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Breaking the Middle East's reliance on oil

What should governments in the Gulf region do to diversify away from oil?

By Marcus Alexander and Adam Kingl and Rob Morris . 18 January 2017

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Oil company executives can be forgiven for feeling distraught. Prices are down to about $57 (£46) a barrel – 70% lower than in 2014 – forcing some companies to decommission their rigs and cut investment in exploration and production. 

Their misery is compounded by an increase in global production, which has seen supply outstrip demand. But Marcus Alexander, Adjunct Professor of Strategy and Entrepreneurship at London Business School (LBS), believes the industry crisis could be a blessing. 

“The shock of low oil prices is a terrific stimulus for oil companies to think differently and that’s what good businesses are seizing on,” he says. “This is a great time for them to push for structural changes. People in the industry realise they have to do something and can’t rely on the oil price going back up to $100 (£81).”

The challenge is particularly acute in the Middle East, where national oil companies support the region’s economies. Global consultancy firm McKinsey said in 2015 that Saudi Arabia “could no longer rely on oil revenues and public spending for growth.”

McKinsey’s report ‘Saudi Arabia beyond oil: The investment and productivity transformation’ added that the kingdom could double its GDP and create as many as six million jobs by 2030 if it shifted to a productivity-led  economy. The government would need to invest about $4 trillion (£3.2 trillion) in eight sectors including healthcare, finance, construction and tourism to achieve 60% of the GDP and jobs growth set out by McKinsey. 


Finding new sources of revenue


Diversifying is now a top priority for many Middle Eastern governments – and Alexander believes national oil companies in the region should follow suit, by creating new revenue streams that suffer less from barrel price fluctuations. One option is to acquire businesses in other industries, although history shows that many oil companies struggle when adopting this strategy. 

“It’s very tempting for large, successful businesses with huge revenues to invest in other sectors when their own industry is under threat,” Alexander says. “The big oil companies such as Shell, Exxon [now ExxonMobil] and BP got into many new business activities, such as mining and minerals, in the 1970s and ‘80s as they were worried about depleting oil resources. 

“They were really bad at it, because exploration in mining and minerals is very different to how it’s done in the oil industry. When diversifying, Middle Eastern oil companies need to be very clear about the sort of businesses they’re buying. Does the target business have similar characteristics to what they understand and are good at? Can they add real value to these targets?” 

Better exploiting existing assets and new technology are other moves oil companies can make to diversify, according to Adam Kingl, Executive Director of Thought Leadership, Executive Education, at LBS. Kingl and senior figures from Abu Dhabi Company for Onshore Petroleum Operations (ADCO) explored these ideas when working together on an LBS Executive Education programme.   

Like most oil companies in the Middle East, ADCO focuses on upstream operations – exploration and extraction – rather than downstream, where businesses refine, market and distribute oil. Kingl advised the company’s executives to look at their supply chain to see where they could improve margins. That led to a conversation about commercialising assets such as temporary accommodation used primarily for ADCO workers living in remote areas. 

“ADCO has oil wells in the middle of the desert that can only be accessed by driving for hours or getting a helicopter ride,” Kingl says. “The sites have hotel rooms for the staff but some of those rooms are often empty, so one idea was to make them available to the public. Desert holidays are becoming increasingly popular for people who love the thought of being somewhere with no distractions, and selling hotel rooms to travellers is a great way to extract value from an existing asset.”

Reallocating resources is another step that Middle Eastern oil companies can take, according to Kingl. Most own several oil wells in their resident country, but those assets have to be taken offline occasionally for cleaning, general maintenance or health and safety reasons. “Instead of having workers sitting around waiting for extraction to restart, why not send them to work on another asset that is operational? It’s about using your assets more intelligently,” Kingl says.

He adds that oil companies seeking to diversify can take inspiration from Orica, an Australian company that provides explosives and blasting systems to the mining industry. Orica realised that the excess amounts of carbon created through mining could be turned into a saleable asset. 

Orica worked with the University of Newcastle in Australia to develop a technology that converts carbon emissions into carbonate rock, which can be used to create eco-friendly carbon bricks for the construction industry. “The carbon isn’t being released into the atmosphere, so Orica is boosting its green credentials while selling an asset that brings in more revenue instead of it going to waste,” Kingl says. 

New industry techniques are giving oil companies in the Middle East other opportunities to maximise existing assets and maximise their revenues. For example, some operators use gas – which is plentiful in the Gulf region and can be cheaper than water – to clean their pipes or push through any excess oil that pools in them. 


Oil companies need to more entrepreneurial


As well as diversifying, Middle Eastern oil companies can do other things to break their reliance on oil prices. One is to encourage people in the organisation to make timely decisions and think more entrepreneurially. “It’s about thinking in a way that leads to action and doesn’t hold things up,” Alexander says. “Companies in an industry going through tough times need to be quicker, better and slicker at everything they do.”

Encouraging people to take on more responsibility is tricky in a region where the hierarchical company structure still rules. The upshot is that employees feel discouraged or lack the confidence to make big decisions – a mindset that needs to change if oil companies are to become more independent.     
 
The good news is that oil companies are adapting, according to Alexander. “On one of our Executive Education programmes at LBS, we work with middle managers from the Middle East who meet and share insights with their peers from other industries, which is great,” he says. “This leads to more strategic thinking and encourages them to feel more responsible and accountable.”

Alexander adds that more change will come if governments find a way to encourage people to take private rather than public-sector roles. “There is a vibrant, growing private sector that doesn’t have the traditional top-down hierarchy, but more support for small businesses is needed,” he says. “People need to be paid decent salaries for jobs that don’t involve working for state-owned organisations. 

“A huge issue for Middle Eastern countries is that they now have large numbers of young people looking for jobs. We’re seeing Saudisation and Emiratisation (replacing foreign workers with local ones) in Saudi Arabia and the UAE, but governments also need to create new roles for those people. Governments need to develop an infrastructure where people start businesses that provide jobs for others. That will then lead to their economies becoming less reliant on national oil companies.”  

Comments (1)

Angeli 7 months and 17 days ago

I am unclear if the authors have spent any time whatsoever actually thinking about diversification away from oil. The McKinsey report is less than adequate and there is a lot that you could add. First, you skimp on the scale of the task at hand: no emerging market economy has been able to grow and/or diversify away from natural resources without a strong manufacturing base. Ignoring the demographic dividend, with depleting oil resources how do you address the real decline in GDP growth? Second, without agriculture, manufacturing, technology and in the future natural resources, what strategic direction should the economies of the Middle East take? Finally, you make no mention of the fact that the region as a whole (except Iran) is not making sufficient investment in education and skill sets, especially around healthcare. Tourism simply does not cut it.

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