Middle East must go beyond the "gas station model"

Dragon Oil CEO Dr Abdul-Jaleel Al-Khalifa on why progress is mandatory

Dr. Abdul-Jaleel Al-Khalifa, CEO of Dragon Oil.
Dr. Abdul-Jaleel Al-Khalifa, CEO of Dragon Oil.

Dr. Abdul-Jaleel Al-Khalifa, CEO of Dragon Oil, examines the economic development of petroleum producing countries in the Middle East and North Africa. He explains why producer countries need to move beyond the "gas station model" of energy production to an 'industrial base model", and assesses the lessons to be learned from South Korea.

Nations are striving to achieve higher standards of living in their continual race for economic development.

They aim to migrate from a simple, low-income economy to a modern, high-income economy. They leverage natural resources and unleash their intellectual capital to sustain the growth of their Gross Domestic Product (GDP) and create the jobs necessary to meet the needs and aspirations of an expanding young generation newly entering the job market.

There is no secure position in the global development race. Developed countries such as Japan, Western Europe and the United States of America, aim to maintain their leading economic position. Developing nations, including emerging economies such as China, India and Brazil are making great strides into the world economy. Many other poor underdeveloped nations simply aspire to meet a minimum acceptable standard of living, including health, education, food and shelter.

Petroleum producing countries in the Middle East and North African (MENA) region continue to rely on producing and selling oil and gas to fund 90% of their fiscal budgets. The focus has been to maximize the dollar value of the petroleum sales revenue “a gas station business model”. Refining and petrochemical industries add incremental value to the bottom line, but they are also dependent on the same limited petroleum resources.

These industries, too, are not labour intensive, thus not enough jobs are created for the young generation. Except for contributing petrodollars revenue to the national finances, the petroleum industry did not directly help to develop the local economy.

Before countries run out of their limited oil and gas reserves, there is an urgent need to diversify their income by investing into their local economies. This will in turn accommodate millions of young people entering the job market. This can be achieved through transforming the petroleum industry into “an industrial base business model” focused on developing the local economy on a wider base. But why had the petroleum countries in the MENA region adopted the “gas station business model” in the beginning?

Historically, the petroleum industry has originated in the MENA region by International Oil Companies (IOCs). They had their operation bases in this region supported by their global supply chain and headquarter offices, based in their home countries (United States of America, Europe, and Japan). IOCs were an essential part of the free market economy.The proceeds of crude sales, given by the IOCs to the producing countries, contributed the vast majority of local economies.

Therefore, most MENA producing countries had adopted the free market economy as their role development model. They had liberated trade, opened borders to imports, pegged their currencies and sold their hydrocarbons in US Dollars, and invested most of their savings in Western economies including treasury bonds, equities and real estates. They continued to set their petroleum production strategies to meet global demand, including production level and spare production capacity.

The climax of this shining free market economy was during the fall of the Berlin Wall and the collapse of the Soviet Union in 1989. Two decades after, this model started to slowly fade away even within the Western hemisphere. Unlike the sudden physical destruction during World War I and II, which wiped out decades of developments in few years, the current economic meltdown is taking more time, but has unfortunately started to cause a serious social and political crisis.

Symptoms of such failure are obvious in Greece, Spain, Ireland and Portugal. Japan and the USA are also sinking deeper into debt and budget deficits. This does not imply that these economies are destined to fail, but they are definitely losing their once rosy historical attraction.

Since the 1980s, in some countries, National Oil Companies (NOCs) started to assume operatorship of the oil and gas resources on behalf of their sole shareholder, the government of the country. In other countries, International Oil Companies (IOCs) and other independents retained operatorship according to modified production contracts but with more emphasis on increasing local content.

Most operating companies in the MENA region have successfully increased the local content of their manpower to a high level. However, due to easy access to the free global market, operating companies had no urgency to localize the supply, services and contracting part of the industry.

Instead, they continued their historical trend of awarding most of the petroleum services and major Engineering, Procurement & Construction contracts to dominant global contractors. They procured most of the equipment and spare parts from global suppliers in USA, Western Europe, Japan and China. As a result, billions of dollars and hundreds of thousands of jobs continued to leak across the borders of the MENA region.

This free market policy had been very successful in sustaining higher oil and gas production targets with time, but had miserably failed to develop the local economy. With a global talent pool and industrial bases in Houston and other hubs, the free market had cultivated “a gas station business model” in the MENA region, aiming to maximize the bottom line of crude sales revenue; i.e. the focus was on exploration and production, refining products for the local market and crude sales for international markets.

There was no focus on establishing a local industrial base in the MENA region to support the petroleum industry in the presence of a vibrant global support network.

As a result, after more than sixty years of petroleum production, the region remains completely reliant on external suppliers and contractors. While operating companies have a 90% local employee base, the domestic content of their major suppliers and contractors is lagging behind at barely 20 % level or less.

The MENA producing countries have produced approximately 250 billion barrels of crude oil since inception, with approximately 500 billion barrels of oil reserves remaining to be produced in the future. Some producers have reached peak production and started to decline already, while others continue to sustain or increase production, but will definitely peak and start to decline in ten to twenty years.

In 2011, the oil and gas revenues in the MENA region will be close to one trillion US dollars. While one hundred billion US dollars, just 10%, will be spent on petroleum industry projects, the remaining 900 billion US dollars will fund the fiscal budgets of the producing countries.

If the local content is carefully enforced, (incrementally increased over a few years from the current 20% level to the target level of 80%), the 100 billion dollars spent on the industry projects has the potential to create half a million jobs for young graduates and can add an incremental gain of 500 billion dollars to the GDP of the region, assuming that each US dollar spent in the local economy will generate a five dollar gain in the GDP.

Most importantly, it will help establish a permanent industrial hub, housing corporations that can support the global petroleum industry. Further, from this hub, other businesses and services will inevitably spawn, adding growth and resilience to the local economy and broadening the opportunities for young people and their families.

The region needs to establish as many “Samsung Group” lookalike corporations as possible to support the petroleum industry. Samsung Group, for example, accounts for about one fifth of South Korea's total exports. In fiscal year 2009, Samsung Group had generated revenue of $172.5 billion, with net income of $ 13.8 billion. Samsung total manpower in 2009 was 276,000 employees. Samsung had embraced their in-house talents and technologies to generate jobs and bring prosperity.

Leadership in petroleum producing countries and senior management of operating companies together needs to enforce a gradual increase in the local content of all support, procurement and services contracts from the current 20% level towards a target level of 80% and more.

Operating companies need to audit all their subcontractors to ensure full adherence to local human development plans, including advanced training and adequate remuneration; as well as procuring most of their services, engineering and construction needs from domestic markets.

This will certainly help incubate and nurture domestic corporations that can position the region as the global hub of technology and innovations. These corporations will transform the petroleum industry from “a gas station model” into “an industrial base model”.

This high priority task should be first and foremost on the agenda during the coming few years. If the MENA region does not leverage the oil and gas resources to bridge the gap and jump on the economic development wagon, it will be too late and the consequences could be alarming.

Dr Al-Khalifa is currently Chief Executive Officer of Dragon Oil Company. He served as 2007 President of the International Society of Petroleum Engineers, and was Manager of Reservoir and Exploration Departments in Saudi Aramco for 12 years. He holds a PhD from Stanford University in Petroleum Engineering.

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