October 18, 2016

GCC needs natural gas pricing reform for sustainable economic growth and diversification

Maintaining the GCC’s low gas prices, which are set considerably below international prices, is unsustainable and will create significant problems for the region in the future, according to a recent study by management consultancy Strategy&, formerly Booz & Company, part of the PwC network. 

  • Average costs for developing new gas production in the GCC expected to rise by a factor of one-third to two-thirds by 2030
  • Potential gas supply gap predicted to exceed 300 billion cubic meters by 2030
  • Artificially low gas prices in the GCC could lead to future supply problems
  • Current gas prices do not reflect true market price in GCC
  • While abundant and cheap gas has played a critical role in the development and diversification of GCC economies, the current system is not sustainable
  • A transition to a market-based gas pricing model is required, coupled with initiatives to mitigate socioeconomic impacts for consumers
  • The establishment of national gas regulators is required to support the transition to a new pricing system

Maintaining the GCC’s low gas prices, which are set considerably below international prices, is unsustainable and will create significant problems for the region in the future, according to a recent study by management consultancy Strategy&, formerly Booz & Company, part of the PwC network.

While keeping GCC gas prices low has supported local economies in the past, the cost of new gas production is set to rise significantly in the future. According to Strategy&,  average weighted costs of new gas production across the GCC could rise by a factor of one-third to two-thirds by 2030 as technology requirements necessary for accessing and successfully extracting gas becomes greater — from US$1.50 to $4.50 per thousand cubic feet in 2015, to $2.00 to $7.00 per thousand cubic feet in 2030. Developing new sources of gas production is therefore not sustainable at current prices which are typically significantly below this level and, if not addressed, will lead to a potential gas supply gap of over 300 billion cubic meters by 2030.

Advising GCC countries on the need to adopt gas pricing reforms, George Sarraf, Partner with Strategy&, said: “If the cost of gas does not start to reflect its true market value and appropriate investment in the oil and gas sector is not allocated soon, the GCC will be unable to meet demand for gas in the future. Reforms should define a mechanism that prices natural gas closer to its true value and that in some manner reflects the global and regional dynamics of supply and demand. While abundant and cheap gas has played a critical role in the development and diversification of GCC economies, the current system is not sustainable.”

The best approach to setting gas prices is to use market mechanisms such as “oil indexation” and “gas hub pricing.” Oil indexation requires gas prices to be linked to a basket of commodities including crude oil and oil products. Gas hub pricing, also known as “gas-to-gas competition,” is when gas is traded based on spot prices set by the market in a liquid trading hub to better reflect the true price of gas to consumers.

According to David Branson, an executive advisor with Strategy& in Dubai and a member of the energy, chemicals and utilities practice in the Middle East, “Many markets around the world are becoming increasingly liberalized and are gradually moving from oil indexation to gas hub pricing as the preferred pricing method. In 2014, 43% of all gas sold was subject to gas hub pricing and 17% was indexed to oil. However, the Middle East is yet to adopt market-based gas pricing with almost all prices regulated by national governments.”

For the GCC market specifically, Strategy& suggests four possible effective gas pricing regimes for countries to implement: 1) increase wholesale prices to match – at a minimum - the increasing production costs and encourage investments in new supply sources, 2) index gas prices to oil prices, 3) link domestic gas prices to prices in existing hubs in other geographies or 4) establish a dedicated GCC gas hub price.

“The time to act is now and some countries have already taken steps in this direction but more is needed to advance this vital reform across the region. Although a new regime will result in higher gas prices, carefully crafted mitigation measures can help with the transition. These will allow the economy as a whole to benefit from increased diversification, private investments, true competition and a greater sense of energy security,” added Dr Yahya Anouti, principal with Strategy& in Dubai and a member of the energy, chemicals and utilities practice in the Middle East.

As a consequence of a new pricing regime however, gas prices will inevitably increase and may have an adverse socioeconomic impact on consumers unless managed carefully. The impact of a new potential gas-pricing mechanism therefore requires proactive and targeted risk mitigation measures to ensure that the benefits of the new pricing model are captured. According to Strategy&, GCC countries need to proactively communicate with all key stakeholders to evaluate potential risks of higher gas prices and offer appropriate solutions.

For example, mitigation measures might include offering incentive packages to industrial customers and instituting targeted compensation mechanisms for the poorest households.  Accompanying a move to market-based gas pricing, a regulator for gas should also be established to govern the new gas pricing regime and monitor its application.