GCC low-cost producers are better positioned to weather the energy transition

We see the national oil companies (NOCs) and large state-owned petrochemical players in the GCC better positioned to weather the increasing and accelerating impact of the energy transition in medium to long-term, compared to global peers.

We believe these players, in particular the NOCs, benefit from large and abundant reserves, good cash flow visibility, attractive cost-competitive profiles, in addition to strong shareholder base of the highly rated sovereigns, which could mean they are the last ones standing among oil producers.

Underscoring that over the past few months, the global investor community has increased scrutiny of the oil majors and environment, social and governance (ESG) strategies; examples include a court ruling against Shell (to reduce greenhouse gas [GHG] emissions 45 per cent by 2030), shareholder activism to cut carbon emissions during Chevron Corp’s annual meeting, and an activist hedge fund winning board seats and pension funds and management lending support to ESG-related investment changes at Exxon Mobil Corp’s annual shareholder meeting.

We think it is unlikely that stakeholders – investors, shareholders, activities, non-governmental organisations, or simply wider society – exert as much pressure on the GCC energy companies as listed players in Europe or North America, at least in the short to medium term. This gives NOCs in the GCC more time to manage the transition and implement strategic changes.

From a pure rating perspective, we believe that the increasing challenges the energy transition poses to these companies, especially NOCs and government related enterprises (GREs), are for now somewhat mitigated by the strength of relevant sovereign shareholders.

These shareholders have a strong incentive to support a sector of high importance to the local economy and/or to create a favourable ecosystem to allow NOCs and GREs to grow and develop despite shifting global dynamics. However, like for corporates globally, we believe overall sustainability strategy is fundamental to these companies’ credit quality and will become even more important.

Despite increasing concerns on profitability, volatility, and the overall energy transition, we view the long reserve life and low production costs of GCC NOCs as supporting credit ratios and balance sheets in the short-to-medium term.

Although the region is still only starting to attract international investors for its debt issuances, our findings suggest that capital markets are not differentiating GCC companies based on perceived ESG risk, at least for now. We note that the appetite for regional NOC issuances has been strong, evidenced with oversubscription for Qatar Petroleum’s June 2021 bond issuance and Saudi Aramco’s 2019 inaugural debt issuance. We looked more specifically at the pricing data in the UAE and Saudi Arabia, given the size of the markets, where our findings suggest opposing trends for energy sector funding costs.

On aggregate, costs appear higher for energy companies in the UAE than for other corporates. This could indicate increased perception by investors of ESG considerations but is also representative of the higher number of lower-rated companies in the sector. The story is quite the opposite in Saudi Arabia, where the energy sector has lower funding costs than other industries, including sovereign. This could partly be explained by companies’ classification as GREs, including Saudi Aramco (not rated), by far the dominant energy player in the kingdom.

If we look at aggregate amounts, companies in the GCC energy sector do not face higher funding costs than other regional corporates, or even banks. In fact, funding costs for the energy sector are currently lower than for other corporates and relatively in line with those of Russian peers and the oil majors. Overall, the GCC also benefits from low-intensity gas-based feedstock like methane and ethane for downstream production with very low lifting costs. This means regional energy players are already better positioned from a GHG emission perspective than most global peers, even low-cost players such as those in Russia.

However, this does not mean that the sector is immune in the region as compared to the global peers. Earlier this year, for example, we lowered our industry risk assessment for the oil and gas exploration and production (E&P) sector, which constrains our business risk assessment, to factor in declining profitability, increasing volatility, and the overall impact from the energy transition.

As a result, even if the energy players in the region will have more time to adjust to the impact of the energy transition, we don’t see them as immune from sector trends.

Rawan Oueidat is a CFA at S&P Global Ratings