city of Leipzig — went online in mid-August, six months after the project received its building permit. 

The 40 MW plant is scheduled for completion in 2009 with an investment volume of 130 million euros; financing will be sourced later this year through a dedicated closed investment fund lead managed by German regional financial firm SachsenFonds GmbH.

The new plant’s developers, alternative energy company juwi Group, said they expect electricity generation from photovoltaic plants to become competitive in Germany and potentially amount for 10% of electricity generation in a state like Saxony where average sunshine per year is in the range of 1,600 to 1,700 or so hours (Saudi Arabia, at the top of the sun spectrum, records 3,500 hours per year in interior regions).

Expansion of the German solar industry was inseparable from legislation that incentivized both commercial and residential photovoltaic projects. The national photovoltaic capacity expanded from mere 2 MW in 1990 to 2,831 MW at the end of 2006 — and 65% of the new capacity was added from 2004 on when the law on support of renewable energies started offering a scheme of higher rewards, guaranteeing operators 20-year sales of their solar electricity at prices of no less than $0.45 per KW/h.

Even though juwi Group put the investment cost in its new plant per kilowatt at 20 to 40% lower than in a smaller and older photovoltaic plant, it is still very steep at 3,250 euros per installed kilowatt. The company conceded in a recent statement that without governmental incentives and programs such as the EU policy to target 20% of all electricity to come from renewable energies by 2020, large scale power production with photovoltaic technology would not be feasible for another decade.

Financial incentives also played a role for other segments of renewables, namely wind and biomass energy sources, where Germany’s capacity increases in the past ten years were also exponential, according to data from the ministry of environment. Across the spectrum of technologies, the country saw capital expenditures of 11.6 billion euros in renewable energy plant projects in 2006. Combined, investments and operational revenues in the renewable energies sector reached a total of 22.9 billion euros. 

On the basis of the German experience, it seems appropriate that Middle East-based investors look first at participating in equity of manufacturing companies and operators which can benefit from high awareness in their markets and have access to government incentives or subsidies in their renewable energy generation projects. Similarly to the Masdar clean energy fund, several investment and private equity firms with Arab partners have in recent years leveraged their networks of Gulf-based investors to source funding that they directed into innovative renewable energy companies outside the region.

But although the number of renewable energy projects under planning for the GCC does not justify any hype at this point, the train of sustainable and profitable innovation is starting to roll in the right direction. Masdar in July signed an agreement with Conergy, another large German producer of solar modules, to install 40 MW of photovoltaic capacity — enough to supply 10,000 homes with electricity — in Abu Dhabi by 2009.

The partnership and the associated knowledge transfer aims at creating a manufacturing base for advanced photovoltaic systems in the emirate which later on would be widened to expertise on other renewable energy generation methods such as wind power, solar cooling, and biomass technologies. Projects on Masdar’s implementation horizon include substantial education and research facilities and a special “energy and technology community,” a free zone in technical terms.

The zone will be thoroughly “green” in its energy design; moreover, it aims to host 1,500 companies with concentration on the area of alternative energy and supporting activities. Abu Dhabi counts on this project to result in an impressive volume of investment opportunities in renewable energies right in the middle of the world’s leading oil producing region, plus a second wave of earnings opportunities when the zone becomes a regional model for green development.